**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended June 30, 2006**

 

**OR**

 

**o**            TRANSITION REPORTPURSUANT 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 ofregistrant as specified in its charter)

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

 

**(888) 703-1122**

(Registrant’s telephonenumber, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes  x    No  o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.  (Check one):
| Large accelerated filer | ** ** | o | Accelerated filer | x | Non-accelerated filer | o |
|-------------------------|------------|---|-------------------|---|-----------------------|---|

 

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

 

Yes  o    No  x

 

As of July 30, 2006, the registrant had 35,090,191 shares of CommonStock outstanding.

 

 

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**PHASE FORWARD INCORPORATEDQUARTERLY REPORT ON FORM 10-QFor the quarterly period ended June 30, 2006Table of Contents**
|                                             | **Page  Number** |
|---------------------------------------------|------------------|
| **Part I—Financial  Information** |             |
| ** **                                  |             |
| Item 1.                                     |             | Condensed Consolidated Balance Sheets as of  December 31, 2005 and  June 30, 2006 (unaudited) | 3 |
|                                        |             |   |   |
|                                        |             | Condensed Consolidated Statements of Income for the  three and six months ended  June 30, 2005 (unaudited) and June 30, 2006 (unaudited) | 4 |
|                                        |             |   |   |
|                                        |             | Condensed Consolidated Statements of Cash Flows for  the six months ended  June 30, 2005 (unaudited) and June 30, 2006 (unaudited) | 5 |
|                                        |             |   |   |
|                                        |             | Notes to Condensed Consolidated Financial Statements  (unaudited) | 6 |
|                                        |             |   |   |
| Item 2.                                     |             | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 20 |
|                                        |             |   |   |
| Item 3.                                     |             | Quantitative and Qualitative Disclosures about Market  Risk | 35 |
|                                        |             |   |   |
| Item 4.                                     |             | Controls and Procedures | 35 |
|                                        |             |   |   |
| **Part II—Other  Information**    |             |
| ** **                                  |             |
| Item  1.                                    |             | Legal  Proceedings | 36 |
|                                        |             |   |   |
| Item 1A.                                    |             | Risk Factors | 36 |
|                                        |             |   |   |
| Item 4.                                     |             | Submission of Matters to a Vote of Security Holders | 45 |
|                                        |             |   |   |
| Item  5.                                    |             | Other  Information | 46 |
|                                        |             |   |   |
| Item 6.                                     |             | Exhibits | 47 |
|                                        |             |   |   |
| Signatures                                  | 48               |
|                                        |             |
|                                        |             |
| Exhibit Index                          |             |

 

2

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**Part I—Financial Information**

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

**Phase Forward Incorporated**

**CondensedConsolidated Balance Sheets**

**(unaudited)**

**(inthousands, except per share amounts)**
| ** **                                                                                          | ** ** | **As of December 31,** | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                              | ** ** | **2006**                          | ** ** |
| **Assets**                                                                                          | ** ** | ** **                            | ** ** | ** **                        | ** ** |
| Current assets:                                                                                     |       |                                  |       |                              |       |
| Cash and cash  equivalents                                                                          |       | $                                     | 51,779     |                              | $          | 41,386 |   |
| Short-term  investments                                                                             |       | 8,807                                 |       | 22,347                            |       |
| Accounts  receivable, net of allowance of $318 and $296 in 2005 and 2006, respectively              |       | 24,923                                |       | 18,589                            |       |
| Deferred set up  costs, current portion                                                             |       | 1,266                                 |       | 1,455                             |       |
| Prepaid  commissions and royalties, current portion                                                 |       | 3,710                                 |       | 3,878                             |       |
| Prepaid expenses  and other current assets                                                          |       | 2,248                                 |       | 1,859                             |       |
| Deferred income  taxes                                                                              |       | 4,025                                 |       | 4,313                             |       |
|                                                                                                |       |                                  |       |                              |       |
| Total current assets                                                                                |       | 96,758                                |       | 93,827                            |       |
|                                                                                                |       |                                  |       |                              |       |
| Property and equipment,  net                                                                        |       | 7,543                                 |       | 8,066                             |       |
| Deferred set up costs,  net of current portion                                                      |       | 782                                   |       | 1,166                             |       |
| Prepaid commissions and  royalties, net of current portion                                          |       | 2,386                                 |       | 2,646                             |       |
| Intangible assets, net  of accumulated amortization of $306 and $741 in 2005 and 2006, respectively |       | 3,594                                 |       | 3,159                             |       |
| Goodwill                                                                                            |       | 24,960                                |       | 24,383                            |       |
| Deferred income taxes                                                                               |       | 3,747                                 |       | 3,726                             |       |
| Other assets                                                                                        |       | 174                                   |       | 266                               |       |
|                                                                                                |       |                                  |       |                              |       |
| Total assets                                                                                        |       | $                                     | 139,944    |                              | $          | 137,239 |   |
|                                                                                                |       |                                  |       |                              |       |
| **Liabilities and Stockholders’  Equity**                                                      | ** ** | ** **                            | ** ** | ** **                        | ** ** |
| Current liabilities:                                                                                |       |                                  |       |                              |       |
| Accounts payable                                                                                    |       | $                                     | 2,110      |                              | $          | 2,620 |   |
| Accrued expenses                                                                                    |       | 12,472                                |       | 10,345                            |       |
| Accrued earn-out                                                                                    |       | 2,000                                 |       | —                            |       |
| Accrued  litigation settlement                                                                      |       | 8,500                                 |       | —                            |       |
| Deferred  revenues, current portion                                                                 |       | 43,751                                |       | 44,949                            |       |
| Deferred rent,  current portion                                                                     |       | 394                                   |       | 273                               |       |
|                                                                                                |       |                                  |       |                              |       |
| Total current liabilities                                                                           |       | 69,227                                |       | 58,187                            |       |
|                                                                                                |       |                                  |       |                              |       |
| Deferred revenues, net  of current portion                                                          |       | 2,743                                 |       | 3,353                             |       |
| Deferred rent, net of  current portion                                                              |       | 1,140                                 |       | 884                               |       |
| Other long-term  liabilities                                                                        |       | 117                                   |       | 284                               |       |
|                                                                                                |       |                                  |       |                              |       |
| Total  liabilities                                                                                  |       | 73,227                                |       | 62,708                            |       |
|                                                                                                |       |                                  |       |                              |       |
| Contingencies (Note 13)                                                                             |       |                                  |       |                              |       |
|                                                                                                |       |                                  |       |                              |       |
| Stockholders’ equity:                                                                          |       |                                  |       |                              |       |
| Preferred stock,  $.01 par value:                                                                   |       |                                  |       |                              |       |
| Authorized—5,000  shares                                                                       |       |                                  |       |                              |       |
| Issued—0 shares                                                                                |       | —                                |       | —                            |       |
| Common stock,  $.01 par value:                                                                      |       |                                  |       |                              |       |
| Authorized—100,000  shares                                                                     |       |                                  |       |                              |       |
| Issued—33,720  and 35,087 shares in 2005 and 2006, respectively                                |       | 337                                   |       | 351                               |       |
| Additional  paid-in capital                                                                         |       | 168,947                               |       | 171,731                           |       |
| Deferred  stock-based compensation                                                                  |       | (611                                  | )          | —                            |       |
| Treasury stock,  37 shares at cost                                                                  |       | (111                                  | )          | (111                              | )          |
| Accumulated  other comprehensive loss                                                               |       | (800                                  | )          | (369                              | )          |
| Accumulated  deficit                                                                                |       | (101,045                              | )          | (97,071                           | )          |
|                                                                                                |       |                                  |       |                              |       |
| Total stockholders’  equity                                                                    |       | 66,717                                |       | 74,531                            |       |
|                                                                                                |       |                                  |       |                              |       |
| Total liabilities and  stockholders’ equity                                                    |       | $                                     | 139,944    |                              | $          | 137,239 |   |

 

See accompanying notes.

3

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**Phase Forward Incorporated**

**Condensed Consolidated Statements ofIncome**

**(unaudited)**

**(in thousands, except per share amounts)**
| ** **                                                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                           | ** ** | **June 30**,                | ** ** | **June 30**,              | ** ** |
| ** **                                                                           | ** ** | **2005**                         | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:                                                                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| License                                                                              |       | $                                | 8,632      |                           | $          | 9,383 |   | $ | 17,451 |   | $ | 18,408 |   |
| Service                                                                              |       | 12,066                           |       | 15,339                         |       | 23,809 |   | 29,930 |   |
| Total revenues                                                                       |       | 20,698                           |       | 24,722                         |       | 41,260 |   | 48,338 |   |
| Costs of  revenues:                                                                  |       |                             |       |                           |       |   |   |   |   |
| License                                                                              |       | 589                              |       | 597                            |       | 1,037 |   | 1,303 |   |
| Service(1)                                                                           |       | 7,464                            |       | 9,007                          |       | 14,676 |   | 17,902 |   |
| Total cost of  revenues                                                              |       | 8,053                            |       | 9,604                          |       | 15,713 |   | 19,205 |   |
| Gross margin:                                                                        |       |                             |       |                           |       |   |   |   |   |
| License                                                                              |       | 8,043                            |       | 8,786                          |       | 16,414 |   | 17,105 |   |
| Service                                                                              |       | 4,602                            |       | 6,332                          |       | 9,133 |   | 12,028 |   |
| Total gross  margin                                                                  |       | 12,645                           |       | 15,118                         |       | 25,547 |   | 29,133 |   |
| Operating  expenses:                                                                 |       |                             |       |                           |       |   |   |   |   |
| Sales and marketing(1)                                                               |       | 3,960                            |       | 5,184                          |       | 7,911 |   | 9,421 |   |
| Research and development(1)                                                          |       | 3,489                            |       | 3,860                          |       | 6,770 |   | 7,484 |   |
| General and administrative(1)                                                        |       | 3,218                            |       | 4,448                          |       | 7,022 |   | 8,587 |   |
| Restructuring                                                                        |       | —                           |       | —                         |       | (92 | ) | — |   |
| Total operating  expenses                                                            |       | 10,667                           |       | 13,492                         |       | 21,611 |   | 25,492 |   |
| Income from  operations                                                              |       | 1,978                            |       | 1,626                          |       | 3,936 |   | 3,641 |   |
| Other income  (expense):                                                             |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                      |       | 439                              |       | 679                            |       | 787 |   | 1,275 |   |
| Interest expense                                                                     |       | —                           |       | —                         |       | (144 | ) | — |   |
| Other expense, net                                                                   |       | (11                              | )          | —                         |       | (141 | ) | (64 | ) |
| Total other  income, net                                                             |       | 428                              |       | 679                            |       | 502 |   | 1,211 |   |
| Income before  provision for income taxes                                            |       | 2,406                            |       | 2,305                          |       | 4,438 |   | 4,852 |   |
| Provision for  income taxes                                                          |       | 568                              |       | 417                            |       | 1,132 |   | 878 |   |
| Net income                                                                           |       | $                                | 1,838      |                           | $          | 1,888 |   | $ | 3,306 |   | $ | 3,974 |   |
| Net income per  share applicable to common stockholders:                             |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                |       | $                                | 0.05       |                           | $          | 0.06 |   | $ | 0.10 |   | $ | 0.12 |   |
| Diluted                                                                              |       | $                                | 0.05       |                           | $          | 0.05 |   | $ | 0.09 |   | $ | 0.11 |   |
| Weighted average  number of common shares used in net income per share calculations: |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                |       | 32,869                           |       | 34,256                         |       | 32,663 |   | 34,006 |   |
| Diluted                                                                              |       | 34,639                           |       | 35,933                         |       | 34,588 |   | 35,587 |   |

 

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| (1) Amounts include  stock-based expenses, as follows: |   |   |   |   |   |   |   |   |   |
|--------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 
| Costs of service revenues                |   | $      | 12     |   | $      | 49     |   | $      | 37     |   | $ | 93    |   |
|------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|-------|--------|
| Sales and marketing                      |   | 12     |   | 98     |   | (4     | )      | 208    |   |
| Research and development                 |   | 40     |   | 67     |   | 95     |   | 127    |   |
| General and administrative               |   | 69     |   | 345    |   | 229    |   | 587    |   |
|                                     |   |   |   |   |   |   |   |   |   |
| Total  stock-based compensation expenses |   | $      | 133    |   | $      | 559    |   | $      | 357    |   | $ | 1,015 |   |

 

See accompanying notes.

4

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**Phase Forward Incorporated****CondensedConsolidated Statements of Cash Flows****(unaudited)****(in thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** ** | **2005**                       | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Operating  activities**                                                          |       |                           |       |   |   |
| Net income                                                                         |       | $                              | 3,306      |   | $ | 3,974 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 1,571                          |       | 2,525 |   |
| Stock-based compensation                                                           |       | 357                            |       | 1,015 |   |
| Loss on disposal of fixed assets                                                   |       | 12                             |       | 12 |   |
| Foreign currency exchange loss                                                     |       | 147                            |       | 61 |   |
| Provision for allowance for doubtful accounts                                      |       | (35                            | )          | 79 |   |
| Deferred income taxes                                                              |       | —                         |       | (267 | ) |
| Tax benefit related to exercise of stock options                                   |       | —                         |       | (724 | ) |
| Non-cash income tax expense                                                        |       | 769                            |       | 912 |   |
| Amortization of premiums or discounts on short-term  investments                   |       | (26                            | )          | (9 | ) |
| Changes in assets and liabilities:                                                 |       |                           |       |   |   |
| Accounts receivable                                                                |       | 3,370                          |       | 6,978 |   |
| Deferred costs                                                                     |       | (945                           | )          | (872 | ) |
| Prepaid expenses and other current assets                                          |       | (226                           | )          | 432 |   |
| Accounts payable                                                                   |       | (352                           | )          | 407 |   |
| Accrued expenses                                                                   |       | (1,052                         | )          | (2,126 | ) |
| Accrued litigation settlement                                                      |       | —                         |       | (8,500 | ) |
| Deferred revenues                                                                  |       | 4,030                          |       | 1,776 |   |
| Deferred rent                                                                      |       | 105                            |       | (375 | ) |
| Net cash  provided by operating activities                                         |       | 11,031                         |       | 5,298 |   |
|                                                                               |       |                           |       |   |   |
| **Investing  activities**                                                          |       |                           |       |   |   |
| Proceeds from  maturities of short-term investments                                |       | (6,549                         | )          | 15,718 |   |
| Purchase of  short-term investments                                                |       | 2,525                          |       | (29,249 | ) |
| Purchase of  property and equipment                                                |       | (1,532                         | )          | (2,530 | ) |
| Payment on  earn-out under acquisition                                             |       | —                         |       | (2,000 | ) |
| Decrease  (increase) in other assets                                               |       | 9                              |       | (79 | ) |
| Net cash used in  investing activities                                             |       | (5,547                         | )          | (18,140 | ) |
|                                                                               |       |                           |       |   |   |
| **Financing  activities**                                                          |       |                           |       |   |   |
| Payments on  lines of credit and notes payable                                     |       | (4,407                         | )          | — |   |
| Proceeds from  issuance of common stock                                            |       | 2,218                          |       | 1,675 |   |
| Proceeds from  repayment of subscriptions receivable                               |       | 127                            |       | — |   |
| Tax benefit  related to exercise of options                                        |       | —                         |       | 724 |   |
| Net cash (used  in) provided by financing activities                               |       | (2,062                         | )          | 2,399 |   |
|                                                                               |       |                           |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | (452                           | )          | 50 |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 2,970                          |       | (10,393 | ) |
| Cash and cash  equivalents at beginning of period                                  |       | 53,485                         |       | 51,779 |   |
| Cash and cash  equivalents at end of period                                        |       | 56,455                         |       | 41,386 |   |
| Short-term  investments at end of period                                           |       | 8,816                          |       | 22,347 |   |
| Total cash, cash  equivalents and short-term investments at end of period          |       | $                              | 65,271     |   | $ | 63,733 |   |

 

See accompanying notes.

5

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

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

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 June30, 2006, the results of its operations for the three and six months ended June30, 2005 and 2006 and its cash flows for the six months ended June 30, 2005 and2006. 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 2005 Annual Report onForm 10-K filed with the SEC on March 13, 2006. The results ofoperations for the interim periods are not necessarily indicative of theresults of operations to be expected for the year ending December 31,2006.

OnAugust 25, 2005, the Company acquired all of the outstanding capital stock ofLincoln Technologies, Inc. (“Lincoln”), a provider of products and services fordrug safety, including clinical trial safety signal detection, and applied datastandards. The results of Lincoln have been included in the unaudited financialstatements since the date of acquisition (see Note 5).

Asof June 30, 2006, the Company’s significant accounting policies and estimates,which are detailed in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2005, have not changed except for the adoption ofFinancial Accounting Standards Board, or FASB, SFAS No. 123(R), *Share-Based Payment*. See Note 9 for additional information regarding the Company’sadoption of SFAS No. 123(R).

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

TheCompany derives revenues from software licenses and services. License revenuesare derived principally from the sale of term licenses for the Company’s software products including; *InFormTM, ClintrialTM,**Clintrace*TM, *WebVDMETM*, *CTSDTM* and *WebSDMTM.*  Service revenues are derived from the Company’sdelivery of the hosted solutions of its *InForm, WebVDME*, *CTSD*and *WebSDM* softwareproducts, and consulting services and customer support, including training, forall of the Company’s products.

Thecomponents of revenues are as follows:
|                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| License                       |       | $                                               | 8,632      |                                          | $          | 9,383 |   | $ | 17,451 |   | $ | 18,408 |   |
| Application  hosting services |       | 7,275                                           |       | 9,374                                         |       | 14,106 |   | 18,328 |   |
| Consulting  services          |       | 1,622                                           |       | 2,617                                         |       | 3,017 |   | 5,356 |   |
| Customer support              |       | 3,169                                           |       | 3,348                                         |       | 6,686 |   | 6,246 |   |
|                          |       |                                            |       |                                          |       |   |   |   |   |
| Total                         |       | $                                               | 20,698     |                                          | $          | 24,722 |   | $ | 41,260 |   | $ | 48,338 |   |

 

The Companyrecognizes software license revenues in accordance with Statement of Position (“SOP”)No. 97-2, *Software Revenue Recognition,*as amended, issued by the American Institute of Certified Public Accountants,while revenues resulting from application hosting services is recognized inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 00-3, *Application of AICPA Statement of Position 97-2 toArrangements that include the Right to Use Software Stored on Another Entity’sHardware*,  SEC StaffAccounting Bulletin (SAB) No. 104, *RevenueRecognition*, and EITF Issue No. 00-21, *Revenue Arrangements with MultipleDeliverables.*

Customersgenerally have the ability to terminate application hosting, consulting andtraining service agreements upon 30 days notice to the Company. 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 within30 days after notice of the breach.

The Companyrecognizes revenues when all of the following conditions are satisfied:(1) there is persuasive evidence of an

6

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arrangement; (2) the product or service has been provided to thecustomer; (3) the collection of fees is probable; and (4) the amountof fees to be paid by the customer is fixed or determinable.

 

The Companygenerally enters into software term licenses for its *InForm*, *Clintrial*and *Clintrace* products with itscustomers for 3- to 5-year periods. License agreements for its *WebVDME, CTSD*and*WebSDM*productsare typically for one-year terms.  Thesearrangements typically include multiple elements: software license, consultingservices and customer support. The Company bills its customers in accordancewith the terms of the underlying contract. Generally, the Company bills licensefees annually in advance for each year of the license term. Payment terms aregenerally net 30 days.

The Company’ssoftware license revenues are earned from the sale of off-the-shelf softwarerequiring no significant modification or customization subsequent to deliveryto 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.

The Companygenerally bundles customer support with the software license for the entireterm of the arrangement. As a result, the Company generally recognizes revenuesfor all elements, including consulting services, ratably over the term of thesoftware license and support arrangement. The Company allocates the revenuesrecognized for these arrangements to the different elements based on management’sestimate of the relative fair value of each element. For its term-basedlicenses, the Company allocates to consulting services the anticipated serviceeffort and value throughout the term of the arrangement at an amount that wouldhave been allocated had those services been sold separately to the customer.The remaining value is allocated to license and support services, with 10% ofthis amount allocated to support services. 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 a multipleelement arrangement, are recognized as the services are performed.

The Company sellsperpetual licenses for the *Clintrial* and *Clintrace* software products in certainsituations to its existing customers with the option to purchase customersupport. The Company has established vendor specific objective evidence of fairvalue for the customer support. Accordingly, license revenues are recognizedupon delivery of the software and when all other revenue recognition criteriaare met. Customer support revenues are recognized ratably over the term of theunderlying support arrangement. The Company continues to generate customersupport and maintenance revenues from its perpetual license customer base.Training revenues are recognized as earned.

In addition to makingits software products available to customers through licenses, the Companyoffers its *InForm*, *WebVDME*, *CTSD* and *WebSDM* software solutions through a hosted applicationsolution delivered through a standard web-browser.  Revenues resulting from *InForm*applicationhosting services consists of three stages for each clinical trial: the firststage involves application set up, including design of electronic case reportforms and edit checks, implementation of the system and server configuration;the second stage involves application hosting and related support services; andthe third stage involves services required to close out, or lock, the databasefor the clinical trial. Services provided for the first and third stages areprovided on a fixed fee basis based upon the complexity of the trial and systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. The Company recognizes revenues from all stages of the *InForm*hosting service ratably over thehosting period. Fees charged and costs incurred for the trial system design,set up and implementation are deferred as applicable, until the start of thehosting period.  These fees and costs areamortized and recognized, as applicable, ratably over the estimated hostingperiod. The deferred costs include incremental direct costs with third partiesand certain internal direct costs related to the trial and application set up,as defined under SFAS No. 91, *Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Indirect Costs of Leases*. These costs include salary andbenefits associated with direct labor costs incurred during trial set up, aswell as third-party subcontract fees and other contract labor costs. Workperformed outside the original scope of work is contracted for separately as anadditional fee and is generally recognized ratably over the remaining term ofthe hosting period. Fees for the first and third stages of the service arebilled based upon milestones. Fees for application hosting and related servicesin the second stage are billed quarterly in advance. Bundled into this revenueelement are revenues attributable to the software license used by the customer.

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

In the event thatan application hosting customer cancels a clinical trial and its relatedstatement of work, all deferred revenues are recognized and all deferred set upcosts are expensed.  In addition, certaintermination related fees may be charged and if so, such fees

7

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are recognized in theperiod of termination.

One customer,GlaxoSmithKline, accounted for approximately 16% and 16% of the Company’s totalrevenues in the three months ended June 30, 2005 and 2006, respectively, and16% and 17% of the Company’s total revenues in the six months ending June 30,2005 and 2006 respectively, and $1,725 and $1,456 of accounts receivableoutstanding as of December 31, 2005 and June 30, 2006, respectively.

The Companydeferred $509 and $970 of set up costs and amortized $398 and $554 during thethree months ended June 30, 2005 and 2006, respectively, and deferred $1,175and $1,601 of set up costs and amortized $847 and $1,028 in the six monthsended June 30, 2005 and 2006, respectively.  The amortization of deferred set up costs is a component of cost ofservices.

Deferredrevenues represent amounts billed or cash received in advance of revenuerecognition.

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

Inaccordance with EITF Issue No. 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred,* the Company included $193 and $254 of out ofpocket expenses in service revenues and cost of service revenues in the threemonths ended June 30, 2005 and 2006, respectively, and included $390 and $321of out-of-pocket expenses in service revenues and cost of service revenues inthe six months ended June 30, 2005 and 2006, respectively.

**3.   Prepaid SalesCommissions and Royalties**

Forarrangements where revenues are recognized over the relevant contract period,the Company capitalizes related commissions paid to its direct sales force andsoftware license royalties paid to third parties, and amortizes these expensesover the period that the related revenues are recognized.

Commissionpayments are nonrefundable unless amounts due from a customer are determined tobe uncollectible or if the customer subsequently changes or terminates thelevel of service, in which case commissions paid are recoverable by theCompany. The Company deferred $646 and $1,193 of commissions and amortized tosales and marketing expense $905 and $1,052 in the three months ended June 30,2005 and 2006, respectively, and deferred $1,323 and $2,282 of commissions andamortized to sales and marketing expense $1,735 and $1,961 in the six monthsended June 30, 2005 and 2006, respectively.

TheCompany’s royalty obligation is based upon the license and customer supportrevenues earned for certain products in an arrangement. The Company has theright to recover the royalties in the event the arrangement is cancelled. TheCompany deferred $1,412 and $637 of royalties and amortized to cost of revenues$728 and $700 in the three months ended June 30, 2005 and 2006, respectively,and deferred $2,234 and $1,631 of royalties and amortized to cost of revenues$1,299 and $1,524 in the six months ended June 30, 2005 and 2006, respectively.

**4.   Warranties andIndemnification**

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

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 consolidated financial statements.

**5.   Acquisition of LincolnTechnologies, Inc.**

OnAugust 25, 2005, the Company acquired all of the outstanding capital stock ofLincoln, a provider of products and services for drug safety, clinical trialsafety signal detection, and applied data standards.  The acquired technology and products ofLincoln provide the Company with an expanded drug safety offering and enhancethe Company’s ability to offer innovative software and services in the drugsafety market.  The Company paid apremium for Lincoln to enable it to expand its offerings in the drug safetymarket and to obtain a valuable workforce.

8

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Theaggregate purchase price was $13,167. The acquisition agreement calls for additional cash consideration to bepaid subject to achievement of certain financial targets in 2005 and 2006, ofup to $2,000 and $4,000, respectively. The 2005 financial targets associated with additional cash considerationwere achieved and, accordingly, the Company accrued additional consideration of$2,000 in 2005 which was paid in May 2006. Additional cash consideration associated with 2006 financial targetswill be accrued if and when achievement of certain financial targets is reachedand will be included as additional consideration towards the purchase price ofthe acquisition.  The acquisition ofLincoln was accounted for as a purchase under SFAS No. 141, *Business Combinations*. Accordingly, the results of Lincoln have been included in the auditedconsolidated financial statements since the date of acquisition.

The components of theconsideration were as follows:
|                                                                                 | ** ** | **Amount** | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|
| Cash paid                                                                       |       | $          | 11,000     |   |
| Acquisition  costs                                                              |       | 167        |       |
| Accrued earn-out                                                                |       | 2,000      |       |
| Total purchase price to  be allocated to acquired asset subject to amortization |       | $          | 13,167     |   |

 

The followingtable summarizes the allocation of the purchase price to the fair value of theassets acquired and liabilities assumed at the date of acquisition and the$2,000 of additional cash consideration earned in 2005:
|                                                        | ** ** | ** ** | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|
| Current assets                                         |       |       |       | $          | 1,486      |   |
| Property, plant  and equipment                         |       |       |       | 263        |       |
| Intangible  assets subject to amortization:            |       |       |       |       |       |
| Developed technology (five year useful life)           |       | $          | 1,800      |       |       |   |
| Customer base (five year useful life)                  |       | 1,600      |       |       |       |
| Other intangible assets (two to five year useful life) |       | 500        |       | 3,900      |       |
| Goodwill                                               |       |       |       | 8,430      |       |
| Total assets  acquired                                 |       |       |       | 14,079     |       |
| Current  liabilities                                   |       |       |       | (912       | )          |
| Net assets acquired                                    |       |       |       | $          | 13,167     |   |
|                                                        |            |            |            |            |            |  |  |

 

Included inliabilities assumed is a provision for lease abandonment costs of approximately$270 relating to the leased facilities of Lincoln.

A rollforward ofthe liability for lease abandonment costs is as follows:
|                                                                   | ** ** | **Amount** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|
| Provision for  lease abandonment costs as of August 25, 2005      |       | $          | 270        |   |
| Payments made during the year ended December 31, 2005             |       | (48        | )          |
| Balance as of  December 31, 2005                                  |       | $          | 222        |   |
| Reduction to provision during the six months ended  June 30, 2006 |       | (116       | )          |
| Payments made during the six months ended June 30,  2006          |       | (57        | )          |
| Balance as of June 30,  2006                                      |       | $          | 49         |   |

 

The followingtable presents selected unaudited financial information of the Company andLincoln as if the acquisition had occurred on January 1, 2005.  The unaudited pro forma results are notnecessarily indicative of the results that would have occurred had theacquisition been consummated on January 1, 2005.
|                                                                    | ** ** | **Three Months  Ended June 30,  2005** | ** ** | **Six Months  Ended June 30,  2005** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Pro forma  revenues                                                |       | $                                                     | 22,005     |                                                | $          | 43,732 |   |
| Pro forma income  from operations                                  |       | 1,909                                                 |       | 3,705                                               |       |
| Pro forma net  income applicable to common stockholders            |       | 1,786                                                 |       | 3,134                                               |       |
| Pro forma net  income per share applicable to common stockholders: |       |                                                  |       |                                                |       |
| Basic                                                              |       | $                                                     | 0.05       |                                                | $          | 0.09 |   |
|                                                               |       |                                                  |       |                                                |       |
| Diluted                                                            |       | $                                                     | 0.05       |                                                | $          | 0.09 |   |

 

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**6.****   Net IncomePer 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. Dilutive net income pershare includes the effects of all dilutive, potentially issuable common shares.

A reconciliationof basic and diluted shares for the three and six months ended June 30, is asfollows:
|                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Basic weighted  average common shares outstanding   |       | 32,869,181                                      |       | 34,256,394                                    |       | 32,662,841 |   | 34,006,222 |   |
| Weighted average  common equivalent shares          |       | 1,769,664                                       |       | 1,676,661                                     |       | 1,924,820 |   | 1,580,287 |   |
| Diluted weighted  average common shares outstanding |       | 34,638,845                                      |       | 35,933,055                                    |       | 34,587,661 |   | 35,586,509 |   |

 

For the threemonths ended June 30, 2005 and 2006, diluted weighted average sharesoutstanding do not include options outstanding to purchase 668,000 and 113,500common equivalent shares, respectively, as their effect would have beenanti-dilutive.

For the six monthsended June 30, 2005 and 2006, diluted weighted average shares outstanding donot include options outstanding to purchase 483,000 and 390,587 commonequivalent shares, respectively, as their effect would have been anti-dilutive.

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

Thefinancial statements of the Company’s foreign subsidiaries are translated inaccordance with SFAS No. 52, *Foreign CurrencyTranslation*. The reporting currency for the Company is the U.S.dollar. The functional currency of the Company’s subsidiaries in the UnitedKingdom, France, Belgium, Germany, Japan and Australia are the local currenciesof those countries. Accordingly, the assets and liabilities of the Company’sforeign subsidiaries are translated into U.S. dollars using the exchange ratein effect at each balance sheet date. Revenues and expense accounts aretranslated generally using an average rate of exchange during the period. Gainsand losses arising from transactions denominated in foreign currencies areprimarily related to intercompany accounts that have been determined to betemporary in nature and cash and accounts receivable denominated innon-functional currencies. The Company has recorded foreign currency gains(losses) of ($17) and $1 for the three months ended June 30, 2005 and 2006,respectively, and ($147) and ($61) for the six months ended June 30, 2005 and2006, respectively.  Such gains (losses)are included in other income (expense) in the accompanying unaudited condensedconsolidated statements of operations.

Foreigncurrency translation adjustments are accumulated as a component of othercomprehensive income (loss) as a separate component of stockholders’ equity.

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

TheCompany accounts for its investments in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*. Under SFAS No. 115, securities that the Company hasthe intent and ability to hold to maturity are reported at amortized cost,which approximates market value, and are classified as held-to-maturity, whilethose securities for which it is not the Company’s intent to hold to maturity areclassified as available-for-sale securities and are reported at fair value,with unrealized gains and (losses) excluded from earnings and reported in aseperate component of stockholders’ equity. The Company considers all highlyliquid investments with original maturities of 90 days or less at the timeof purchase to be cash equivalents and investments with original maturities ofbetween 91 days and one year to be short-term investments. All securities,with the exception of auction rate securities, are classified asheld-to-maturity securities.

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Cash,cash equivalents and short-term investments as of December 31, 2005 and June30, 2006 consist of the following:
|                                  | ** ** | ** **     | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|----------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Contracted** | ** ** | ** **                      | ** ** | **Fair Market** | ** ** |
| **Description**                  | ** ** | **Maturity**   | ** ** | **Amortized Cost**         | ** ** | **Value** | ** ** |
| Cash                             |       | Demand         |       | $                               | 20,108     |   | $ | 20,108 |   |
| U.S. agency  notes               |       | 50  days       |       | 4,716                           |       | 4,717 |   |
| Money market  funds              |       | Demand         |       | 26,955                          |       | 26,955 |   |
| Total cash and  cash equivalents |       |           |       | $                               | 51,779     |   | $ | 51,780 |   |
|                             |       |           |       |                            |       |   |   |
| Banker’s  acceptance        |       | 139  days      |       | $                               | 420        |   | $ | 420 |   |
| Certificate of  deposit          |       | 298  days      |       | 400                             |       | 400 |   |
| U.S. agency  notes               |       | 153  days      |       | 3,639                           |       | 3,639 |   |
| Corporate bonds                  |       | 302  days      |       | 4,348                           |       | 4,338 |   |
| Total short-term  investments    |       |           |       | $                               | 8,807      |   | $ | 8,797 |   |

 
|                                  | ** ** | ** **     | ** ** | **June 30, 2006** | ** ** |
|----------------------------------|------------|----------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **Contracted** | ** ** | ** **                  | ** ** | **Fair Market** | ** ** |
| **Description**                  | ** ** | **Maturity**   | ** ** | **Amortized Cost**     | ** ** | **Value** | ** ** |
| Cash                             |       | Demand         |       | $                           | 14,764     |   | $ | 14,764 |   |
| U.S. agency  notes               |       | 41  days       |       | 5,481                       |       | 5,481 |   |
| Certificate of  deposit          |       | 66  days       |       | 1,299                       |       | 1,299 |   |
| Money market  funds              |       | Demand         |       | 19,842                      |       | 19,842 |   |
| Total cash and  cash equivalents |       |           |       | $                           | 41,386     |   | $ | 41,386 |   |
|                             |       |           |       |                        |       |   |   |
| Auction rate  securities         |       | 32  years      |       | $                           | 10,600     |   | $ | 10,600 |   |
| Certificate of  deposit          |       | 210  days      |       | 1,647                       |       | 1,646 |   |
| U.S. agency  notes               |       | 166  days      |       | 5,591                       |       | 5,584 |   |
| Corporate bonds                  |       | 290  days      |       | 4,509                       |       | 4,498 |   |
| Total short-term  investments    |       |           |       | $                           | 22,347     |   | $ | 22,328 |   |

 

TheCompany has had no realized gains or losses to date from the sale of moneymarket accounts or short-term investments.

**9.****   Stock-Based Compensation**

The Companycurrently has four plans under which it may grant stock-based compensationawards to its employees and non-employees.

**Stock-BasedCompensation Plans**

In 1997, theCompany adopted the Phase Forward Incorporated 1997 Stock Option Plan (the “1997Plan”).  Under the 1997 Plan, the Boardof Directors may grant incentive and nonqualified stock options to employees ofthe Company and non-employees. The exercise price of each option is determinedby the Board of Directors. Incentive stock options may not be granted with anexercise price less than the fair market value of the stock on the date ofgrant, as defined by the Board of Directors. Options granted under the 1997Plan generally vest over four or five year periods and expire ten years fromthe grant date. In January and March 2004, the Company granted options tocertain employees to purchase a total of 205,000 shares of common stock thatvest upon the earlier of 7 years from date of grant or the attainment ofspecified milestones.  As of June 30,2006, the Company had 233,728 share options unissued under this plan.  The Company has not issued options under thisplan since its July 2004 initial public offering, but may do so in the future.

In 2004, the Boardof Directors and stockholders approved the Phase Forward Incorporated 2004Stock Option and Incentive Plan (the “2004 Plan”) which became effective uponthe closing of the Company’s initial public offering. The Company had reservedfor issuance an aggregate of 1.5 million shares of common stock under the 2004Plan.  Under the 2004 Plan, the Board ofDirectors may grant stock options and other equity interests in the Company toemployees of the Company and non-employees. The exercise price of each optionis determined by the Board of Directors. Incentive stock options may not begranted with an exercise price less than the fair market value of the stock onthe date of grant, as defined by the Board of Directors. Options granted underthe 2004 Plan generally vest over a four to seven year period and expire tenyears from the grant date. In February 2005, the Company granted options tocertain employees to purchase a total of 419,000 shares of common stock thatvest upon the earlier of attainment of specified milestones or 7 years from thedate of grant.  The remainder of thestock options granted in 2005 were service-based options and vest over a periodof four years from the date of grant.  OnMay 3, 2006, the Company’s shareholders approved an amendment to the 2004 Planto increase the number of shares available for issuance from 1.5 million sharesto 3.5 million shares.  As of June 30,2006, the

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Company had 1,124,250shares available for grant under this plan.

In2003, the Board of Directors and stockholders approved the Phase ForwardIncorporated 2003 Non-Employee Director Stock Option Plan (the “2003 NED Plan”).  The Company reserved for issuance anaggregate of 362,000 shares of common stock under this plan.  Effective April 20, 2004, the 2003 NEDPlan was amended to increase the number of shares the Company may grant underthis plan to 562,000 shares. The 2003 NED Plan provided solely for theautomatic, one-time grant of a nonqualified stock option to a non-employeedirector upon initial election to the Company’s Board of Directors to purchase100,000 shares of common stock.  On June23, 2005, the 2003 NED Plan was amended to reduce the one-time grant from100,000 to 50,000 share options.  Theexercise price of the options must not be less than 100% of the fair marketvalue on the grant date. Options vest fully on the fifth anniversary of thedate of grant, so long as the non-employee director has continuously served onthe Board of Directors through such vesting date. If the non-employee directormeets certain board attendance criteria, options may vest earlier at a rate ofone-sixteenth at the end of each fiscal quarter following the date of grant. Asof June 30, 2006, the Company had 234,875 share options available for futuregrant under this plan.

In 2004, the Board of Directors and stockholdersapproved the Phase Forward Incorporated 2004 Employee Stock Purchase Plan (the “2004ESPP”), which became effective after the completion of the Company’s initialpublic offering on July 20, 2004. The Company has reserved for issuanceunder this plan an aggregate of 320,000 shares of common stock. The 2004 ESPPallows eligible employees the opportunity to purchase shares of the Company’scommon stock through payroll deductions of up to 10% of a participant’s annualcompensation with a maximum of 5,000 shares available per participant duringeach payment period, subject to statutory limitations. The first payment periodbegan on September 2, 2004 and ended on November 30, 2004.  All subsequent payment periods consist ofsix-month periods commencing on December 1 and June 1 and ending onthe last day of November and May of each calendar year.

Prior to December 1, 2005, the price per shareunder the 2004 ESPP for each payment period was the lesser of (1) 85% ofthe last reported sale price of the Company’s common stock on the firstbusiness day of the payment period and (2) 85% of the last reported saleprice of the common stock on the last business day of the payment period.Effective December 1, 2005, the Company amended the price provision of the2004 ESPP such that the option price is now set at 95% of the last reportedsale price of the common stock on the last business day of the payment period.Accordingly, the 2004 ESPP is considered a non-compensatory plan under SFASNo.123(R).

**Accountingfor Stock-Based Compensation**

OnDecember 16, 2004 the FASB issued SFAS No. 123(R), which is arevision of SFAS No. 123, *Accounting for Stock-BasedCompensation*. SFAS No. 123(R) supersedes Accounting Principles Board(APB) Opinion No. 25, *Accounting for StockIssued to Employees*, and amends SFAS No. 95, *Statement of Cash Flows*. Generally, the approach under SFASNo. 123(R) is similar to the approach described in SFAS No. 123. However, SFASNo. 123(R) requires all share-based payments to employees to be recognized inthe income statement based on their fair values. Pro forma disclosure is nolonger an alternative.

SFAS No. 123(R)requires adoption for fiscal years starting after June 15, 2005. As a result,the Company adopted SFAS No. 123(R) starting in its fiscal firstquarter of 2006, which began on January 1, 2006.

The Companyadopted the “modified prospective” method outlined in SFAS No. 123(R). Underthe “modified prospective” method, compensation cost is recognized in theincome statement beginning on the adoption date of SFAS No. 123(R):(a) based on the requirements of SFAS No. 123(R) for all share-basedpayments granted on or after the adoption date; (b) based on the requirements of SFAS No. 123 for all share-basedpayments that are unvested as of December 31, 2005, and (c) excludes thosestock options issued by the Company prior to it becoming a public entity whichwere valued using the “minimum value” method. Therefore commencing January 1,2006, in accordance with the modified prospective method, the Company isamortizing the unamortized stock-based compensation expense related to thosestock options that remained unvested as of December 31, 2005, whose fair valuewas calculated utilizing a Black-Scholes option pricing model.

In accordance withthe adoption of the modified prospective method, the Company’s results ofoperations and financial position for prior periods have not been restated.

**DeferredStock-Based Compensation**

Prior to theadoption of SFAS No. 123(R) and as permitted by SFAS No. 123, the Companyhistorically accounted for share-based payments to employees using the APBOpinion No. 25 intrinsic value method and, as such, generally recognized nocompensation cost for employee share-based payments other than the stock-basedcompensation cost associated with stock options granted at a discount from thedeemed fair market value.  Thisstock-based compensation expense is recorded in the amount by which theexercise price of an option is less than the deemed fair value of the Company’scommon stock at the date of grant. Because there had been no public market forthe Company’s stock prior to the July 2004 initial public offering, the Company’sBoard of Directors

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had determined the fairvalue of the common stock based upon several factors, including, but notlimited to, the Company’s operating and financial performance, issuance ofconvertible preferred stock, the rights and preferences of all securitiessenior to common stock and the anticipated offering price of the Company’scommon stock in connection with the initial public offering.

Duringthe six months ended June 30, 2005 and 2006, the Company recorded stock-basedcompensation expense of $357 and $212, respectively, related to such previouslygranted stock options.

Asof June 30, 2006, there was an aggregate of $384 of stock-based compensationremaining to be expensed in connection with previously granted discounted stockoptions.  This expense will be recordedas follows: $156 in the remaining two quarters of 2006; $156 in 2007; $41 in2008; $20 in 2009; and $11 through 2011. The Company amortizes the deferred compensation charges over the vestingperiod of the underlying option awards in accordance with FASB InterpretationNo. 28, *Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans*.

Inthe past, the Company awarded a limited number of stock options tonon-employees. For these options, the Company recognizes the stock-basedcompensation expense over the vesting periods of the underlying awards, basedon an estimate of their fair value on the date of grant using the Black-Scholesoption-pricing model.

**StockOption Grant Date Fair Value**

Effective with theadoption of SFAS No. 123(R), the Company elected to use the Black-Scholesoption pricing model to determine the weighted average fair value of optionsgranted.

TheCompany has a limited trading history for its common stock as it began tradingon the NASDAQ National Market on July 15, 2004. Accordingly, the Companydetermined the expected life and the volatility for options granted in 2005based on an analysis of reported data for a peer group of companies that haveissued stock options with substantially similar terms. The expected life ofoptions granted by the Company has been determined based on the averageexpected life of the options as reported by this peer group of companies duringa similar reporting period. The expected volatility of options granted has beendetermined using an average of the historical volatility measures of this peergroup of companies as well as the historical volatility of the Company’s commonstock beginning with January 2005. The risk-free interest rate is based on atreasury instrument whose term is consistent with the expected life of thestock options. The Company has not paid and does not anticipate paying cashdividends on its shares of common stock; therefore, the expected dividend yieldis assumed to be zero. In addition, while SFAS No. 123 permitted companies torecord forfeitures based on actual forfeitures, which was the Company’shistorical policy under SFAS No. 123, SFAS No. 123(R) requires companies toutilize an estimated forfeiture rate when calculating stock-based compensationexpense for the period.  As a result, theCompany has applied a forfeiture rate of 8%, derived from an analysis of itshistorical data, in determining the expense recorded in the Company’sconsolidated statement of income.

The weightedaverage fair value of options granted during the three months ended June 30,2005 under the Black-Scholes option pricing model was $3.19. The Company didnot issue stock options during the three months ended June 30, 2006.   The weighted average assumptions utilized todetermine fair value for the periods reported are indicated in the followingtable:
|                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Risk-free  interest rate  |       | 3.96                                            | %          | —                                        |       | 3.99 | % | 4.65 | % |
| Expected  volatility      |       | 58                                              | %          | —                                        |       | 61 | % | 53 | % |
| Expected life  (in years) |       | 4.00                                            |       | —                                        |       | 4.12 |   | 4.28 |   |
| Expected dividend yield   |       | —                                          |       | —                                        |       | — |   | — |   |

 

**Restricted Stock Awards**

On June 6, 2006, the Company awarded 942,250 shares ofrestricted stock to its Chief Executive Officer, members of the Company’ssenior management team and other key employees. The restricted stock award to theChief Executive Officer vests 25% after three years of service, 50% after fouryears and 100% after five years. The remaining restricted stock awardsgenerally vest 50% after two years of service, 75% after three years and 100%after four years.   The Companycalculated restricted stock award expense using the fair value on the date ofgrant. This expense is amortized on a straight-line basis over the serviceperiod. The stock-based compensation expense associated with the 942,250restricted stock awards is weighted based on the period of time the awards wereoutstanding during the three and six month period ended June 30, 2006.  Generally, employees will forfeit awardedrestricted shares if their employment is terminated prior to vesting.  The Company is applying an estimated annualforfeiture rate of 8% in determining the expense recorded in the

13

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Company’sconsolidated statements of income.  Therestricted stock awards have also been reflected in the calculation of basicand diluted earnings per share.

**Stock-BasedCompensation Expense**

During the quarterended June 30, 2006, the Company recorded $559 of stock-based compensationexpense, $476 of which resulted from adoption of SFAS No. 123(R). The remaining$83 of stock-based compensation expense is due to the amortization ofstock-based compensation associated with previously issued stock optionsgranted at a discount from the deemed fair market value prior to the Company’sinitial public offering. The stock-based compensation expense included $49 incost of revenues, $67 in research and development, $98 in sales and marketingand $345 in general and administrative expense for the three months ended June30, 2006.  For the three months endingJune 30, 2005 and 2006, stock-based compensation expense reduced basic anddiluted earnings per share by $0.01 and $0.02, respectively. For the six monthsended June 30, 2005 and 2006, stock-based compensation expense reduced dilutedearnings per share by $0.02 and $0.03, respectively.  As of June 30, 2006, there was $12,725 ofdeferred stock-based compensation related to unvested market-based share awardsthat is expected to be recognized over a weighted average period of 3.6 years.

Prior to adoptingSFAS No. 123(R), the Company accounted for stock-based compensation under APBOpinion No. 25. The following table illustrates the effect on net income andearnings per share if the fair value based method had been applied to theyear-ago period. 
|                                                                                                             | ** ** | **Three Months  Ended** | ** ** | **Six Months  Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------|------------|
| ** **                                                                                                  | ** ** | **June 30,**            | ** ** | **June 30,**          | ** ** |
| ** **                                                                                                  | ** ** | **2005**                     | ** ** | **2005**                   | ** ** |
| ** **                                                                                                  | ** ** | ** **                   | ** ** | ** **                 | ** ** |
| Net income as  reported                                                                                     |       | $                            | 1,838      |                       | $          | 3,306 |   |
| Stock-based  compensation expense included in reported net income                                           |       | 133                          |       | 357                        |       |
| Stock-based  compensation expense determined under the fair value based method, net of  related tax effects |       | (755                         | )          | (1,304                     | )          |
|                                                                                                        |       |                         |       |                       |       |
| Net income – pro  forma                                                                                |       | $                            | 1,216      |                       | $          | 2,359 |   |
|                                                                                                        |       |                         |       |                       |       |
| Income per  common equivalent share:                                                                        |       |                         |       |                       |       |
| Basic – as reported                                                                                    |       | $                            | .05        |                       | $          | .10 |   |
|                                                                                                        |       |                         |       |                       |       |
| Diluted – as reported                                                                                  |       | $                            | .05        |                       | $          | .09 |   |
|                                                                                                        |       |                         |       |                       |       |
| Basic – pro forma                                                                                      |       | $                            | .04        |                       | $          | .07 |   |
|                                                                                                        |       |                         |       |                       |       |
| Diluted – pro  forma                                                                                   |       | $                            | .04        |                       | $          | .07 |   |

 

The 2004 ESPP was amended effective December 1, 2005such that the plan is a non-compensatory plan under SFAS No. 123(R) in 2006.The assumptions used to calculate the SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosures,*pro formadisclosure for shares purchased under the 2004 ESPP under the Black-Scholesoption pricing model were as follows: 
|                                  | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** |
|----------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Average risk-free  interest rate |       | 3.12                                                  | %          | 2.77                                                | %          |
| Expected  volatility             |       | 60                                                    | %          | 60                                                  | %          |
| Expected life  (in years)        |       | 0.5                                                   |       | 0.5                                                 |       |
| Expected dividend yield          |       | —                                                |       | —                                              |       |

 

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**Stock Option Activity**

 

Asummary of stock option activity under the three plans as of June 30, 2006, andchanges during the three months ended June 30, 2006, is as follows:
| Options                                          | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (years)** | ** ** | **Aggregate  Intrinsic Value (2)** | ** ** |
|--------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------|------------|
| Outstanding at  March 31, 2006                   |       | 4,170,090  |       | $                                          | 4.70       |                                                                 |       |                                         |       |   |
| Granted                                          |       | —     |       | —                                     |       |                                                                 |       |                                         |       |
| Exercised                                        |       | (250,496   | )          | 3.79                                       |       |                                                                 |       |                                         |       |
| Cancelled                                        |       | (8,597     | )          | 5.77                                       |       |                                                                 |       |                                         |       |
| Outstanding at June 30, 2006                     |       | 3,910,997  |       | 4.75                                       |       | 7.18                                                                 |       | $                                            | 26,475     |   |
|                                             |       |       |       |                                       |       |                                                                 |       |                                         |       |
| Exercisable at June 30, 2006                     |       | 2,271,997  |       | 3.62                                       |       | 6.33                                                                 |       | $                                            | 17,938     |   |
|                                             |       |       |       |                                       |       |                                                                 |       |                                         |       |
| Vested or expected  to vest at June 30, 2006 (1) |       | 3,648,190  |       | $                                          | 4.63       |                                                                 | 7.09       |                                         | $          | 25,850 |   |

 

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(1)          Thevested or expected to vest options at June 30, 2006 include both the vestedoptions and the number of options expected to vest calculated by applying anestimated forfeiture rate to the unvested options.

(2)          Theaggregate intrinsic value was calculated based on the positive differencebetween the estimated fair value per share of the Company’s common stock onJune 30, 2006 of $11.52 and the exercise price of the underlying options.

Asummary of the status of the Company’s unvested stock option shares as of June30, 2006, and changes during the three months ended June 30, 2006, is asfollows:
| Unvested Shares        | ** ** | **Shares** | ** ** | **Weighted  Average Grant-  Date Fair Value** | ** ** |
|-----------------------------|------------|------------|------------|--------------------------------------------------------------|------------|
| Unvested at  March 31, 2006 |       | 1,860,339  |       | $                                                            | 6.14       |   |
| Granted                     |       | —     |       | —                                                       |       |
| Vested                      |       | (212,742   | )          | 4.85                                                         |       |
| Forfeited                   |       | (8,597     | )          | 5.77                                                         |       |
| Unvested at June 30,  2006  |       | 1,639,000  |       | $                                                            | 6.31       |   |

 

The followingtable summarizes information regarding the Company’s stock options outstandingand exercisable at June 30, 2006:

| Options Outstanding                | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|
| **Range of Exercise  Prices** | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Remaining  Contractual Life  (in Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $ 0.10 - 0.60                      |       | 26,351                       |       | 2.03 |   | $ | 0.14 |   | 26,351 |   | $ | 0.14 |   |
| 0.61 - 1.20                             |       |                         | 29,850     |   | 3.30 |   | 1.00 |   | 29,850 |   | 1.00 |   |
| 1.21 - 2.40                             |       |                         | 5,000      |   | 3.47 |   | 2.00 |   | 5,000 |   | 2.00 |   |
| 2.41 - 3.00                             |       |                         | 2,009,209  |   | 6.14 |   | 3.00 |   | 1,751,802 |   | 3.00 |   |
| 3.01 - 4.80                             |       |                         | 168,959    |   | 7.58 |   | 4.50 |   | 67,134 |   | 4.50 |   |
| 4.81 - 5.40                             |       |                         | 52,850     |   | 3.74 |   | 5.00 |   | 52,850 |   | 5.00 |   |
| 5.41 - 6.00                             |       |                         | 85,388     |   | 7.70 |   | 6.00 |   | 39,298 |   | 6.00 |   |
| 6.01 - 7.80                             |       |                         | 1,192,390  |   | 8.64 |   | 6.75 |   | 280,962 |   | 6.91 |   |
| 7.81 - 9.00                             |       |                         | 241,000    |   | 9.18 |   | 7.87 |   | — |   | — |   |
| 9.01 - 10.29                            |       | 100,000                      |       | 9.40 |   | 10.29 |   | 18,750 |   | 10.29 |   |
|                                    |       | 3,910,997                    |       | 7.18 |   | $ | 4.75 |   | 2,271,997 |   | $ | 3.62 |   |

 

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**RestrictedStock Awards Activity**

Asummary of restricted stock awards activity during the three months ended June30, 2006, is as follows:

| Restricted Stock Awards        | ** ** | **Shares** | ** ** | **Weighted  Average Fair  Value Per Share** | ** ** | **Weighted Average  Remaining  Contractual Term  (years)** | ** ** | **Aggregate  Intrinsic Value (2)** | ** ** |
|------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------|------------|
| Outstanding at  March 31, 2006           |       | —     |       |                                                       |       |                                                                 |       |                                         |       |
| Awarded                                  |       | 942,250    |       | $                                                          | 12.12      |                                                                 |       |                                         |       |   |
| Forfeited                                |       | —     |       |                                                       |       |                                                                 |       |                                         |       |
| Outstanding at June 30, 2006             |       | 942,250    |       | $                                                          | 12.12      |                                                                 | 4.23       |                                         | $          | 10,855 |   |
|                                     |       |       |       |                                                       |       |                                                                 |       |                                         |       |
| Expected to be  free of restrictions (1) |       | 750,945    |       | $                                                          | 12.12      |                                                                 | 4.23       |                                         | $          | 8,651 |   |

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(1)          Theexpected to be free of restrictions at June 30, 2006 was calculated by applyingan estimated forfeiture rate to the unvested shares.

(2)          Theaggregate intrinsic value is the fair value per share of the Company’s commonstock on June 30, 2006 of $11.52.

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

Goodwill andintangible assets that have indefinite lives are not amortized but areevaluated for impairment annually or whenever events or changes incircumstances indicate the carrying value may not be recoverable. Intangibleassets that have finite lives are amortized over their useful lives.

The goodwillresulting from acquisitions is reviewed for impairment on an annual basis inaccordance with SFAS No. 142,*Goodwill and Other Intangible Assets.*  Consistent with prior years, the Companyconducted its annual impairment test of goodwill during the fourth quarter of2005 and determined that no impairment of goodwill existed at December 31,2005.

A rollforward ofthe net carrying amount of goodwill is as follows:
|                                                                                          | ** ** | **Amount** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|
| Balance as of December 31, 2004                                                     |       | $          | 21,817     |   |
| Utilization of acquired net operating losses – Clinsoft                             |       | (2,057     | )          |
| Increase associated with the acquisition of Lincoln                                      |       | 8,430      |       |
| Release of valuation allowance related to acquired net operating losses –  Clinsoft |       | (3,230     | )          |
| Balance as of December 31, 2005                                                     |       | $          | 24,960     |   |
| Decrease associated with the acquisition of Lincoln                                      |       | (386       | )          |
| Release of valuation allowance related to acquired net operating losses –  Clinsoft |       | (191       | )          |
| Balance as of June 30, 2006                                                              |       | $          | 24,383     |   |

 

The utilization ofor release of the valuation allowance related to acquired net operating lossesreflects an actual or anticipated reduction in cash payments to local taxingauthorities for income taxes that are not reflected as a benefit in the incometax provision for financial statement purposes but rather as a reduction togoodwill.  In the year ended December 31,2005, the Company determined that it is more likely than not that the Companywill realize a portion of its deferred tax assets and therefore reduced thevaluation allowance by $7,772 in December 2005. This benefit of the release in valuation allowance was realized throughreductions to income tax expense of $4,542 and to goodwill of $3,230.

During the six monthsending June 30, 2006, adjustments totaling $386 were recorded as decreases togoodwill associated with the acquisition of Lincoln. The Company receivedpayment of $147 for previously written-off accounts receivable, deferredrevenues were reduced by $123 due to the completion of two services engagementsand $116 was related to the sublease of the abandoned Lincoln facility.

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Intangible assets,all of which relate to the acquisition of Lincoln, consist of the following:
|                                    | ** ** | ** **                          | ** ** | **As of December 31, 2005** | ** ** | **As of June 30, 2006** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|
| **Description**                    | ** ** | **Estimated Useful Life** | ** ** | **Gross  Carrying  Value**                      | ** ** | **Accumulated  Amortization**               | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology and know-how |       | 5  years                            |       | $                                               | 1,800      |                                        | $          | 127 |   | $ | 1,800 |   | $ | 307 |   |
| Customer  relationships            |       | 5  years                            |       | 1,600                                           |       | 112                                         |       | 1,600 |   | 272 |   |
| Non-compete  agreements            |       | 2  years                            |       | 300                                             |       | 53                                          |       | 300 |   | 128 |   |
| Tradename                          |       | 5  years                            |       | 200                                             |       | 14                                          |       | 200 |   | 34 |   |
| Total                              |       |                                |       | $                                               | 3,900      |                                        | $          | 306 |   | $ | 3,900 |   | $ | 741 |   |

 

Amortizationexpense related to intangible assets for the three months ended June 30, 2005and 2006 was $0 and $217, respectively, and for the six months ended June 30,2005 and 2006, was $0 and $435, respectively.

The estimatedremaining amortization expense for each of the five succeeding fiscal years isas follows:

| Year ended December 31, | ** ** | **Amount** | ** ** |
|----------------------------------------|------------|------------|------------|
| 2006                                   |       | $          | 435        |   |
| 2007                                   |       | 817        |       |
| 2008                                   |       | 720        |       |
| 2009                                   |       | 720        |       |
| 2010                                   |       | 467        |       |
| Total                                  |       | $          | 3,159      |   |

 

**11.  Accrued Expenses**

Accruedexpenses consist of the following:
|                                       | ** ** | **As of  December 31,** | ** ** | **As of  June 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **2005**                          | ** ** | **2006**                      | ** ** |
| Accrued payroll  and related benefits |       | $                                 | 5,327      |                          | $          | 4,374 |   |
| Accrued other  expenses               |       | 4,037                             |       | 3,549                         |       |
| Accrued royalties                     |       | 2,411                             |       | 1,867                         |       |
| Accrued income  taxes                 |       | 697                               |       | 555                           |       |
| Total                                 |       | $                                 | 12,472     |                          | $          | 10,345 |   |

 

**12.  Debt**

Priorto August, 2005, all borrowings under the Company’s $5,000 working capital lineof credit were secured by substantially all assets of the Company. Under arelated negative pledge agreement, the Company was generally prohibited frompledging its intellectual property to others, subject to certainexceptions.  In August of 2005, the working capital line of creditwas amended to eliminate the security interest in the Company’s assets and thenegative pledge on the Company’s intellectual property. The amendment alsoremoved or modified the financial covenants.  Effective March 31, 2006,the working capital line of credit was reduced from $5,000 to $2,000.  Asof December 31, 2005 and June 30, 2006, there were no amounts outstandingunder the working capital line of credit. At June 30, 2006, there was $1,500 available under the line of credit,and $500 reserved under a letter of credit associated with the Company’s leasedfacility.  At June 30, 2006, the Companywas in compliance with all financial covenants.

**13.  Contingencies**

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. The outcome of litigation cannot bepredicted with certainty and some lawsuits, claims or proceedings may bedisposed of unfavorably to the Company, which could materially and adverselyaffect its financial condition or results of operations.

OnFebruary 15, 2006, the Company entered into a Settlement Agreement andrelated License Agreement with Dr. Mark L. Kozam d/b/a MLK Software andDatasci, LLC.  The Settlement Agreement relates to a lawsuit filed byDatasci in 2004 alleging that certain of the Company’s products and servicesand certain products and services of the Company’s customers, Quintiles, Inc.,

17

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infringe a United Statespatent claimed to be owned by Datasci. Under the Settlement Agreement andrelated License Agreement, the Company agreed to make a one-time, lump sumpayment to Datasci in the amount of $8,500 to settle the claim. Theconfidential settlement, in which neither party admits liability, provides formutual releases and dismissal of all actions between the parties. The Companydoes not anticipate changing any of its products as a result of the license to thispatent.

Pursuant to SFASNo. 142, *Goodwill and Other Intangible Assets*,the Company reviewed the attributes of the license obtained and estimated thatthe license obtained had no value or useful life and that the license would notcontribute to the future cash flows of the Company, either directly orindirectly. As such, the settlement amount was recorded as a charge tooperations. Since the contingency existed as of December 31, 2005 and thesettlement was concluded prior to the issuance of the Company’s 2005 auditedconsolidated financial statements, in accordance with SFAS No. 5, *Accounting for Contingencies*, the Company recorded theimpact of the settlement in 2005 as a charge to operations.   The settlement was paid during the threemonths ending March 31, 2006.

**14.  Stockholders’ Equity**

During the sixmonths ended June 30, 2006, the Company issued 410,470 shares of common stockin connection with the exercise of stock options resulting in proceeds of$1,517 and 14,137 shares of common stock under the 2004 ESPP resulting inproceeds of $152.

**15.  Comprehensive Income**

The Company’sother comprehensive income relates to foreign currency translation adjustmentsand is presented separately on the balance sheet as required.

Comprehensiveincome consists of the following:
|                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                        | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income                         |       | $                                               | 1,838      |                                          | $          | 1,888 |   | $ | 3,306 |   | $ | 3,974 |   |
| Cumulative  translation adjustment |       | (368                                            | )          | 306                                           |       | (533 | ) | 431 |   |
| Comprehensive income               |       | $                                               | 1,470      |                                          | $          | 2,194 |   | $ | 2,773 |   | $ | 4,405 |   |

 

**16.  Forward Foreign Exchange Contracts**

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

The following tablesummarizes the outstanding forward foreign exchange contracts held by theCompany:
|               | ** ** | ** **          | ** ** | **As of December 31, 2005** | ** ** | **As of June 30, 2006**       | ** ** |
|---------------|------------|---------------------|------------|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **Currency**  | ** ** | **Hedge Type** | ** ** | **Local Currency  Amount**                 | ** ** | **Approximate U.S.  Dollar Equivalent** | ** ** | **Local Currency  Amount** | ** ** | **Approximate U.S.  Dollar Equivalent** | ** ** |
| British pound |       | Sale                |       | 6,000                                           |       | $                                                 | 10,303     |   | 900 |   | $ | 1,664 |   |
| Euro          |       | Purchase            |       | (500                                            | )          | (592                                              | )          | — |   | — |   |
| Japanese yen  |       | Sale                |       | 156,000                                         |       | 1,317                                             |       | 100,000 |   | 873 |   |
|          |       |                |       |                                            |       | $                                                 | 11,028     |   |   |   | $ | 2,537 |   |

 

As of December 31,2005 and June 30, 2006, the forward foreign exchange contracts are short-termand mature within 35 days of origination.

Due to the shortperiod of time between entering into the forward foreign exchange contracts andJune 30, 2006, the forward foreign exchange contract rate approximates theexchange rate as of the end of the reporting period.

Realized andunrealized foreign currency gains (losses), net of hedging are accounted for innon-operating income (expense). Foreign currency gains (losses), net ofhedging, were ($17), and $1 for the three months ended June 30, 2005 and 2006,respectively,

18

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and ($147) and ($61) forthe six months ended June 30, 2005 and 2006, respectively.   The Company settles forward foreign exchangecontacts in cash.

**17.**       Income Taxes

**The Company’s effective taxrates for the three months ended June 30, 2005 and 2006****were 24% and 18%, respectively, and 26%and 18% for the six months ended June 30, 2005 and 2006, respectively.  The Company’s effective tax rates were lowerthan the Company’s statutory federal and state rate of 40% due to theutilization of previously unrecognized net operating losses. The Companycurrently expects to realize recorded deferred tax assets as of June 30, 2006of approximately $8.0 million. The Company’s conclusion that such assets willbe recovered is based upon its expectation that future earnings of the Companycombined with tax planning strategies available to the Company will providesufficient taxable income to realize recorded tax assets. Such tax strategiesinclude estimates and involve judgment. While the realization of the Company’snet recorded deferred tax assets cannot be assured, to the extent that futuretaxable income against which these tax assets may be applied is not sufficient,some or all of the Company’s net recorded deferred tax assets would not berealizable.

**18.****       Recently Issued AccountingPronouncement**

In July 2006, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (“FIN48”), *Accounting for Uncertainty in Income Taxes*,which is an interpretation of SFAS No. 109*, Accounting for IncomeTaxes*. FIN 48 clarifies the accounting for income taxes byprescribing the minimum recognition threshold a tax position is required tomeet before being recognized in the financial statements. FIN 48 also providesguidance on derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition. In addition, FIN 48clearly scopes out income taxes from FASB Statement No. 5, *Accountingfor Contingencies*. FIN 48 is effective for fiscal years beginningafter December 15, 2006. The Company will implement this interpretation in thefiscal year starting January 1, 2007. The Company is currently analyzing theeffect, if any, FIN 48 will have on the Company’s consolidated financial positionand results of operations.

19

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**Item 2.  *Management’s Discussionand Analysis of Financial 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 that appear elsewhere in this Quarterly Report on Form 10-Q.In addition to historical consolidated financial information, the followingdiscussion contains forward-looking statements that reflect our plans,estimates and beliefs. Our actual results could differ materially from thosediscussed in the forward-looking statements. Factors that could cause orcontribute to these differences include those discussed below and elsewhere inthis Quarterly Report on Form 10-Q. In addition to historicalconsolidated financial information, the following discussion containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended, and are intended to be covered by the “safeharbor” created by those sections. Forward-looking statements, which are basedon certain assumptions and reflect our plans, estimates and beliefs, cangenerally be identified by the use of forward-looking terms such as “believes,”“expects,” “may,” “will,” “should,” “could,” “seek,” “intends,” “plans,” “estimates,”“anticipates” or other comparable terms. Our actual results could differmaterially from those discussed in the forward-looking statements. Factors thatcould cause or contribute to these differences include those discussed belowand elsewhere in this Quarterly Report on Form 10-Q.  We urge you to consider the risks anduncertainties described in Item 1A of this Quarterly Report on Form 10-Qin evaluating our forward-looking statements. We caution readers not to place undue reliance upon any suchforward-looking statements, which speak only as of the date made. Except asotherwise required by the federal securities laws, we disclaim any obligationor 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.*

**Overview**

Phase ForwardIncorporated is a provider of integrated enterprise-level software products,services and hosted solutions for use in our customers’ global clinical trialand drug safety monitoring activities. Our customers include pharmaceutical,biotechnology and medical device companies, as well as academic institutions,governmental regulatory agencies, clinical research organizations, or CROs, andother entities engaged in clinical trial and safety monitoring activities. Byautomating essential elements of the clinical trial and drug safety monitoringprocesses, 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.

**Acquisitions**

From time to timewe have expanded our product and service offerings through the acquisition ofother businesses or technologies.  Themost significant of these transactions are the acquisitions of ClinsoftCorporation (“Clinsoft”) and Lincoln Technologies, Inc. (“Lincoln”), which aredescribed below.

*LincolnTechnologies, Inc.*

On August 25,2005, we acquired all of the outstanding capital stock of Lincoln, a providerof products and services for drug safety, clinical trial safety signaldetection, and applied data standards. Lincoln’s products consisted of *WebVDME,CTSD*and*WebSDM.*Theaggregate purchase price was approximately $13.2 million.  The acquisition agreement calls foradditional cash consideration, to be paid subject to achievement of certainfinancial targets in 2005 and 2006, of up to $2.0 million and $4.0 million in2005 and 2006, respectively.  The 2005financial targets associated with additional cash consideration were achievedand, accordingly, we accrued additional consideration of $2.0 million in 2005which was paid in May of 2006.  Additionalcash consideration associated with 2006 financial targets will be accrued ifand when achievement of certain financial targets is reached and will beincluded as additional consideration towards the purchase price of theacquisition.  The acquisition of Lincolnwas accounted for as a purchase under Statement of Financial AccountingStandards (SFAS) No. 141, *Business Combinations*.  Accordingly, the results of Lincoln have beenincluded in our consolidated financial statements since the date of acquisition.

*ClinsoftCorporation*

On August 14,2001, we acquired Clinsoft, a developer, marketer and provider of clinical datamanagement and adverse event reporting and tracking products and services.  Clinsoft’s products consisted of *Clintrial*and *Clintrace. *The aggregate purchase price wasapproximately $44.1 million, which consisted of the issuance of 3.9 millionshares of our Series D redeemable convertible preferred stock, the assumptionof liabilities and direct acquisition costs. The acquisition of the Clinsoft business was accounted for as a purchaseunder SFAS No. 141.  Accordingly, theresults of Clinsoft have been included in our consolidated financial statementssince the date of acquisition.

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**Litigation Settlement**

 

OnFebruary 15, 2006, we entered into a Settlement Agreement and relatedLicense Agreement with Dr. Mark L. Kozam d/b/a MLK Software and Datasci, LLC.The Settlement Agreement relates to a lawsuit filed by Datasci in 2004 allegingthat certain of our products and services and certain products and services ofone of our customers, Quintiles, Inc., infringe a United States patentclaimed to be owned by Datasci. Under the Settlement Agreement and relatedLicense Agreement, we agreed to make a one-time, lump-sum payment to Datasci inthe amount of $8.5 million to settle the claim. The confidential settlement, inwhich neither party admits liability, provides for mutual releases anddismissal of all actions between the parties. We do not anticipate changing any of our productsas a result of the license to this patent.

Pursuant to SFASNo. 142, *Goodwill and Other Intangible Assets,*wereviewed the attributes of the license obtained and estimated that the licenseobtained had no value or useful life and that the license would not contributeto our future cash flows, either directly or indirectly.  As such, the settlement amount was recordedas a charge to operations.  Since the contingency existed as of December 31, 2005 and thesettlement was concluded prior to the issuance of our 2005 audited consolidatedfinancial statements, in accordance with SFAS No. 5, *Accountingfor Contingencies,* we recorded the impact of the settlement in 2005as a charge to operations.  Thesettlement was paid during the three months ended March 31, 2006.  During the six months ended June 30,2006, we incurred expense of $373,000 relating to our defense in this suit,which is included in general and administrative expenses.

**Sourcesof Revenues**

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

One customer,GlaxoSmithKline, accounted for approximately 16% and 16% of our total revenuesin the three months ended June 30, 2005 and 2006, respectively, and 16% and 17%of our total revenues in the six months ending June 30, 2005 and 2006respectively, and $1.7 million and $1.5 million of accounts receivableoutstanding as of December 31, 2005 and June 30, 2006, respectively.  Our top 20 customers accounted for approximately69% and 68% of our total revenues, net of reimburseable out-of-pocket expensesin the three months ended June 30, 2005 and 2006, respectively, and 69% and 67%of our total revenues, net of reimburseable out-of-pocket expenses in the sixmonths ended June 30, 2005 and 2006, respectively.

*LicenseRevenues*

We derive ourlicense revenues from the following products: *InForm*,our Internet based electronic data capture solution; *Clintrial*, our clinical data management solution; and ourdrug safety solutions, including *Clintrace*, andour recently acquired *WebVDME*, *CTSD*, and *WebSDM*products. Although each of our software solutions are available as stand-aloneenterprise applications, we offer integrated enterprise solutions incorporatingcertain of our electronic data capture, data management and drug safetyproducts.

License revenuesfor our *InForm* electronic datacapture software solution, either on a stand-alone or integrated basis, aredetermined primarily by the number, complexity and duration of the clinicaltrials and the number of participants in each clinical trial. License revenuesfor our *Clintrial,**Clintrace,**WebVDME*,*CTSD* and *WebSDM*software solutions are determined primarily by the number of users accessingthe software solution. Except as discussed below, we enter into softwarelicense agreements for our *InForm*,*Clintrial* and *Clintrace* products**withterms generally of three to five years with payment terms generally annually inadvance. License agreements for our *WebVDME, CTSD*and*WebSDM* products are typically annual with payment terms generallyin advance.  License revenues arerecognized ratably over the duration of the software term license agreement, tothe extent that amounts are fixed or determinable and collectable.

Following ouracquisition of Clinsoft in August 2001, we began converting holders ofClinsoft perpetual software licenses to our software term license arrangements.We continue to sell perpetual licenses of these products in certain situationsto our existing customers with the option to purchase customer support, and mayin the future do so for new customers based on customer requirements or marketconditions. We recognize revenues on the perpetual licenses upon delivery ofthe software.  We continue to provide andcharge for maintenance and support on our products to those customers who donot convert to our software term license arrangements. We generally charge 18%of the perpetual license fee for customer support. We will continue our effortsto convert the remaining former Clinsoft customer base to software term licensearrangements.  However, we anticipatethat some customers will not convert and instead will continue to make annualcustomer support payments.

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*Service Revenues*

 

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

Revenues resultingfrom the *InForm*hosting serviceconsist of three stages for each clinical trial:

·                  *First stage—*trial and application set up,including design of electronic case report forms and edit checks, installationand server configuration of the system;

·                  *Second stage—*application hosting andrelated support services; and

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

Services providedfor the first and third stages are provided on a fixed fee basis depending uponthe complexity of the trial and system requirements. Services for the secondstage are charged separately as a fixed monthly fee. We recognize revenues fromall stages of the hosting service ratably over the hosting period. Fees chargedand costs incurred for the trial system design, set up and implementation aredeferred until the start of the hosting period and then amortized ratably overthe estimated hosting period. The deferred costs include direct costs relatedto the trial and application set up. Fees for the first and third stages of theservices are billed based upon milestones. Fees for application hosting andrelated services in the second stage are billed quarterly in advance. Bundledinto this revenue element are the revenues attributable to the software licenseused by the customer.

In the event thatan application hosting customer cancels a clinical trial and its relatedstatement of work, all deferred revenues are recognized and all deferred set upcosts are expensed.  In addition, certaintermination-related fees may be charged and if so, such fees are recognized inthe period of termination.

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

In addition,application hosting service revenues include hosting services associated withterm license customers and reimbursable out-of-pocket expenses.

*ConsultingServices.*    Consulting services includethe design and documentation of the processes related to our customers’ use ofour products and services in their clinical trials. Consulting services alsoinclude project planning and management services, guidance on best practices inusing our software products, data management and configuration services fordata mining and reporting, as well as implementation services consisting ofapplication architecture design, systems integration, installation andvalidation.  Revenues from consultingservices included in either a multiple element software license agreement or inan application hosting agreement are recognized ratably over the term of thearrangement. The associated costs are expensed as incurred. Revenues fromconsulting services that are not included in a multiple element softwarelicense arrangement are recognized as services are performed. Fixed pricedarrangements are billed based upon contractual milestones, andtime-and-materials arrangements are billed monthly.

*CustomerSupport.*    We have a multinationalservices organization to support our software products and hosted solutionsworldwide. Customer support includes telephone support, software maintenanceand training. We bundle customer support in our software term licenses andallocate 10% of the value of the license to customer support revenues. Ourcustomer support revenues also consist of customer support fees paid byperpetual license customers. Customer support revenues are recognized ratablyover the period of the customer support or term license agreement, with paymentterms generally annually in advance.

**Cost ofRevenues and Operating Expenses**

We allocateoverhead expenses such as rent and occupancy charges and employee benefit coststo all departments based on headcount. As such, general overhead expenses arereflected in cost of service revenues and in the sales and marketing, researchand development, and general and administrative expense categories.

*Costof Revenues.*    Cost of license revenuesconsists primarily of the amortization of royalties paid for certain moduleswithin our *Clintrial* softwareproduct as well as our *InForm*software product. In addition to these costs we have also incurred expense forthe amortization of acquired technologies associated with the acquisition ofLincoln. The cost of license revenues vary based upon the mix of revenues fromsoftware licenses for our products. We operate our service organization on aglobal basis as one distinct unit, and do

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not segment costs for ourvarious service revenue elements. These services include performing applicationhosting, consulting and customer support services, and costs consist primarilyof employee-related costs associated with these services, amortization of thedeferred clinical trial set up costs, allocated overhead, outside contractors,royalties associated with providing customer support for use with the *Clintrial* and *InForm*softwareproducts and reimbursable out-of-pocket expenses. Cost of services alsoincludes hosting costs that primarily consist of hosting facility fees andserver depreciation.

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

*GrossMargin.*    Our gross margin on licenserevenues varies based on the mix of royalty- and non-royalty-bearing licenserevenues and the amount of amortization of acquired technologies. Our grossmargin 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, typicallythree to five years, our costs associated with delivery of the services arerecognized as the services are performed, which is typically during the first 6to 12 months of the contract period. Accordingly, our gross margin onservice revenues will vary significantly over the life of a contract due to thetiming, amount and type of service required in delivering certain projects. Inaddition, consolidated gross margin will vary depending upon the mix of licenseand service revenues.

*Salesand Marketing.*    Sales and marketingexpenses consist primarily of employee-related expenses, including travel,marketing programs which include product marketing expenses such as tradeshows, workshops and seminars, corporate communications, other brand buildingand advertising, allocated overhead and the amortization of commissions. Weexpect that sales and marketing expenses will continue to increase in absolutedollars as commission expense increases with our revenues and as we continue toexpand sales coverage and to build brand awareness through what we believe arethe most cost effective channels available, but may fluctuate quarter overquarter due to the timing of marketing programs.

*Researchand Development.*    Research anddevelopment expenses consist primarily of employee-related expenses, allocatedoverhead and outside contractors. We focus our research and development effortson increasing the functionality, performance and integration of our softwareproducts. We expect that in the future, research and development expenses willincrease in absolute dollars as we introduce additional integrated softwaresolutions to our product suite.

*Generaland Administrative.*    General andadministrative expenses consist primarily of employee-related expenses,professional fees, primarily consisting of expenses for accounting, compliancewith the Sarbanes-Oxley Act of 2002, and legal services, including litigation,information technology and other corporate expenses and allocated overhead. Weexpect that in the future, general and administrative expenses will fluctuatequarter by quarter due to the timing of outside contractor and professionalfees associated with Sarbanes-Oxley compliance, as well as legal services.

*Restructuring.*    Werecorded a $4.5 million restructuring charge in 2003 which related to therelocation of our corporate headquarters. This charge includes approximately$2.5 million relating to the estimated future obligation under thenon-cancelable lease and an approximate $2.0 million write-off of the relatedabandoned leasehold improvements and fixed assets. As of June 30, 2005,payments for all remaining expenses were completed and as a result we recordeda restructuring benefit of $92,000 representing the elimination of accruedexpenses associated with the restructuring charge.

*Stock-BasedCompensation Expenses.*    Our cost ofservice revenues, sales and marketing, research and development, and generaland administrative include stock-based compensation expense since January 1,2006.  Stock-based compensation costsincludes the fair value of stock options and the fair market value ofrestricted stock awards expensed over their respective service periods.  It also includes amortization of the excessof the deemed fair market value over the exercise price of stock optionsgranted prior to when we became a public company.

**ForeignCurrency Translation**

With regard to ourinternational operations, we frequently enter into transactions in currenciesother than the U.S. dollar. As a result, our revenues, expenses and cash flowsare subject to fluctuations due to changes in foreign currency exchange rates,particularly changes in the euro, British pound, Australian dollar and Japaneseyen. In the three months ended June 30, 2005 and 2006, approximately 48% and50%, respectively, of our revenues were generated in locations outside theUnited States.  In the six months

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ended June 30, 2005 and2006, approximately 48% and 49%, respectively, of our revenues were generatedin locations outside the United States. The majority of these revenues are in currencies other than the U.S.dollar, as are many of the associated expenses. In periods when the U.S. dollardeclines in value as compared to the foreign currencies in which we conductbusiness, our foreign currency-based revenues and expenses generally increasein value when translated into U.S. dollars.

**CriticalAccounting Policies and Estimates**

Our unaudited condensedconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. On an ongoingbasis, we evaluate our estimates and assumptions with our audit committee,including those related to revenue recognition, deferred set up costs, commissionsand royalties, accounts receivable reserves, stock-based compensation,long-lived assets, intangibles assets and goodwill, income taxes,restructuring, contingencies and litigation. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. There have been no material changes tothese estimates for the periods presented in this Quarterly Report onForm 10-Q. Our actual results may differ from these estimates underdifferent assumptions or conditions.

We believe that of oursignificant accounting policies, which are described in Note 2 of thenotes to our 2005 consolidated financial statements included in our AnnualReport on Form 10-K and in the Notes to our unaudited condensed consolidatedfinancial statements included in this Quarterly Report on Form 10-Q,the following accounting policies involve a greater degree of judgment andcomplexity. Accordingly, these are the policies we believe are the mostcritical to aid in fully understanding and evaluating our consolidatedfinancial condition and results of operations.

*RevenueRecognition and Deferred Set Up Costs.*    Werecognize software license revenues in accordance with Statement of Position(SOP) No. 97-2, *Software RevenueRecognition,* as amended, issued by the American Institute ofCertified Public Accountants, while revenues resulting from applicationservices are recognized in accordance with Emerging Issues Task Force (EITF)Issue No. 00-3, *Application of AICPAStatement of Position 97-2 to Arrangements that Include the Right to UseSoftware Stored on Another Entity’s Hardware* and Securities andExchange Commission’s (SEC) Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition*. On August 1,2003, we adopted EITF Issue No. 00-21, *RevenueArrangements with Multiple Deliverables.* The adoption of EITF IssueNo. 00-21 did not have a material impact on our financial position orresults of operations.

Customersgenerally have the ability to terminate application hosting, consulting andtraining service agreements upon 30 days notice to us. License agreements,multiple element arrangements, including license and services agreements, andcertain application hosting services can generally be terminated by eitherparty for material breach of obligations not corrected within 30 daysafter notice of the breach.

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

We generally enterinto software term licenses for our *InForm*,*Clintrial* and *Clintrace* products with our customers for3- to 5-year periods. License agreements for our *WebVDME,CTSD*and*WebSDM*products are typically for one-year terms. These arrangements typically include multiple elements: softwarelicense, consulting services and customer support. We bill our customers inaccordance with the terms of the underlying contract. Generally, we billlicense fees annually in advance for each year of the license term. Our paymentterms are generally net 30 days.

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

We generally bundle customer support with thesoftware license for the entire term of the arrangement. As a result, wegenerally recognize revenues for all elements, including consulting services,ratably over the term of the software license and support arrangement. Weallocate the revenues recognized for these arrangements to the differentelements based on management’s estimate of the relative fair value of eachelement. For our term-based licenses, we allocate to consulting services theanticipated service effort and value throughout the term of the arrangement atan amount that would have been allocated had those services been soldseparately to the customer. The remaining value is allocated to license andsupport services, with 10% of this amount allocated to support services. Wehave allocated the estimated fair value to our multiple element arrangements toprovide meaningful disclosures about

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each of our revenue streams. The costsassociated with the consulting and customer support services are expensed asincurred. There are instances in which we sell software licenses based on usagelevels. These software licenses can be based on estimated usage, in which casethe license fee charged to the customer is fixed based on this estimate. Whenthe fee is fixed, the revenues are generally recognized ratably over thecontractual term of the arrangement. If the fee is based on actual usage, andtherefore variable, the revenues are recognized in the period of use. Revenuesfrom certain follow-on consulting services, which are sold separately tocustomers with existing software licenses and are not considered part of amultiple element arrangement, are recognized as the services are performed.

We continue tosell perpetual licenses for the *Clintrial*and *Clintrace* software productsin certain situations to our existing customers with the option to purchasecustomer support and may in the future do so for new customers based oncustomer requirements or market conditions. We have established vendor specificobjective evidence of fair value for the customer support. Accordingly, licenserevenues are recognized upon delivery of the software and when all otherrevenue recognition criteria are met.  Customer support revenues are recognized ratably over the term of theunderlying support arrangement. We continue to generate customer support andmaintenance revenues from our perpetual license customer base. Trainingrevenues are recognized as earned.

In addition tomaking our software products available to customers through licenses, we offerour *InForm*, *WebVDME*, *CTSD* and *WebSDM*software solutions through a hosted application solution delivered through astandard web-browser.

Revenues resultingfrom *InForm*application hosting servicesconsists of three stages for each clinical trial: the first stage involvesapplication set up, including design of electronic case report forms and editchecks, implementation of the system and server configuration; the second stageinvolves application hosting and related support services; and the third stageinvolves services required to close out, or lock, the database for the clinicaltrial. Services provided for the first and third stages are provided on a fixedfee basis based upon the complexity of the trial and system requirements.Services for the second stage are charged separately as a fixed monthly fee. Werecognize revenues from all stages of the *InForm*hosting service ratably over the hosting period. Fees charged andcosts incurred for the trial system design, set up and implementation aredeferred as applicable, until the start of the hosting period and thenamortized and recognized, as applicable, ratably over the estimated hostingperiod. The deferred costs include incremental direct costs with third partiesand certain internal direct costs related to the trial and application set up,as defined under SFAS No. 91, *Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Indirect Costs of Leases*. These costs include salary andbenefits associated with direct labor costs incurred during trial set up, aswell as third-party subcontract fees and other contract labor costs. Workperformed outside the original scope of work is contracted for separately as anadditional fee and is generally recognized ratably over the remaining term ofthe hosting period. Fees for the first and third stages of the 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 resultingfrom hosting services for our *WebVDME*,*CTSD* and *WebSDM* products consist of installationand server configuration, application hosting and related supportservices.  Services for this offering arecharged monthly as a fixed fee.  Revenuesare recognized ratably over the period of the service.

In the event thatan application hosting customer cancels a clinical trial and its relatedstatement of work, all deferred revenues are recognized, all deferred set upcosts are expensed and certain termination related fees may be charged.

We deferred$509,000 and $970,000 of set up costs and amortized $398,000 and $554,000during the three months ended June 30, 2005 and 2006, respectively and deferred$1.2 million and $1.6 million of set up costs and amortized $847,000 and $1.0million in the six months ended June 30, 2005 and 2006, respectively.  The amortization of deferred set up costs isa component of cost of services.

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

Provisions forestimated 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, we have not experienced any materiallosses on uncompleted application hosting contracts.

*Accountingfor Prepaid Sales Commissions and Royalties.*    Forarrangements where we recognize revenues over the relevant contract period, wedefer related commission payments to our direct sales force and softwarelicense royalties paid to third parties and amortize these amounts over thesame period that the related revenues are recognized. This is done to bettermatch commission and royalty expenses with the related revenues. We deferred$646,000 and $1.2 million of commissions and amortized to sales and marketingexpense $905,000 and $1.1 million in the three months ended June 30, 2005 and2006, respectively, and deferred $1.3 million and $2.3 million of commissionsand amortized to sales and marketing expense $1.7 million and $2.0 million inthe six months ended June 30, 2005 and 2006, respectively.  Royalties are paid on a percentage ofbillings basis for certain of our products. We deferred $1.4 million and$637,000 of royalties and amortized to cost of revenues $728,000 and $700,000 inthe three months ended June 30, 2005 and 2006, respectively, and deferred $2.2million and $1.6 million of royalties and amortized to cost of revenues $1.3

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million and $1.5 millionin the six months ended June 30, 2005 and 2006, respectively.

*AccountsReceivable Reserves.*    We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. We regularly evaluate the collectibilityof our trade receivables based on a combination of factors, which may includedialogue with the customer to determine the cause of non-payment, the use ofcollection agencies, and/or the use of litigation. In the event it isdetermined that the customer may not be able to meet its full obligation to us,we record a specific allowance to reduce the related receivable to the amountthat we expect to recover given all information available to us. Wecontinuously monitor collections from our customers and maintain a provisionfor estimated credit losses based upon our historical experience and any specificcustomer collection issues that we have identified. While such credit losseshave historically been within our expectations and the provisions established,we cannot guarantee that we will continue to experience the same credit lossrates in the future. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required. Our accounts receivable reserves were$318,000 and $296,000 as of December 31, 2005 and June 30, 2006,respectively.

*Accountingfor Income Taxes.*    In connection withpreparing our financial statements, we are required to estimate income taxexpense in each jurisdiction in which we operate.  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 the need for a valuationallowance, we have considered our recent operating results, future taxableincome projections and all prudent and feasible tax planning strategies.  In the year ended December 31, 2005, wedetermined that it is more likely than not that we will realize a portion ofour deferred tax assets and reduced the valuation allowance by $7.8 million in December2005.  This benefit of the release invaluation allowance was realized through reductions to income tax expense of$4.5 million and to goodwill of $3.2 million. During the three months and six months ended June 30, 2006 the Companyreleased a portion of its valuation allowance, resulting in a reduction inincome tax expense of $748,000 and $1.4 million, respectively.

*Accountingfor Stock-Based Awards. * OnDecember 16, 2004, the FASB issued SFAS No. 123(R), *Share-Based Payment*, which is a revision of SFASNo. 123, *Accounting for Stock-Based Compensation*.SFAS No. 123(R) supersedes Accounting Principles Board (APB) OpinionNo. 25, *Accounting for Stock Issued to Employees*,and amends SFAS No. 95, *Statement of Cash Flows*.Generally, the approach under SFAS No. 123(R) is similar to the approachdescribed in SFAS 123. However, SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values.  Pro forma disclosure is no longer analternative.

As prescribed, weadopted SFAS No. 123(R) starting in our fiscal first quarter of 2006, whichbegan on January 1, 2006.

As permitted bySFAS 123, we historically accounted for share-based payments to employees usingthe APB Opinion No. 25 intrinsic value method and, as such, generallyrecognized no compensation cost for employee stock options other than theamortization of deferred stock-based compensation cost associated with stockoptions granted at a discount from the deemed fair market value. We adopted the“modified prospective” method, outlined in SFAS No. 123(R). Under the “modifiedprospective” method compensation cost is recognized in the income statementbeginning on the adoption date of SFAS No. 123(R):  (a) based on the requirements of SFASNo. 123(R) for all share-based payments granted on or after the adoptiondate;  (b) based on the requirementsof SFAS 123 for all share-based payments that are un-vested as of December 31,2005; and (c) excludes those options issued prior to the Phase Forward becominga public entity which were valued using the “minimum value method”.  Therefore, in accordance with the modifiedprospective method, we are amortizing the unamortized stock-based compensationexpense related to those stock options that remained unvested as of December31, 2005, whose fair value was calculated utilizing a Black-Scholes optionpricing model.

In accordance with the modified prospective method ofadoption, our results of operations and financial position for prior periodshave not been restated.

Effective with theadoption of SFAS No. 123(R), we have elected to use the Black-Scholes optionpricing model to determine the weighted average fair value of options granted.

We have a limitedtrading history for our common stock as it began trading on the NASDAQ NationalMarket on July 15, 2004. Accordingly, we have determined the expected lifeand the volatility for options granted in 2005 based on an analysis of reporteddata for a peer group of companies that issued options with substantiallysimilar terms. The expected life of options we granted has been determinedbased on the average expected life of the options as reported by this peergroup of companies.  The expectedvolatility of options granted has been determined using an average of thehistorical volatility measures of this peer group of companies as well as theweighted average historical volatility of our own common stock beginning withJanuary 2005.  The risk-free interestrate is based on a treasury instrument whose term is consistent with theexpected life of the stock options. We have not paid and do not anticipatepaying cash dividends on our shares of common stock; therefore, the expecteddividend yield is assumed to be zero. In addition, SFAS No. 123(R) requirescompanies to utilize an estimated forfeiture rate when calculating the expensefor the period. We have applied an estimated forfeiture rate based onhistorical experience.

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On June 6, 2006,we granted 942,250 shares of restricted stock awards to our Chief ExecutiveOfficer, members of our senior management team and other key employees. Wedetermine restricted stock award expense based on the closing market price ofour common stock on the day before the date of grant. This expense is amortizedon a straight-line basis over the service period.

Prior to theadoption of SFAS No. 123(R), we recorded deferred stock-based compensation inthe amount by which the exercise price of an option is less than the deemedfair value of our common stock at the date of grant. Because there had been nopublic market for the our stock prior to the July 2004 initial public offering,our Board of Directors had determined the fair value of the common stock basedupon several factors, including, but not limited to, our operating andfinancial performance, issuance of convertible preferred stock, the rights andpreferences of all securities senior to common stock and the anticipatedoffering price of our common stock in connection with the initial publicoffering.  We amortize the deferredcompensation charges over the vesting period of the underlying option awards inaccordance with FASB Interpretation No. 28, *Accounting for StockAppreciation Rights and Other Variable Stock Option or Award Plans*.

During the three and six months ended June 30, 2006,we recorded $559,000 and $1.1 million of aggregate stock-based compensationexpense, of which $476,000 and $804,000 were a result of the adoption of SFASNo. 123(R). The remaining stock-based compensation expense is due to theamortization of stock-based compensation associated with previously issuedstock options which amounted to $133,000 and $357,000, respectively. For thethree months ended June 30, 2006 stock-based compensation expense included$49,000 in cost of revenues, $67,000 in research and development, $98,000 inselling and marketing and $345,000 in general and administrative expense.  For the six months ended June 30, 2006stock-based compensation expense included $93,000 in cost of revenues, $127,000in research and development, $208,000 in sales and marketing and $587,000 ingeneral and administrative expense.  Forthe three months ending June 30, 2005 and 2006, stock-based compensationexpense reduced basic and diluted earnings per share by $0.01 and $0.02,respectively. For the six months ended June 30, 2005 and 2006, stock-basedcompensation expense reduced diluted earnings per share by $0.02 and $0.03,respectively.  As of June 30, 2006, therewas $12,725 of unrecognized compensation expense related to unvestedmarket-based share awards that is expected to be recognized over a weightedaverage period of 3.6 years.

*OtherSignificant Estimates*

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

**Overviewof Results of Operations for the Three Months Ended June 30, 2005 and 2006**

Total revenuesincreased by 19% or $4.0 million in the three months ended June 30, 2006compared to the same period in 2005 due to an increase in service revenues of27%.

Our gross marginincreased by 20% or $2.5 million in the three months ended June 30, 2006compared to the same period in 2005, primarily due to the increase in servicesrevenues.

Operating incomefor the three months ended June 30, 2006 of $1.6 million decreased $352,000 or18% compared to the same period in 2005. The operating income for the three months ended June 30, 2005 and 2006included $133,000 and $559,000 of stock-based compensation expense,respectively.

The results forthe three months ended June 30, 2006 were impacted by foreign exchange ratefluctuations, resulting in an approximately 2% decrease in revenues and nochanges in expenses for the period.

As of June 30,2006, we had $63.7 million of cash, cash equivalents and short-terminvestments, an increase of $3.1 million from $60.6 million atDecember 31, 2005.  As of June 30,2006, we had no outstanding debt.

27

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*Revenues*

|                               | ** ** | **Three Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-------------------------------|------------|-----------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                            | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                    | ** ** | ** **                                          | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| **Revenues**                  | ** ** | **Amount**                                          | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands)**                             | ** ** |
| License                       |       | $                                                   | 8,632      |                 | 42         | %          | $          | 9,383 |   | 38 | % | $ | 751 |   | 9 | % |
| Application  hosting services |       | 7,275                                               |       | 35                   |       | 9,374      |       | 38 |   | 2,099 |   | 29 |   |
| Consulting  services          |       | 1,622                                               |       | 8                    |       | 2,617      |       | 10 |   | 995 |   | 61 |   |
| Customer support              |       | 3,169                                               |       | 15                   |       | 3,348      |       | 14 |   | 179 |   | 6 |   |
| Total                         |       | $                                                   | 20,698     |                 | 100        | %          | $          | 24,722 |   | 100 | % | $ | 4,024 |   | 19 | % |

 

Total revenuesincreased in the three months ended June 30, 2006 due to an increase inrevenues in all categories.  The increasein revenues associated with our application hosting services in the threemonths ended June 30, 2006 was due to an increase in trials under management,which include both application hosting services trials as well as trials hostedfor our *InForm* license customers.  The increase in consulting revenues wereprimarily attributable to services relating to new business relationshipsrelating to the *WebVDME* product we began offeringafter the August 2005 acquisition of Lincoln as well as additional *InForm* consulting revenues which were primarily related toour existing customer base. The increase in license revenues was the result ofan increase across each of our product lines. The increase in customer support revenues in the three months ended June30, 2006 were primarily due to an increase in *InForm*customer support revenues.  Our revenueswere not significantly impacted by price increases or decreases.  Inflation had only a nominal impact on ourrevenues.  Revenues were impacted byforeign exchange rate fluctuations, resulting in a decrease in revenues for theperiod of 2%. In the future, we anticipate that the percentage of licenserevenues and service revenues will fluctuate as a percentage of total revenues,primarily due to changes in the type, amounts and delivery schedules of licenseand service orders, which are based on the requirements of our customers.

|                                     | ** ** | **Three Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                          | ** ** | **2005**                                            | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                          | ** ** | ** **                                          | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                          | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                             | ** ** |
| United States                       |       | $                                                   | 10,779     |                 | 52         | %          | $          | 12,483 |   | 50 | % | $ | 1,704 |   | 16 | % |
|                                |       |                                                |       |                 |       |       |       |   |   |   |   |   |   |
| United Kingdom                      |       | 6,330                                               |       | 31                   |       | 7,940      |       | 32 |   | 1,610 |   | 25 |   |
| France                              |       | 1,936                                               |       | 9                    |       | 2,483      |       | 10 |   | 547 |   | 28 |   |
| Asia Pacific                        |       | 1,653                                               |       | 8                    |       | 1,816      |       | 8 |   | 163 |   | 10 |   |
| International subtotal              |       | 9.919                                               |       | 48                   |       | 12,239     |       | 50 |   | 2,320 |   | 23 |   |
| Total                               |       | $                                                   | 20,698     |                 | 100        | %          | $          | 24,722 |   | 100 | % | $ | 4,024 |   | 19 | % |

 

Theincrease in revenues worldwide was primarily due to an increase in applicationhosting service revenues associated with our *InForm*product and to revenues related to our *WebVDME*products. The increase in U.S. revenues is primarily related to new businessrelationships relating to the *WebVDME* productwe began offering after the August 2005 acquisition of Lincoln and to growth inrevenues from our *InForm* product offerings, whilethe increase in international revenues is primarily the result of additional *InForm* application hosting services revenues with both newand existing customers.

*Cost ofRevenues*

|                                 | ** ** | **Three Months Ended June 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                      | ** ** | **2005**                                            | ** ** | **2006**            | ** ** | **Change** | ** ** |
| ** **                      | ** ** | ** **                                          | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                          | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | ** ** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                          | ** ** | **Revenues**        | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                             | ** ** |
| License                         |       | $                                                   | 589        |                | 7          | %          | $          | 597 |   | 6 | % | $ | 8 |   | 1 | % |
| Services                        |       | 7,464                                               |       | 62                  |       | 9,007      |       | 59 |   | 1,543 |   | 21 |   |
| Total                           |       | $                                                   | 8,053      |                | 39         | %          | $          | 9,604 |   | 39 | % | $ | 1,551 |   | 19 | % |

 

Thecost of license revenues remained consistent in the three months ended June 30,2006.  The increase in cost of servicesin the three months ended June 30, 2006 was primarily due to increases inemployee-related and contractor expenses of $845,000and $358,000, respectively, associated with delivering increasedservices revenues.  We also had expenseincreases for depreciation and hosting related expenses of $166,000 and$91,000, respectively, which were the result of an increase in trials undermanagement in the three months ended June 30, 2006 as compared to the sameperiod in 2005.  In addition, there werealso expense increases in travel

28

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and pass through expenseof $70,000 and $69,000, respectively.  Theseincreases were partially offset by an expense decrease of $304,000 associatedwith an increase in the amount of time spent in the set up phase forapplication hosting service arrangements, for which the associated expenses aredeferred and recognized over the duration of the trial, rather than expensed asincurred.

*GrossMargin*

 

|                       | ** ** | **Three Months Ended June 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------|------------|-----------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **            | ** ** | **2005**                                            | ** ** | **2006**            | ** ** | **Change** | ** ** |
| ** **            | ** ** | ** **                                          | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                          | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | ** ** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                          | ** ** | **Revenues**        | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                             | ** ** |
| License               |       | $                                                   | 8,043      |                | 93         | %          | $          | 8,786 |   | 94 | % | $ | 743 |   | 9 | % |
| Services              |       | 4,602                                               |       | 38                  |       | 6,332      |       | 41 |   | 1,730 |   | 38 |   |
| Total                 |       | $                                                   | 12,645     |                | 61         | %          | $          | 15,118 |   | 61 | % | $ | 2,473 |   | 20 | % |

 

Thelicense gross margin percentage increased in the three months ended June 30,2006 due to an increase in license revenues for all of our products.   The services gross margin percentageincreased during the three months ended June 30, 2006, primarily due to theincrease in application hosting and consulting services revenues combined withincreased efficiencies within our services organization.  The overall gross margin percentage wasunchanged in the three months ended June 30, 2006.  It is likely that gross margin, as apercentage of revenues will fluctuate quarter by quarter due to the timing andmix of license and service revenues, and the type, amount and timing of servicerequired in delivering certain projects. For example, when services are performed on a time and material basis,the timing of expense and revenue recognition is more closely aligned than whenservices are performed under bundled arrangements, where the revenues arerecognized ratably over the license period, while the expenses are recognizedas incurred.

*Operating Expenses*

 

|                             | ** ** | **Three Months Ended June 30,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|----------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                                            | ** ** | **2006**       | ** ** | **Change** | ** ** |
| ** **                  | ** ** | ** **                                          | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                          | ** ** | **of**         | ** ** | ** ** | ** ** | **of** | ** ** | ** ** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                          | ** ** | **Revenues**   | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                             | ** ** |
| Sales and  marketing        |       | $                                                   | 3,960      |           | 19         | %          | $          | 5,184 |   | 21 | % | $ | 1,224 |   | 31 | % |
| Research and  development   |       | 3,489                                               |       | 17             |       | 3,860      |       | 16 |   | 371 |   | 11 |   |
| General and  administrative |       | 3,218                                               |       | 16             |       | 4,448      |       | 18 |   | 1,230 |   | 38 |   |
| Total                       |       | $                                                   | 10,667     |           | 52         | %          | $          | 13,492 |   | 55 | % | $ | 2,825 |   | 26 | % |

 

*Sales and Marketing.*    Salesand marketing expenses increased in the three months ended June 30, 2006primarily due to a $524,000 increase in employee-related expenses related to aheadcount increase of 11 people and a $148,000 increase in commission expensedue to both an increase in revenues and an increase in the effective commissionrate.  We also experienced increases inamortization expense of $128,000 associated with our purchase of Lincoln inAugust 2005 as well as travel and marketing program expenses of $137,000 and$113,000, respectively.  We expect thatour sales and marketing expense will continue to increase in absolute dollarsas commission expense increases with our revenues and as we continue to expandsales coverage and to build brand awareness through what we believe are themost cost effective channels available, but may fluctuate quarter over quarterdue to the timing of marketing programs.

*Researchand Development.*   Research and development expenses increased in the three months endedJune 30, 2006 primarily due to employee-related expenses of $339,000.  This increase was primarily due to anincrease in the average headcount in the three month period ended June 30, 2006as compared to the three month period in the prior year, due to the timing ofheadcount changes within each period.  Inaddition, occupancy expense increased $44,000. These increases were partially offset by $103,000 expense decrease inoutside contractors.  We expect that ourresearch and development costs will continue to increase in absolute dollars aswe continue to add features and functionality to our products and expand ourproduct and service offerings.

*General and Administrative.*    General and administrativeexpenses increased in the three months ended June 30, 2006 primarily due to$438,000 for professional services related to an acquisition opportunity thatwas evaluated during the quarter, but which we decided not to pursue.  In addition, outside contractors andstock-based compensation expense increased by $298,000 and $276,000,respectively.  Further expense increasesincluded depreciation and computer related expenses of $88,000 and$81,000.  Computer related expensesinclude hardware and software support agreements as well as computeraccessories.  These expense increaseswere partially offset by a decrease in professional fees of $209,000 primarilyassociated with legal fees related to defending our intellectualproperty.

29

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*OperatingIncome, Other Income (Expense)*

|                          | ** ** | **Three Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **               | ** ** | **2005**                                            | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **               | ** ** | ** **                                          | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Amount**                                          | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **               | ** ** | **(in thousands)**                             | ** ** |
| Operating income         |       | $                                                   | 1,978      |                 | 10         | %          | $          | 1,626 |   | 7 | % | $ | (352 | ) | (18 | )% |
| Other income  (expense): |       |                                                |       |                 |       |       |       |   |   |   |   |   |   |
| Interest income          |       | 439                                                 |       | 2                    | %          | 679        |       | 3 |   | 240 |   | 55 |   |
| Other, net               |       | (11                                                 | )          | —               |       | —     |       | — |   | 11 |   | 100 |   |
| Total other  income      |       | $                                                   | 428        |                 | 2          | %          | $          | 679 |   | 3 | % | $ | 251 |   | 59 | % |

 

*Operating Income.*   Thedecrease in operating income in the three months ended June 30, 2006 wasprimarily due to the increase in operating expenses which was partially offsetby an increase in gross margin.

*Other Income (Expense).*    Theincrease in interest income in the three months ended June 30, 2006 wasprimarily due to an increase in cash and cash equivalents available forinvestment, short term investments and an increase in the yield on investment.

*Provision for Income Taxes*

|                             | ** ** | **Three Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                                            | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                  | ** ** | ** **                                          | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amount**                                          | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                             | ** ** |
| ** **                  | ** ** | ** **                                          | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Provision for income  taxes |       | $                                                   | 568        |                 | 3          | %          | $          | 417 |   | 2 | % | $ | (151 | ) | (27 | )% |
|                             |            |                                                     |            |                      |            |            |            |  |  |  |  |  |  |  |  |  |

 

*Provisionfor Income Taxes.* The provision for income taxes in 2005and 2006 represents income taxes payable in both our U.S. and foreignoperations that cannot be offset through loss carryforwards.  The effective tax rate for 2006 decreased to 18%compared to an effective tax rate of 24% for 2005. The decrease in oureffective tax rate associated with U.S income taxes is primarily due to therelease of a portion of our deferred tax asset valuation allowance of $1.4million, which was recognized through a reduction to income tax expense, and toa lesser extent, a reduction in foreign taxes payable associated with ouroperations in Japan which are taxed at higher rates.  These decreases in our effective tax ratewere partially offset by a reduction in the amount of U.S. net operating losscarryforwards which can be used to offset taxable income, and to a lesserextent, an increase in tax payable for our U.K. operations due to a reductionin our net operating loss carryforwards which can be used to offset taxableincome.  In utilizing our net operatingloss carryforwards, we are required to use our net operating losses in theorder they were incurred.  Theutilization of the acquired net operating losses reduces the amount of incometaxes payable to local tax authorities, but does not reduce the amount ofincome tax expense for financial reporting purposes as it is recorded as areduction to goodwill.

**Overviewof Results of Operations for the Six Months Ended June 30, 2005 and 2006**

Totalrevenues increased by 17% or $7.1 million in the six months ended June 30, 2006compared to the same period in 2005 primarily due to an increase in servicerevenues of 26%.

Ourgross margin increased by 14% or $3.6 million in the six months ended June30, 2006 compared to the same period in 2005, primarily due to the increase inservices revenues.

Operatingincome for the six months ended June 30, 2006 of $3.6 million decreased 7% or$295,000 compared to the same period in 2005. The operating income for the six months ended June 30, 2005 and 2006also included $357,000 and $1.1 million of stock-based compensation expense,respectively.

Theresults for the six months ended June 30, 2006 were impacted by foreignexchange rate fluctuations, resulting in decreases in both revenues and expensesfor the period of 3% and 2%, respectively.

30

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*Revenues*

* *

|                               | ** ** | **Six Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                          | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                    | ** ** | ** **                                        | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| **Revenues**                  | ** ** | **Amount**                                        | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands)**                           | ** ** |
| License                       |       | $                                                 | 17,451     |                 | 42         | %          | $          | 18,408 |   | 38 | % | $ | 957 |   | 5 | % |
| Application hosting  services |       | 14,106                                            |       | 35                   |       | 18,327     |       | 38 |   | 4,221 |   | 30 |   |
| Consulting services           |       | 3,017                                             |       | 7                    |       | 5,357      |       | 11 |   | 2,340 |   | 78 |   |
| Customer support              |       | 6,686                                             |       | 16                   |       | 6,246      |       | 13 |   | (440 | ) | (7 | ) |
| Total                         |       | $                                                 | 41,260     |                 | 100        | %          | $          | 48,338 |   | 100 | % | $ | 7,078 |   | 17 | % |

 

Totalrevenues increased in the six months ended June 30, 2006 as compared to thesame period in 2005, primarily due to increases in application hosting andconsulting services revenues.  Theincrease in revenues associated with our application hosting services in thesix months ended June 30, 2006 was primarily due to an increase in trials undermanagement, which include both application hosting services trials as well astrials hosted for our InForm license customers. The increase in consulting revenues was primarily attributable toservices relating to new business relationships relating to the *WebVDME* product we began offering after the August 2005acquisition of Lincoln as well as additional *InForm*consulting revenues which was primarily related to our existing customerbase.  The decrease in customer supportrevenues in the six months ended June 30, 2006 was primarily due to a reductionin InForm training revenues as well as a decrease in *Clintrace*customer support revenues.  Our revenueswere not significantly impacted by price increases or decreases.  Inflation had only a nominal impact on ourrevenues.   Revenues were impacted byforeign exchange rate fluctuations, resulting in a decrease in revenues for theperiod of 3%.

|                                     | ** ** | **Six Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                          | ** ** | **2005**                                          | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                          | ** ** | ** **                                        | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                        | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                           | ** ** |
| United States                       |       | $                                                 | 21,524     |                 | 52         | %          | $          | 24,507 |   | 51 | % | $ | 2,983 |   | 14 | % |
| United Kingdom                      |       | 12,476                                            |       | 30                   |       | 15,460     |       | 32 |   | 2,984 |   | 24 |   |
| France                              |       | 4,218                                             |       | 10                   |       | 4,856      |       | 10 |   | 638 |   | 15 |   |
| Asia Pacific                        |       | 3,042                                             |       | 8                    |       | 3,515      |       | 7 |   | 473 |   | 16 |   |
| International subtotal              |       | 19,736                                            |       | 48                   |       | 23,831     |       | 49 |   | 4,095 |   | 21 |   |
| Total                               |       | $                                                 | 41,260     |                 | 100        | %          | $          | 48,338 |   | 100 | % | $ | 7,078 |   | 17 | % |

 

The increase in revenuesworldwide was primarily due to an increase in application hosting services revenuesassociated with our *InForm* productand to revenues related to our *WebVDME* product.The increase in U.S. revenues is primarily related to new businessrelationships relating to the *WebVDME* productwe began offering after the August 2005 acquisition of Lincoln and to growth inrevenues from our *InForm* product offerings, whilethe increase in international revenues is primarily the result of additional *InForm* application hosting services revenues with both newand existing customers.

 

*Cost ofRevenues*

|                                 | ** ** | **Six Months Ended June 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                      | ** ** | **2005**                                          | ** ** | **2006**            | ** ** | **Change** | ** ** |
| ** **                      | ** ** | ** **                                        | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                        | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | ** ** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                        | ** ** | **Revenues**        | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                           | ** ** |
| License                         |       | $                                                 | 1,037      |                | 6          | %          | $          | 1,303 |   | 7 | % | $ | 266 |   | 26 | % |
| Services                        |       | 14,676                                            |       | 62                  |       | 17,902     |       | 60 |   | 3,226 |   | 22 |   |
| Total                           |       | $                                                 | 15,713     |                | 38         | %          | $          | 19,205 |   | 40 | % | $ | 3,492 |   | 22 | % |

 

The cost of license revenues increased in the six monthsended June 30, 2006 primarily due to amortization expense from acquiredtechnologies relating to our recent acquisition of Lincoln of $180,000.  In addition, our royalty costs increased by$101,000 which was attributable to fees associated with our *InForm*software product. The increase in cost of services in the six months ended June 30, 2006was primarily due to increases in employee-related and contractor expenses of$1.3 million and $1.1 million, respectively, associated with deliveringincreased services revenues.  We also hadexpense increases for depreciation, hosting and computer related expenses of$340,000, $130,000 and $232,000, respectively, which were the result of anincrease in trials under management in the six months ended June 30, 2006 ascompared to the same period in 2005. Computer related expenses include hardware and software supportagreements as well as computer accessories. In addition, there were also increases in travel and

31

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royaltyexpense of $202,000 and $123,000, respectively. These increases were partially offset by a an expense decrease of$246,000 associated with an increase in the amount of time spent in the set upphase for application hosting service arrangements, for which the associatedexpenses are deferred and recognized over the duration of the trial, ratherthan expensed as incurred.

*GrossMargin*

|                       | ** ** | **Six Months Ended June 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------|------------|---------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **            | ** ** | **2005**                                          | ** ** | **2006**            | ** ** | **Change** | ** ** |
| ** **            | ** ** | ** **                                        | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                        | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | ** ** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                        | ** ** | **Revenues**        | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                           | ** ** |
| License               |       | $                                                 | 16,414     |                | 94         | %          | $          | 17,105 |   | 93 | % | $ | 691 |   | 4 | % |
| Services              |       | 9,133                                             |       | 38                  |       | 12,028     |       | 40 |   | 2,895 |   | 32 |   |
| Total                 |       | $                                                 | 25,547     |                | 62         | %          | $          | 29,133 |   | 60 | % | $ | 3,586 |   | 14 | % |

 

The license gross marginpercentage declined in the six months ended June 30, 2006 due to amortizationexpense relating to our acquisition of Lincoln as well as an increase inroyalty expense relating to our InForm software.  The services gross margin percentage wasincreased during the six months ended June 30, 2006, as revenues grew at afaster rate than the associated expenses. The overall gross margin decreased in the six months ended June 30, 2006due to the combination of additional license expenses and less license revenuesas a percentage of total revenues.

 

*Operating Expenses*

 

|                             | ** ** | **Six Months Ended June 30,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------|------------|----------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                                          | ** ** | **2006**       | ** ** | **Change** | ** ** |
| ** **                  | ** ** | ** **                                        | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                        | ** ** | **of**         | ** ** | ** ** | ** ** | **of** | ** ** | ** ** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                        | ** ** | **Revenues**   | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                           | ** ** |
| Sales and  marketing        |       | $                                                 | 7,911      |           | 19         | %          | $          | 9,421 |   | 20 | % | $ | 1,510 |   | 19 | % |
| Research and  development   |       | 6,770                                             |       | 16             |       | 7,484      |       | 15 |   | 714 |   | 11 |   |
| General and  administrative |       | 7,022                                             |       | 17             |       | 8,587      |       | 18 |   | 1,565 |   | 22 |   |
| Restructuring               |       | (92                                               | )          | —         |       | —     |       | — |   | 92 |   | 100 |   |
| Total                       |       | $                                                 | 21,611     |           | 52         | %          | $          | 25,492 |   | 53 | % | $ | 3,881 |   | 18 | % |

* *

*Salesand Marketing.*    Salesand marketing expenses increased in the six months ended June 30, 2006primarily due to a $680,000 increase in employee-related expenses related to aheadcount increase of 11 people and a $221,000 increase in commission expensedue to both an increase in revenues and an increase in the effective commissionrate.  We also experienced increases inamortization expense of $255,000 associated with our purchase of Lincoln inAugust 2005, as travel and marketing programs of $114,000 and $96,000,respectively.  In addition, stock-basedcompensation expense increased by $212,000.

*Researchand Development.*    Research and developmentexpenses increased in the six months ended June 30, 2006 primarily due toemployee-related expenses of $663,000.  Thisincrease was primarily due to an increase in the average headcount in the sixmonth period ended June 30, 2006 as compared to the six month period in theprior year, due to the timing of headcount changes within each period. Inaddition, travel expense increased $47,000. These increases were partiallyoffset by a decrease of $111,000 in outside contractor expense.

*Generaland Administrative.*   General and administrative expenses increased in the six months endedJune 30, 2006 primarily due to an increase of $462,000 in outside contractorexpenses as well as $438,000 for professional services related to anacquisition opportunity that was evaluated during the quarter, but which wedecided not to pursue. Further, stock-based compensation and bad debt expenseincreased $358,000 and $114,000, respectively. In addition, other expense increases included depreciation and computerrelated expenses of $158,000 and $144,000. These expense increases were partially offset by a decrease inprofessional fees of $382,000 primarily associated with legal fees related todefending our intellectual property.

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*Operating Income, Other Income(Expense)*

* *

|                         | ** ** | **Six Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-------------------------|------------|-------------------------------|------------|----------------------|------------|------------|------------|
| ** **              | ** ** | **2005**                      | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **              | ** ** | ** **                    | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Amount**                    | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **              | ** ** | **(in thousands)**       | ** ** |
| Operating income        |       | $                             | 3,936      |                 | 10         | %          | $          | 3,641 |   | 8 | % | $ | (295 | ) | (7 | )% |
| Other income (expense): |       |                          |       |                 |       |       |       |   |   |   |   |   |   |
| Interest income         |       | $                             | 787        |                 | 2          | %          | 1,275      |   | 3 |   | 488 |   | 62 |   |
| Interest expense        |       | (144                          | )          | —               |       | —     |       | — |   | 144 |   | 100 |   |
| Other, net              |       | (141                          | )          | —               |       | (64        | )          | — |   | 77 |   | 55 |   |
| Total other income      |       | $                             | 502        |                 | 1          | %          | $          | 1,211 |   | 3 | % | $ | 709 |   | 141 | % |

* *

*Operating Income.*   The decreasein operating income in the six months ended June 30, 2006 was primarily due toan increase in operating expenses which was partially offset by an increase ingross margin.

*OtherIncome (Expense).*    The increase ininterest income in the six months ended June 30, 2006 was primarily due to anincrease in cash and cash equivalents available for investment, short terminvestments and an increase in the yield on investment.  The decrease in interest expense was due tothe pay off of our debt in the quarter ended June 30, 2005.  Other, net expense decreased primarily due toa decrease in foreign exchange losses compared to the same period in 2005.

*Provision for Income Taxes*

|                             | ** ** | **Six Months Ended June 30,** | ** ** | ** **           | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------|------------|----------------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                                          | ** ** | **2006**             | ** ** | **Change** | ** ** |
| ** **                  | ** ** | ** **                                        | ** ** | **Percentage**       | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amount**                                        | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                           | ** ** |
| Provision for  income taxes |       | $                                                 | 1,132      |                 | 3          | %          | $          | 878 |   | 2 | % | $ | (254 | ) | (22 | )% |
|                             |            |                                                   |            |                      |            |            |            |  |  |  |  |  |  |  |  |  |

 

*Provisionfor Income Taxes.* The provision for income taxes in 2005and 2006 represents income taxes payable in both our U.S. and foreignoperations that cannot be offset through loss carryforwards.  The effective tax rate for 2006 decreased to18% compared to an effective tax rate of 26% for 2005. The decrease in oureffective tax rate associated with U.S. income taxes is primarily due to therelease of a portion of our deferred tax asset valuation allowance of $1.4million, which was recognized through a reduction to income tax expense, and toa lesser extent, a reduction in foreign taxes payable associated with ouroperations in Japan which are taxed at higher rates.  These decreases in our effective rate werepartially offset by a reduction in the amount of U.S. net operating losscarryforwards which can be used to offset taxable income, and to a lesserextent, an increase in tax payable for our U.K. operations due to a reductionin our net operating loss carryforwards which can be used to offset taxableincome.  In utilizing our net operatingloss carryforwards, we are required to use our net operating losses in theorder they were incurred.  Theutilization of the acquired net operating losses reduces the amount of incometaxes payable to local tax authorities, but does not reduce the amount ofincome tax expense for financial reporting purposes as it is recorded as areduction to goodwill.

**Liquidityand Capital Resources**

Our principalsources of liquidity were cash, cash equivalents, and short-term investmentstotaling $60.6 million and $63.7 million at December 31, 2005 andJune 30, 2006, respectively, and accounts receivable of $24.9 million and$18.6 million, respectively.

Cash provided byand used in operating activities has historically been affected by changes inworking capital accounts, primarily deferred revenues, accounts receivable andaccrued expenses, and add-backs of non-cash expense items such as depreciationand amortization and stock-based compensation. Fluctuations within accountsreceivable and deferred revenues are primarily related to the timing ofbillings of our term license customers and the associated revenue recognition.Movements in deferred costs are related to the volume and stages of hostedclinical trials and movements in accrued expenses and accounts payable are dueto the timing of certain transactions.

Net cash providedby operating activities was $5.3 million in the six months ended June 30,2006, which was greater than net income of $4.0 million. This differenceis primarily due to $2.5 million of non-cash depreciation and amortization,$1.0 million of stock-based compensation, an increase in deferred revenues of$1.8 million, and a decrease in accounts receivable of $7.0 million, partiallyoffset by the payment of accrued litigation settlement of $8.5 million, anincrease in deferred costs of $872,000 and a

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reduction of accruedexpenses of $2.1 million.

Net cash used byinvesting activities was $18.1 million during the six months ending June30, 2006, which was primarily due to the purchase of short-term investments of$29.2 million, capital expenditures associated with expansion of ourhosting facility and purchase of computer equipment to support our work forceof $2.5 million and the payment of accrued earn-out of $2.0 million,partially offset by $15.7 million of proceeds from maturities of short-terminvestments.

Net cash providedby financing activities was $2.4 million in the six months ended June 30, 2006,consisting of $1.7 million of proceeds from the exercise of common stockoptions and sales of common stock under our employee stock purchase plan and$724,000 from the tax benefit associated with the exercise of options.

At December 31,2005 and June 30, 2006, we had a $1.3 million and $500,000, respectively,outstanding letter of credit related to our facility.  The letter of credit reduces the amountavailable under our line of credit with a bank.

Substantially allof our long-lived assets as December 31, 2005 and June 30, 2006 arelocated in the United States.

We generally donot enter into long-term binding purchase commitments. Our principalcommitments consist of obligations under non-cancelable operating leases foroffice space.

The followingtable of our material contractual obligations as of June 30, 2006summarizes the aggregate effect that these obligations are expected to have onour cash flows in the periods indicated:

|                                  | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | ** **                                | ** ** | **1 year or** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **less** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
| ** **                       | ** ** | **(in thousands)**                   | ** ** |
| Operating lease  obligations     |       | $                                         | 7,565      |   | $ | 3,097 |   | $ | 4,468 |   | $ | — |   | $ | — |   |
| Total                            |       | $                                         | 7,565      |   | $ | 3,097 |   | $ | 4,468 |   | $ | — |   | $ | — |   |

 

Prior to August,2005, borrowings under our $5.0 million working capital line of credit weresecured by substantially all our assets. Under a related negative pledge agreement we were generally prohibitedfrom pledging our intellectual property to others, subject to certainexceptions.  In August of 2005, the working capital line of creditwas amended to eliminate the security interest in our assets and the negativepledge on our intellectual property.  Theamendment also removed or modified the financial covenants.  Under theterms of this credit line, we are required to comply with certain financialcovenants.  Effective June 30, 2006, the working capital line of creditwas reduced from $5.0 million to $2.0 million. As of December 31, 2005 andJune 30, 2006, there were no amounts outstanding under the working capital lineof credit.  At June 30, 2006, there was$1.5 million available under the line of credit and $500,000 reserved under aletter of credit associated with our leased facilities.  At June 30, 2006, we were in compliance withall financial covenants.

AtDecember 31, 2005, we had $81.8 million of net operating losscarryforwards and $6.0 million of federal research and development tax creditcarryforwards that may be used to offset future U.S. federal taxable income.Approximately $17.2 million and $3.0 million of net operating loss and taxcredit carryforwards were acquired in the Clinsoft acquisition. These attributesmay reduce our future cash tax liability; however this benefit will bereflected through reductions to goodwill and not as reductions to income taxexpense. Additionally, we had $3.9 million of foreign net operating losscarryforwards. The net operating loss and tax credit carryforward periodextends through 2024 and both are subject to review and possible adjustment bythe taxing authorities. Also, the Internal Revenue Code contains provisionsthat may limit the net operating loss and tax credit carryforwards available inany given year in the event of certain changes in the ownership interests ofsignificant stockholders.** **We currently expect to realizerecorded deferred tax assets as of June 30, 2006 of approximately $8.0million.  Our conclusion that such assetswill be recovered is based upon our expectation that our future earningscombined with tax planning strategies available to us will provide sufficienttaxable income to realize recorded tax assets.

We believe ourexisting cash, cash equivalents, short-term investments and cash provided byoperating activities and our various debt facilities will be sufficient to meetour working capital and capital expenditure needs over 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 services and enhancements to existing services,and the continuing market acceptance of our services.  To the extent that existing cash andsecurities and cash from operations are insufficient to fund our futureactivities, we may need to raise additional funds through public or privateequity or debt financing.  From time totime, we may also enter into agreements with respect to potential investmentsin, or acquisitions of, businesses, services or technologies, which could alsorequire us to seek additional equity or debt financing.

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**Recently Issued AccountingPronouncement**

In July 2006, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (“FIN48”),*Accounting for Uncertainty in Income Taxes*,which is an interpretation of SFAS No. 109*, Accounting for IncomeTaxes*. FIN 48 clarifies the accounting for income taxes byprescribing the minimum recognition threshold a tax position is required tomeet before being recognized in the financial statements. FIN 48 also providesguidance on derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition. In addition, FIN 48clearly scopes out income taxes from FASB Statement No. 5, *Accountingfor Contingencies*. FIN 48 is effective for fiscal years beginningafter December 15, 2006. We will implement this interpretation in the fiscalyear starting January 1, 2007. We are currently analyzing the effect, if any, FIN48 will have on our consolidated financial position and results of operations.

**Off-Balance Sheet Arrangements**

 

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

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

 

*ForeignCurrency Exchange Risk*

Our results ofoperations and cash flows are subject to fluctuations due to changes in foreigncurrency exchange rates, particularly changes in the Euro, British pound,Australian dollar and Japanese yen. During the six months ended June 30, 2005 and 2006, 48% and 49%,respectively, of our revenues were generated in locations outside the UnitedStates. The majority of these revenues are denominated in currencies other thanthe U.S. dollar, as are many of the associated expenses. Except for revenuetransactions in Japan, we enter into transactions directly with substantiallyall of our foreign customers. This creates a foreign currency exchange risk forus.

As of June 30,2006, we had $6.0 million of receivables denominated in currencies other thanthe U.S. dollar. If the foreign exchange rates fluctuated by 10% as of June 30,2006, our foreign exchange receivable exposure would have fluctuated byapproximately $600,000.  In addition,although our foreign subsidiaries have intercompany accounts that eliminateupon consolidation, such accounts expose us to foreign currency rate movements.Exchange rate fluctuations on short-term intercompany accounts are recorded inour consolidated statements of operations under “other income (expense)”, whileexchange rate fluctuations on long-term intercompany accounts are recorded inour consolidated balance sheets under “accumulated other comprehensive loss” instockholders’ equity. We also maintain cash accounts denominated in currenciesother than the local currency which expose us to foreign exchange ratemovements.

We haveimplemented a risk management program under which we measure foreign currencyexchange risk monthly and manage those exposures through the use of variousinternal controls and the use of forward foreign exchange contracts. Thisprocess is designed to minimize foreign currency translation exposures thatcould otherwise affect consolidated results of operations. As of June 30, 2006,we entered into contracts to hedge approximately $2.5 million, of receivables,intercompany accounts and cash balances denominated in currencies other thanthe U.S. dollar.

*InterestRate Sensitivity*

We hadunrestricted cash, cash equivalents and short term investments totaling $63.7million at June 30, 2006.  Investments insecurities are invested primarily in high quality securities of a shortduration and are not materially affected by fluctuations in interest rates. Theunrestricted cash and cash equivalents are held for working capital purposes.We do not enter into investments for trading or speculative purposes. Due tothe short-term nature of these investments, we believe that we do not have anymaterial exposure to changes in the fair value of our investment portfolio as aresult of changes in interest rates. Declines in interest rates, however, wouldreduce future investment income.

We have a workingcapital line of credit which bears interest based upon the prime rate. AtDecember 31, 2005 and June 30, 2006, there were no amounts outstandingunder our working capital line of credit. At June 30, 2006, there was $1.5million available under the line of credit and $500,000 reserved under a letterof credit associated with our leased facilities.

**Item4.  *Controls and Procedures***

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourSecurities Exchange Act reports is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and thatsuch information is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure. In designing andevaluating the disclosure controls and procedures, management recognized thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives,as ours are designed to do,

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and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

As of June 30, 2006, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures, asdefined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in enabling us to record, process,summarize and report information required to be included in our periodic SECfilings within the required time period.

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.

**Part II—OtherInformation**

**Item 1.  *Legal Proceedings***

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

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

**CertainFactors Which May Affect Future Results**

*From time to time we update, revise and supplement therisk factors described under the title “Risk Factors” in our Annual Report onForm 10-K for the fiscal year ended December 31, 2005.  There are no material changes to the riskfactors described in the “Risk Factors” section in our Annual Report on Form10-K for the fiscal year ended December 31, 2005 other than the inclusion hereinof an additional Risk Factor below entitled “Consolidation among our clientscould cause use to lose clients, decrease the market for our products andresult in a reduction of our revenues.”*

*We operate in a rapidly changing environment thatinvolves a number of risks, some of which are beyond our control.  This discussion highlights some of the riskswhich may affect future operating results. These are the risks and uncertainties we believe are most important foryou to consider.  Additional risks anduncertainties not presently known to us, which we currently deem immaterial orwhich are similar to those faced by other companies in our industry or businessin general, may also impair our business operations.  If any of the following risks or uncertaintiesactually occurs, our business, financial condition and operating results wouldlikely suffer.*

**RisksRelated to Our Industry**

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

Our businessdepends on the clinical trial, post approval and safety monitoring activitiesconducted or sponsored by pharmaceutical, biotechnology and medical devicecompanies and other entities engaged in these activities. General economicdownturns, increased consolidation or decreased competition in the industriesin which these companies operate could result in fewer products underdevelopment or decreased pressure to accelerate product approval which, inturn, could materially adversely impact our revenues. Our operating results mayalso be adversely impacted by other developments that affect these industriesgenerally, including:

·                  the discovery ofsafety issues with approved products or products in clinical development;

·                  the assertion ofproduct liability claims;

·                  changes inthird-party reimbursement practices;

·                  changes inmedical practices; and

·                  changes in thepurchasing patterns of entities conducting clinical research and monitoringsafety.

Any decrease in researchand development expenditures or in the size, scope or frequency of clinicaltrial, post approval and safety monitoring activities conducted or sponsored bypharmaceutical, biotechnology or medical device companies or other entities

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as a result of theforegoing or other factors could materially adversely affect our operations orfinancial condition.

***We operate in a highly competitive industry and if we arenot able to compete effectively, our business and operating results will beharmed.***

The market for oursoftware products, services and hosted solutions is characterized by rapidlychanging technologies, evolving industry standards and frequent new product andservice introductions and enhancements that may render existing products andservices obsolete. Accordingly, we are susceptible to rapid and significantdeclines in market share due to unforeseen changes in the features, functionsor pricing of competing products. Barriers to entry are relatively low and,with the introduction of new technologies and new market entrants, we expectthat competition will increase. Increased competition is likely to result inpricing pressures, which could negatively impact our sales, gross margins ormarket share. Our failure to compete effectively could materially adverselyaffect our business, financial condition or results of operations.

Some of ourcurrent competitors, as well as many of our potential competitors, have greatername recognition, longer operating histories and significantly greaterresources. As a result, our competitors may be able to respond more quickly andeffectively than we can to new or changing opportunities, technologies,standards or customer requirements. In addition, current and potentialcompetitors have established, and may in the future establish, cooperativerelationships with vendors of complementary products, technologies or servicesto increase the availability of their products to the marketplace. Accordingly,new competitors or alliances may emerge that have greater market share, largercustomer bases, more widely adopted proprietary technologies, greater marketingexpertise and larger sales forces than we have, which could put us at acompetitive disadvantage. Further, in light of these advantages, even if ourproducts and services are more effective than the product or service offeringsof our competitors, current or potential customers might accept competitiveproducts and services in lieu of purchasing our software products, services andhosted solutions. We cannot assure you that we can maintain or enhance ourcompetitive position against current and future competitors.

***Changing customer or prospective customer requirements coulddecrease the demand for our products and services, which would adversely affectour revenues and operating results.***

Our future successwill depend in large part on our ability to enhance and broaden our softwareproducts, services and hosted solutions to meet the evolving needs of ourcustomers and prospective customers. To achieve our goals, we need toeffectively respond to our customers’ and prospective customers’ needs,technological changes and new industry standards and developments in a timelymanner. If we are unable to enhance our existing product and service offeringsor develop new products and services to meet changing requirements, demand forour software products, services and hosted solutions could suffer and ourrevenues and operating results could be materially adversely affected. We couldalso incur substantial costs if we need to modify our products or services, orinformation technology infrastructure, to adapt to technological changes or newindustry standards or developments.

***Changes in regulations and regulatory guidance applicable toour customers or potential customers and the approval process for theirproducts may result in our inability to continue to do business.***

Demand for oursoftware products, services and hosted solutions is largely a function ofregulation and regulatory guidance associated with the approval and safety trackingof drugs, biological products and medical devices imposed upon the clinicaltrial process and post-approval activities by the U.S. federal government andrelated regulatory authorities such as the FDA and by foreign governments. Inrecent years, efforts have been made to streamline the FDA approval process andcoordinate U.S. standards with those of other developed countries. Any changein the scope of applicable regulations and regulatory guidance could alter thetype or amount of clinical trial or safety monitoring spending or negativelyimpact interest in our software products, services and hosted solutions. Anyregulatory reform that limits or reduces the research and development or safetyspending of our customers or potential customers upon which our businessdepends could have a material adverse effect on our revenues or gross margins.

In addition, anyfailure to conform our software products, services and hosted solutions todomestic or international changes in regulations and regulatory guidanceapplicable to our customers or potential customers and the approval process fortheir products may result in our inability to continue to do business. Changingour software products, services and hosted solutions to allow our customers tocomply with future changes in regulation or regulatory guidance, eitherdomestically or internationally, could cause us to incur substantial costs. Wecannot assure you that our product and service offerings will allow ourcustomers and potential customers to stay in compliance with regulations andregulatory guidance as they develop. If our product and service offerings failto allow our customers and potential customers to operate in a manner that iscompliant with applicable regulations and regulatory guidance, clinical trialsponsors and other entities engaged in clinical trial and safety monitoringactivities may be unwilling to use our software products, services and hostedsolutions.

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***Ifentities engaged in clinical trials do not shift from traditional paper-based methodsof collecting clinical trial data to electronic system, we may not achieve themarket penetration necessary to maintain profitability.***

If entitiesengaged in clinical trials are unwilling to use our electronic data capturesolutions or to change the way of collecting clinical trial data, our futuregrowth and market share may be limited. Most clinical trials today rely on pre-printed, three-part paper casereport forms for data collection.  Ourefforts to establish an electronic process to capture clinical trial data are asignificant departure from the traditional paper-based methods of collectingclinical trial data.  As is typical fornew and rapidly evolving industries, customer demand for recently introducedtechnology is highly uncertain.  We maynot be successful in persuading entities engaged in clinical trials to changethe manner in which they have traditionally collected clinical trial data andto accept our software products, services and hosted solutions.  If we fail to convince entities engaged inclinical trials to use our methods of capturing clinical trial data, ourrevenues may be limited and we may fail to maintain profitability.

***Consolidation among our clients could cause us to loseclients, decrease the market for our products and result in a reduction of ourrevenues.***

Our customer basecould decline because of consolidation, and we may not be able to expand salesof our products and services to new clients. Consolidation in thepharmaceutical, biotechnology and medical device industries and among CROs hasaccelerated in recent years, and we expect this trend to continue. In addition,new companies or organizations that result from such consolidation may decidethat our products and services are no longer needed because of their owninternal processes or the use of alternative systems. As these entitiesconsolidate, competition to provide products and services to industryparticipants will become more intense and the importance of establishingrelationships with large industry participants will become greater. Theseindustry participants may try to use their market power to negotiate pricereductions for our products and services. Also, if consolidation of largercurrent customers occur, the combined organization may represent a largerpercentage of business for us and, as a result, we are likely to rely moresignificantly on the combined organization’s revenues to continue to achievegrowth.

**RisksRelated to Our Company**

***Oursoftware products and hosted solutions are at varying stages of marketacceptance and the failure of any of our products to achieve or maintain wideacceptance would harm our operating results.***

We began offeringour*InForm *electronic datacapture software solution for clinical trials in December 1998. Althoughthe*Clintrial* and*Clintrace* products were introduced over10 years ago, we did not begin offering these products until after ouracquisition of Clinsoft Corporation in 2001. We only began begin offering our *WebVDME,CTSD*and*WedSDM*products after our August 2005 acquisition of Lincoln. Continued use of our *InForm*,*Clintrial*and*Clintrace* software products,and broad and timely acceptance of our*WebVDME, CTSD*and*WebSDM*products,as well as integrated solutions combining one or more of our software products,is critical to our future success and is subject to a number of significantrisks, some of which are outside our control. These risks include:

·                     our customers’and prospective customers’ desire for and acceptance of our electronic datacapture, management and safety software solutions;

·                     our softwareproducts and hosted solutions’ ability to support large numbers of users andmanage vast amounts of data;

·                     our customers’ability to use our software products and hosted solutions, train theiremployees and successfully deploy our technology in their clinical trial andsafety monitoring activities;

·                     our abilityto meet product development and release schedules; and

·                     our abilityto significantly expand our internal resources and increase our capital andoperating expenses to support the anticipated growth and continued integrationof our software products, services and hosted solutions.

Our failure toaddress, mitigate or manage these risks would seriously harm our business,particularly if the failure of any or all of our software products or hostedsolutions to achieve market acceptance negatively affects our sales of ourother products and services.

***Our operating results may fluctuate and could cause themarket price of our common stock to fall rapidly and without notice.***

Our revenues andoperating results are difficult to predict and may fluctuate from quarter toquarter, particularly because of the evolving market in which we operate andour term license model. Our results of operations in any given quarter will bebased on a number of factors, including:

·                  thetiming and mix of license and services revenues, and the amount and type ofservice required in delivering certain projects;

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·                  changes in andtiming of our operating expenses;

·                  the extent towhich our software products, services and hosted solutions achieve or maintainmarket acceptance;

·                  our ability tointroduce new products and services and enhancements to our existing productsand services on a timely basis;

·                  the competitiveenvironment in which we operate;

·                  our ability tohire and retain qualified personnel;

·                  changes in theregulatory environment related to the clinical trial and safety monitoringmarket;

·                  changes in ourcustomers’ purchasing patterns;

·                  the financialcondition of our current and potential customers; and

·                  the timing, sizeand integration success of potential future acquisitions.

Asignificant portion of our operating expense is relatively fixed in nature andplanned expenditures are based in part on expectations regarding futurerevenues. Accordingly, unexpected revenue shortfalls or operating expenses maydecrease our gross margins and could cause significant changes in our operatingresults from quarter to quarter. Results of operations in any quarterly periodshould not be considered indicative of the results to be expected for anyfuture period. In addition, our future quarterly operating results mayfluctuate and may not meet the expectations of securities analysts orinvestors. If this occurs, the trading price of our common stock could fallsubstantially either suddenly or over time.

***The loss of one or more major customers could materially andadversely affect our results of operations and financial condition.***

Ourtop five customers accounted for approximately 39% of our revenues during thesix months ended June 30, 2006. One customer, GlaxoSmithKline, accountedfor approximately 17% of our total revenues for the same period. The loss ofany of our major customers could have a material adverse effect on our resultsof operations or financial condition. We may not be able to maintain ourcustomer relationships, and our customers may not renew their agreements withus, which could adversely affect our results of operations or financialcondition. A significant change in the liquidity or financial position of anyof these customers could also have a material adverse effect on the collectability of our accounts receivables, our liquidity and our future operatingresults.

***If we are unable to retain our personnel and hire additionalskilled personnel, we may be unable to achieve our goals.***

Ourfuture success depends upon our ability to attract, train and retain highlyskilled employees and contract workers, particularly our management team, salesand marketing personnel, professional services personnel and softwareengineers. Each of our executive officers and other employees could terminatehis or her relationship with us at any time. The loss of any member of ourmanagement team might significantly delay or prevent the achievement of ourbusiness or development objectives and could materially harm our business. Inaddition, because of the technical nature of our software products, servicesand hosted solutions and the dynamic market in which we compete, any failure toattract and retain qualified direct sales, professional services and productdevelopment personnel, as well as our contract workers, could have a materialadverse affect on our ability to generate sales, successfully develop newsoftware products, services and hosted solutions or software enhancements ordeliver services and solutions as requested by our customers.

***We may acquire or make investments in companies ortechnologies that could cause disruption of our business and loss of value ordilution to our stockholders.***

Fromtime to time, we evaluate potential investments in, and acquisitions of,complimentary technologies, services and businesses. We have made in the past,and may make in the future, acquisitions or significant investments in otherbusinesses. For example, we acquired Clinsoft Corporation in 2001 and Lincolnin 2005. Entering into an acquisition entails many risks, any of which couldharm our business, including:

·                  difficulties inintegrating the operations, technologies, products, existing contracts andpersonnel of the target company and realizing the anticipated synergies of thecombined businesses;

·                  the price we payor other resources that we devote may exceed the value we eventually realize orthe value we could have realized if we had allocated the purchase price orother resources to another opportunity;

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·                  potential lossof key employees, customers and strategic alliances from either our currentbusiness or the target company’s business;

·                  managing therisks of entering markets or types of businesses in which we have limited or nodirect experience;

·                  the diversion ofmanagement’s attention from other business concerns; and

·                  assumption ofunanticipated problems or latent liabilities, such as problems with the qualityof the target company’s products.

Inaddition, if we finance any future acquisitions by issuing equity securities orconvertible debt, our existing stockholders may be diluted or the market priceof our stock may be adversely affected. The failure to successfully evaluateand execute acquisitions or investments or otherwise adequately address theserisks could materially harm our business and financial results.

***As a result of long sales cycles and our business model, wemay be required to spend substantial time and expense before we recognize asignificant portion of the revenues, if any, attributable to our customercontracts.***

Thesales cycle for some of our software solutions frequently takes in excess ofnine months from initial customer contact to contract execution. During thistime, we may expend substantial time, effort and financial resources withoutrealizing any revenues with respect to the potential sale. In addition, whilewe generally begin recognizing revenues upon the execution of our agreementsfor software term licenses and related services, it may be difficult for us torapidly increase our revenues through additional sales in any period, aslicense revenues and, when applicable, related services revenues, from newcustomers is recognized over the applicable license term, typically three tofive years. As a result, we may not recognize significant revenues, if any,from some customers despite incurring considerable expense related to oursales, implementation, and service delivery processes. Even if we do realizerevenues from a contract, our term license pricing model may keep us fromrecognizing a significant portion of these revenues (including revenues forrelated services) during the same period in which sales, implementation, andservice delivery expenses were incurred. For example, pursuant to our contractwith GlaxoSmithKline, we incurred significant up-front implementation and otherservice expenses associated with delivery of services for the initial ordersunder the contract, whereas the revenues for these initial orders are beingrecognized ratably over an approximately 5-year period fromJuly 2004. Timing differences of this nature could cause our service grossmargins and profitability to fluctuate significantly from quarter to quarter.Similarly, a decline in new or renewed software term licenses in any onequarter will not necessarily be fully reflected in the revenues in that quarterand may negatively affect our revenues in future quarters. This could alsocause our operating results to fluctuate from quarter to quarter.

***We have incurred substantial losses in the past and may notcontinue to be profitable in the future.***

Weincurred significant losses in each year from our inception inSeptember 1997 through 2003 and we may incur significant operating lossesin the future. As a result of our operating losses and accretion of preferreddividends, we had an accumulated deficit of $97.1 million at June 30,2006. You should not consider recent revenue growth as indicative of our futureperformance as our operating results may fluctuate significantly from quarterto quarter. In addition, we expect our development, sales and other operatingexpenses to increase in the future. If our revenues do not grow to offset theseexpected increased expenses, we may not continue to be profitable. In fact, infuture quarters we may not have any revenue growth and our revenues coulddecline. Furthermore, if our operating expenses exceed our expectations, ourfinancial performance will be adversely affected.

***Claims that we or our technologies infringe upon theintellectual property or other proprietary rights of a third party may requireus to incur significant costs, to enter into royalty or licensing agreements orto develop or license substitute technology.***

Wehave been, and may in the future be, subject to claims that our technologiesinfringe upon the intellectual property or other proprietary rights of a thirdparty. For instance, we recently settled a lawsuit filed in 2004 byDr. Mark L. Kozam, doing business under the name MLK Software and Datasci,LLC against us and one of our customers which alleged that we infringed apatent claimed to be owned by them. We incurred substantial professional feesin connection with this claim and agreed to make a one-time payment of $8.5million to Datasci in order to settle this litigation. In addition, the vendorswho provide us with technology that we use in our technology could becomesubject to similar infringement claims. Although we believe that our softwaresolutions do not infringe the patents of any third party, we cannot assure youthat our technology does not infringe patents held by others or that they willnot in the future. Any future claims of infringement could cause us to incursubstantial costs defending against the claim, even if the claim is withoutmerit, and could distract our management from our business. Moreover, anysettlement or adverse judgment resulting from the claim could require us to paysubstantial amounts or obtain a license to continue to use the technology thatis the subject of the claim, or otherwise restrict or prohibit our use of thetechnology. There can be no assurance that we would be able to obtain a licensefrom the third party asserting the claim on commercially reasonable terms, ifat all, that we would be able to successfully develop alternative technology ona timely basis, if at all, or that we would be able to obtain a license fromanother provider of suitable alternative technology to permit us to continueoffering, and our customers to continue using, the applicable technology. Inaddition, we generally provide in our customer agreements that we willindemnify our customers against third-party

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infringementclaims relating to our technology provided to the customer, which couldobligate us to fund significant amounts. Infringement claims asserted againstus or our vendors may have a material adverse effect on our business, resultsof operations or financial condition.

***We may be unable to adequately protect, and we may incursignificant costs in defending, our intellectual property and other proprietaryrights.***

Oursuccess depends on our ability to protect our intellectual property and otherproprietary rights. We rely upon a combination of trademark, trade secret,copyright, patent and unfair competition laws, as well as license agreementsand other contractual provisions, to protect our intellectual property andother proprietary rights. In addition, we attempt to protect our intellectualproperty and proprietary information by requiring our employees and consultantsto enter into confidentiality, non-competition and assignment of inventionsagreements. To the extent that our intellectual property and other proprietaryrights are not adequately protected, third parties might gain access to ourproprietary information, develop and market products or services similar toours, or use trademarks similar to ours, each of which could materially harmour business. Existing U.S. federal and state intellectual property laws offeronly limited protection. Moreover, the laws of other countries in which wemarket our software products, services and hosted solutions may afford littleor no effective protection of our intellectual property. If we resort to legalproceedings to enforce our intellectual property rights or to determine thevalidity and scope of the intellectual property or other proprietary rights ofothers, the proceedings could be burdensome and expensive, even if we were toprevail. The failure to adequately protect our intellectual property and otherproprietary rights may have a material adverse effect on our business, resultsof operations or financial condition.

***Interruptions or delays in service from our third-party providerscould impair the delivery of our hosted solutions and harm our business.***

Wehost some of our software solutions, primarily our *InForm *hosted solution, at third-party facilities.Consequently, the occurrence of a natural disaster, technical or servicelapses, or other unanticipated problems at the facilities of our third-partyproviders could result in unanticipated interruptions in our customers’ accessto our hosted**solutions. Ourhosted services may also be subject to sabotage, intentional acts ofmalfeasance and similar misconduct due to the nature of the Internet. In thepast, Internet users have occasionally experienced difficulties with Internetand online services due to system or security failures. We cannot assure youthat our business interruption insurance will adequately compensate ourcustomers or us for losses that may occur. Even if covered by insurance, anyfailure or breach of security of our systems could damage our reputation andcause us to lose customers. Further, certain of our hosted*InForm *electronic data capturesolutions are subject to service level agreements that guarantee 95% to 99%server availability. In the event that we fail to meet those levels, whetherresulting from an interruption in service caused by our technology or that of athird-party provider, we could be subject to customer credits or termination ofthese customer contracts.

***Failure to manage our rapid growth effectively could harmour business.***

Wehave been experiencing a period of rapid growth that is placing a significantstrain on our operational and financial resources and our personnel. FromJanuary 1, 1999 to March 31, 2006, the number of our employeesincreased from 35 to 421. To manage our anticipated future growth effectively,we must continue to maintain and may need to enhance our information technologyinfrastructure, financial and accounting systems and controls and manageexpanded operations in geographically distributed locations. We will also berequired to attract, integrate, train and retain a significant number ofqualified sales and marketing personnel, professional services personnel,software engineers and other management personnel. Our failure to manage ourrapid growth effectively could have a material adverse effect on our business, operatingresults or financial condition.

***Failure of our technology and products could harm ourbusiness and operating results.***

Thetechnology underlying our software products and hosted solutions processes vastamounts of clinical and safety data. Customers relying on our products tocollect, to manage and report clinical and safety information may have agreater sensitivity to product errors and security vulnerabilities thancustomers of software products in general. In the past, failures of ourtechnology and human error have negatively impacted the data capture,management or reporting capabilities of our products, and new errors may bedetected in the future. Any delay or failure of our technology may result inthe disruption of our customers’ clinical trial or safety monitoring processesand could harm our business and operating results. Product or service errorscould materially and adversely affect our reputation, result in significantcosts to us and impair our ability to sell our products and services in thefuture. The costs incurred in correcting any defects or errors may besubstantial and could adversely affect our operating margins. In addition,security breaches, whether intentional or accidental, could expose us to a riskof loss of data, litigation and possible liability.

***The global nature of our business exposes us to multiplerisks.***

For the six months endedJune 30, 2006, approximately 49% of our revenues were derived frominternational operations. We expect that our international operations willcontinue to account for a significant portion of our revenues. As a result ofour

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international operations, we are exposed tomany risks and uncertainties, including:

·                  difficulties instaffing, managing and supporting operations in multiple countries;

·                  tariff andinternational trade barriers;

·                  fewer legalprotections for intellectual property and contract rights abroad;

·                  different andchanging legal and regulatory requirements in the jurisdictions in which wecurrently operate or may operate in the future;

·                  governmentcurrency control and restrictions on repatriation of earnings;

·                  fluctuations inforeign currency exchange and interest rates; and

·                  political andeconomic changes, hostilities and other disruptions in regions where wecurrently operate or may operate in the future.

Negativedevelopments in any of these areas in one or more countries could result in areduction in demand for our software products, services and hosted solutions,the cancellation or delay of orders already placed, threats to our intellectualproperty, difficulty in collecting receivables, and a higher cost of doingbusiness, any of which could adversely affect our business, results ofoperations or financial condition. Moreover, with regard to our internationaloperations, we frequently enter into transactions in currencies other than theU.S. dollar and we incur operating expenses in currencies other than the U.S.dollar. This creates a foreign currency exchange risk for us that could have amaterial adverse effect on our results of operations and financial condition.

***We may lose or delay revenues related to our hostedsolutions and consulting services if our customers terminate or delay theircontracts with us.***

Certainof our hosted electronic data capture and other service and consultingcontracts are subject to cancellation by our customers at any time with limitednotice. Entities engaged in clinical trials may terminate or delay a clinicaltrial for various reasons including the failure of the tested product to satisfysafety or efficacy requirements, unexpected or undesired clinical results,decisions to de-emphasize a particular product or forego a particular clinicaltrial, decisions to downsize clinical development programs, insufficientpatient enrollment or investigator recruitment and production problemsresulting in shortages of required clinical supplies. In the case of our hostedsolutions, any termination or delay in the clinical trials would likely resultin a consequential delay or termination in those customers’ service contracts.We have experienced terminations and delays of our customer service contractsin the past and expect to experience additional terminations and delays in thefuture. Because we do not recognize any portion of a hosted service contract’srevenues until the implementation cycle is complete, the termination or delayof our customers’ clinical trials could result in decreased or delayed revenuesunder these contracts which could materially harm our business.

***In the course of conducting our business, we possess orcould be deemed to possess personal medical information in connection with theconduct of clinical trials, which if we fail to keep properly protected, couldsubject us to significant liability.***

Oursoftware solutions are used to collect, manage and report information inconnection with the conduct of clinical trial and safety monitoring activities.This information is or could be considered to be personal medical informationof the clinical trial participants or patients. Regulation of the use anddisclosure of personal medical information is complex and growing. Increasedfocus on individuals’ rights to confidentiality of their personal information,including personal medical information, could lead to an increase of existing andfuture legislative or regulatory initiatives giving direct legal remedies toindividuals, including rights to damages, against entities deemed responsiblefor not adequately securing such personal information. In addition, courts maylook to regulatory standards in identifying or applying a common law theory ofliability, whether or not that law affords a private right of action. Since wereceive and process personal information of clinical trial participants andpatients from customers utilizing our hosted solutions, there is a risk that wecould be liable if there were a breach of any obligation to a protected personunder contract, standard of practice or regulatory requirement. If we fail toproperly protect this personal information that is in our possession or deemedto be in our possession, we could be subjected to significant liability.

***We could incur substantial costs resulting from productliability claims relating to our products or services or our customers’ use ofour products or services.***

Any failureor errors in a customer’s clinical trial, post approval or adverse eventreporting obligations caused or allegedly caused by our products or servicescould result in a claim for substantial damages against us by our customers orthe clinical trial participants, regardless of our responsibility for thefailure. Although we are generally entitled to indemnification under ourcustomer contracts

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against claimsbrought against us by third parties arising out of our customers’ use of ourproducts, we might find ourselves entangled in lawsuits against us that, evenif unsuccessful, divert our resources and energy and adversely affect ourbusiness. Further, in the event we seek indemnification from a customer, wecannot assure you that a court will enforce our indemnification right ifchallenged by the customer obligated to indemnify us or that the customer willbe able to fund any amounts for indemnification owed to us. We also cannotassure you that our existing general liability insurance coverage will continueto be available on reasonable terms or will be available in amounts sufficientto cover one or more large claims, or that the insurer will not disclaimcoverage as to any future claim.

***We and our products and services could be subjected togovernmental regulation, requiring us to incur significant compliance costs orto cease offering our products and services.***

Theclinical trial process is subject to extensive and strict regulation by theFDA, as well as other regulatory authorities worldwide. Our electronic datacapture, management and safety products and services could be subjected tostate, federal and foreign regulations. We cannot assure you that our productsand service offerings will comply with applicable regulations and regulatoryguidelines as they develop. If our products or services fail to comply with anyapplicable government regulations or guidelines, we could incur significantliability or be forced to cease offering our applicable products or services.Also, conforming our products and services to any applicable regulations andguidelines could substantially increase our operating expenses.

***Our business could be seriously harmed by our dependence ona limited number of suppliers.***

Wedepend upon a limited number of suppliers for specific components of oursoftware products and hosted solutions. We may increase our dependence oncertain suppliers as we continue to develop and enhance our software andservice solutions. Our dependence on a limited number of suppliers leaves usvulnerable to having an inadequate supply of required components, priceincreases, delayed supplier performance and poor component quality. Forinstance, we rely on Oracle Corporation to supply the database component of oursoftware solutions and on Equinix, Inc. to provide server facilities forour hosting services. Oracle Corporation also offers a software package that iscompetitive with our products and services. If we are unable to obtaincomponents for our software solutions from third-party suppliers in the quantitiesand of the quality that we need, on a timely basis or at acceptable prices, wemay not be able to deliver our software products, services and hosted solutionson a timely or cost-effective basis to our customers, and our business, resultsof operations and financial condition could be seriously harmed. Moreover,delays or interruptions in our service, including without limitation delays orinterruptions resulting from a change in suppliers, may reduce our revenues,cause customers to terminate their contracts and adversely affect our customerrenewals.

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

Weanticipate that our current cash and cash equivalents will be sufficient to meetour current needs for general corporate purposes. However, we may needadditional financing to execute on our current or future business strategies,including to:

·                  hire additionalpersonnel;

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

·                  enhance ouroperating infrastructure;

·                  acquirebusinesses or technologies; or

·                  otherwiserespond to competitive pressures.

If weraise additional funds through the issuance of equity or convertible debtsecurities, the percentage ownership of our stockholders could be significantlydiluted, and these newly issued securities may have rights, preferences orprivileges senior to those of existing stockholders. We cannot assure you thatadditional financing will be available on terms favorable to us, or at all. Ifadequate funds are not available or are not available on acceptable terms, whenwe desire them, our ability to fund our operations, take advantage ofunanticipated opportunities, develop or enhance our software products, servicesand hosted solutions, or otherwise respond to competitive pressures would besignificantly limited.

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**Risks Related to our Common Stock**

***The market price of our common stock may be volatile, whichcould result in substantial losses for investors purchasing shares in thepublic markets and subject us to securities class action litigation. Thecurrent market price of our common stock may not be indicative of future marketprices and we may be unable to sustain or increase the value of an investmentin our common stock.***

Marketprices for securities of software, technology and health care companies havebeen volatile. The trading price of our common stock may fluctuatesignificantly and, accordingly, may not be indicative of future trading pricesand we may be unable to sustain or increase the value of an investment in ourcommon stock. Some of the factors that may cause the market price of our commonstock to fluctuate include:

·                  changes inestimates of our financial results or recommendations by securities analysts;

·                  financialresults that are below estimate of such results;

·                  period-to-periodfluctuations in our financial results or those of companies that are perceivedto be similar to us;

·                  changes inmarket valuations of similar companies;

·                  announcements byus or our competitors of significant products, contracts, acquisitions orstrategic alliances;

·                  litigationinvolving our company or our general industry or both;

·                  the failure ofany of our software products, services and hosted solutions to achieve ormaintain commercial success;

·                  success ofcompetitive products and technologies;

·                  sales ortransfers of large blocks of stock by existing investors;

·                  future issuancesof securities or the incurrence of debt by us, or other changes in our capitalstructure;

·                  regulatorydevelopments in the United States and foreign countries;

·                  additions ordepartures of key personnel;

·                  investors’general perception of us; and

·                  changes ingeneral economic, industry and market conditions.

Inaddition, if the market for software, technology or health care stocks or thestock market in general experiences a loss of investor confidence, the tradingprice of our common stock could decline for reasons unrelated to our business,operating results or financial condition. If any of the foregoing occurs, itcould cause our stock price to fall and may expose us to class action lawsuitsthat, even if unsuccessful, could be costly to defend and a distraction tomanagement.

***Ownership of our common stock is concentrated among a smallnumber of stockholders and sales of a large block of which could cause themarket price of our common stock to drop significantly, even if our business isdoing well.***

Arelatively small number of our stockholders own large blocks of shares. Wecannot predict the effect, if any, that public sales of these shares or theavailability of these shares for sale will have on the market price of ourcommon stock. If our stockholders, and particularly our directors and officers,sell substantial amounts of our common stock in the public market, or if thepublic perceives that such sales could occur, this could have an adverse impacton the market price of our common stock, even if there is no relationshipbetween such sales and the performance of our business.

***Our directors and management may be able to exercisesignificant control over our company.***

AtJune 30, 2006, our directors and executive officers and their affiliatesbeneficially controlled approximately 17% of our outstanding common stock. As aresult, these stockholders, if they act together, are able to influence ourmanagement and affairs and all matters requiring stockholder approval,including the election of directors and approval of significant corporatetransactions. This concentration of ownership may have the effect of delayingor preventing a change in control of our company and might affect the marketprice of our common stock.

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***Delaware law and our corporate documents may prevent orfrustrate a change in control or a change in management that stockholdersbelieve is desirable.***

Provisionsof our certificate of incorporation and bylaws and Delaware law may discourage,delay or prevent a merger, acquisition or other change in control thatstockholders may consider favorable, including transactions in which you mightotherwise receive a premium for your shares. These provisions may also preventor frustrate attempts by our stockholders to replace or remove our management.These provisions include:

·                  limitations onthe removal of directors;

·                  advance noticerequirements for stockholder proposals and nominations;

·                  the inability ofstockholders to act by written consent or to call special meetings; and

·                  the ability ofour board of directors to designate the terms of and issue new series ofpreferred stock without stockholder approval, which could be used to institutea rights plan, or a poison pill, that would work to dilute the stock ownershipof a potential hostile acquirer, likely preventing acquisitions that have notbeen approved by our board of directors.

Theaffirmative vote of the holders of at least 75% of our shares of capital stockentitled to vote is necessary to amend or repeal the above provisions of ourcertificate of incorporation. In addition, absent approval of our board ofdirectors, our bylaws may only be amended or repealed by the affirmative voteof the holders of at least 75% of our shares of capital stock entitled to vote.

Inaddition, Section 203 of the Delaware General Corporation Law prohibits apublicly held Delaware corporation from engaging in a business combination withan interested stockholder, generally a person which together with itsaffiliates owns, or within the last three years has owned, 15% of our votingstock, for a period of three years after the date of the transaction in whichthe person became an interested stockholder, unless the business combination isapproved in a prescribed manner.

Theexistence of the foregoing provisions could limit the price that investorsmight be willing to pay in the future for shares of our common stock.

**Item 4.  Submission ofMatters to a Vote of Security Holders**

At theannual meeting of our stockholders held May 3, 2006, our stockholders tookthe following actions:

Ourstockholders elected Axel Bichara, Paul A. Bleicher, Richard D’Amore, James I.Cash, Jr., Gary E. Haroian, Dennis R. Shaughnessy, Dr. Eve E. Slater,and Robert K. Weiler, each to serve for a one-year term and until theirsuccessors have been duly elected and qualified or until their earlier death,resignation or removal. The directors were elected by a plurality of the votescast at the 2006 annual meeting, as follows:
| Nominee                 | ** ** | **Votes  For** | ** ** | **Shares  Withheld** |   |
|-------------------------|------------|----------------|------------|----------------------|--------|
|                    |       |           |       |                 |   |
| Axel Bichara            |       | 31,933,316     |       | 271,707              |   |
| Paul A. Bleicher        |       | 31,778,991     |       | 426,032              |   |
| Richard D’Amore    |       | 31,933,558     |       | 271,465              |   |
| James I. Cash, Jr. |       | 31,933,316     |       | 271,707              |   |
| Gary E. Haroian         |       | 31,459,578     |       | 745,445              |   |
| Dennis R. Shaughnessy   |       | 32,198,728     |       | 6,295                |   |
| Eve E. Slater           |       | 30,563,774     |       | 1,641,249            |   |
| Robert K. Weiler        |       | 32,093,933     |       | 111,090              |   |

 

Noother persons were nominated, nor received votes, for election as a director atthe 2006 annual meeting.

Ourstockholders approved the selection of Ernst & Young LLP as ourindependent registered public accounting firm for the fiscal year endingDecember 31, 2006. The votes cast at the 2006 annual meeting were asfollows: 30,532,441 shares voted for, 49,915 shares voted against and 1,622,667shares abstained from voting.

At theannual meeting, our stockholders approved an amendment to our amended andrestated 2004 Stock Option and Incentive Plan (the “2004 Option and IncentivePlan”) to increase to 3,500,000 the number of shares available for issuancethereunder, an increase of 2,000,000 shares. In addition to the increase innumber of shares available, the 2004 Option and Incentive Plan, as

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amended andrestated, among other things, provides that the exercise price of any optionsgranted under the Plan may not be less than the fair market value on the dateof grant, and restricts our ability to re-price any awards without stockholderapproval. The votes cast at the 2006 annual meeting were as follows: 17,668,140shares voted for, 11,422,233 shares voted against and 50,916 shares abstainedfrom voting. There were 3,063,774 broker non-votes.

**Item 5.  *Other Information***

Ourpolicy governing transactions in our securities by directors, officers andemployees permits our officers, directors and certain other persons to enterinto trading plans complying with Rule 10b5-1 under the SecuritiesExchange Act of 1934, as amended. We have been advised that our Vice President,Human Resources, Victor P. Becker; our Vice President, General Counsel andSecretary, D. Ari Buchler; our Vice President of Worldwide Sales, Stephen J.Powell; our Senior Vice President, Steven J. Rosenberg; and our President andChief Executive Officer, Robert K. Weiler have each entered into a trading plancovering periods after the date of this Quarterly Report in accordance withRule 10b5-1 and our policy governing transactions in our securities.Generally, under these trading plans, the individual relinquishes control overthe transactions once the trading plan is put into place. Accordingly, salesunder these plans may occur at any time, including possibly before,simultaneously with, or immediately after significant events involving ourcompany.

**We anticipate that, as permitted byRule 10b5-1 and our policy governing transactions in our securities,some or all of our officers, directors and employees may establish tradingplans in the future. We intend to disclose the names of executive officers anddirectors who establish a trading plan in compliance with Rule 10b5-1and the requirements of our policy governing transactions in our securities inour future quarterly and annual reports on Form 10-Q and 10-Kfiled with the Securities and Exchange Commission. However, we undertake noobligation to update or revise the information provided herein, including forrevision or termination of an established trading plan, other than in suchquarterly and annual reports.**

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**Item 6.    *Exhibits.***
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                  |
|--------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** ** | ** **                                                                                                                                                                                                                                                       |
| 10.1+        |       | Phase Forward Incorporated 2004 Stock Option and  Incentive Plan as Amended and Restated March 2006 (Incorporated by  reference herein to Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed with the SEC on May 8, 2006). |
| 10.2+        |       | Form of Restricted Stock Award Agreement.  (Incorporated by reference herein to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on June 12,  2006).                                                        |
| 10.3+        |       | Amendment to Executive Agreement (Incorporated by  reference herein to Exhibit 10.2 to the Company’s Current Report on  Form 8-K filed with the SEC on June 12, 2006).                                                                       |
| 31.1         |       | Certification of CEO pursuant to Rule 13a-14(a) and  15d-14(a) under the Securities Exchange Act of 1934.                                                                                                                                         |
| 31.2         |       | Certification of CFO pursuant to rules 13a-14(a) and  15d-14(a) under the Securities Exchange Act of 1934.                                                                                                                                        |
| 32.1         |       | Certification of CEO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                     |
| 32.2         |       | Certification of CFO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                     |

 

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+ Indicates amanagement contract or any compensatory plan, contract or arrangement.

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**SIGNATURES**

Pursuant to therequirement of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned there untoduly authorized.
|                      | ** ** | **Phase Forward  Incorporated** |
|----------------------|------------|---------------------------------|
|                 |       |                            |   |   |
|                      |       | By:                             |   | /s/ Robert  K. Weiler |
|                 |       | * *                        | * * | Robert K. Weiler  Chief Executive Officer  (Duly authorized officer) |
|                 |       |                            |   |   |
|                 |       | By:                             |   | /s/ Rodger  Weismann |
|                 |       | * *                        | * * | Rodger Weismann  Chief Financial Officer  (Duly authorized officer and  principal financial officer) |
|                 |       |                            |   |
| Date: August 8, 2006 |       |                            |   |

 

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**EXHIBIT INDEX**
| ExhibitNo. | ** ** | **Description**                                                                                                                                                                                                                              |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1+      |       | Phase Forward Incorporated 2004 Stock Option and  Incentive Plan as Amended and Restated March 2006 (Incorporated by reference  herein to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with  the SEC on May 8, 2006). |
| 10.2+      |       | Form of Restricted Stock Award Agreement.  (Incorporated by reference herein to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed with the SEC on June 12, 2006).                                                         |
| 10.3+      |       | Amendment to Executive Agreement (Incorporated by  reference herein to Exhibit 10.2 to the Company’s Current Report on Form 8-K  filed with the SEC on June 12, 2006).                                                                  |
| 31.1       |       | Certification of CEO pursuant to  Rule 13a-14(a) and 15d-14(a) under the Securities Exchange Act  of 1934.                                                                                                                    |
| 31.2       |       | Certification of CFO pursuant to  rules 13a-14(a) and 15d-14(a) under the Securities Exchange  Act of 1934.                                                                                                                   |
| 32.1       |       | Certification of CEO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                 |
| 32.2       |       | Certification of CFO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                 |

 

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+ Indicates a managementcontract or any compensatory plan, contract or arrangement.

49

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