Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

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

 

**For the quarterly period ended September 30, 2009**

 

**OR**

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

 

**For the transition period from                     to                    **

 

**Commission File Number: 000-50839**

 

**PhaseForward Incorporated**

(Exact name of registrant as specified in itscharter)

 

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

 

**(888) 703-1122**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by 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 check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 ofthe Exchange Act.  (Check one):

 

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

 

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

 

Asof November 1, 2009, the registrant had 43,292,866 shares of common stockoutstanding.

 

 

 

----

Table ofContents

 

**PHASE FORWARDINCORPORATED**

**QUARTERLY REPORT ON FORM10-Q**

**For the quarterly periodended September 30, 2009**

**Table of Contents**

 
| ** **                            | ** **                                                                                                                                          | **Page  Number** |
|---------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------------|
| **Part I—Financial Information** | ** **                                                                                                                                          |
|                                  |                                                                                                                                                |             |
| Item 1.                               | Condensed  Consolidated Balance Sheets as of December 31, 2008 (unaudited) and September  30, 2009 (unaudited)                                      | 3                |
|                                  |                                                                                                                                                |             |
|                                  | Condensed Consolidated Statements of Income for the  three and nine months ended September 30, 2008 (unaudited) and September 30,  2009 (unaudited) | 4                |
|                                  |                                                                                                                                                |             |
|                                  | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2008 (unaudited) and September 30, 2009  (unaudited)       | 5                |
|                                  |                                                                                                                                                |             |
|                                  | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                   | 6                |
|                                  |                                                                                                                                                |             |
| Item 2.                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                         | 25               |
|                                  |                                                                                                                                                |             |
| Item 3.                               | Quantitative  and Qualitative Disclosures about Market Risk                                                                                         | 47               |
|                                  |                                                                                                                                                |             |
| Item 4.                               | Controls and  Procedures                                                                                                                            | 48               |
|                                  |                                                                                                                                                |             |
| **Part  II—Other Information**   |                                                                                                                                                |
|                                  |                                                                                                                                                |             |
| Item 1.                               | Legal Proceedings                                                                                                                                   | 49               |
|                                  |                                                                                                                                                |             |
| Item 1A.                              | Risk Factors                                                                                                                                        | 49               |
|                                  |                                                                                                                                                |             |
| Item 2.                               | Unregistered  Sale of Equity Securities and Use of Proceeds                                                                                         | 49               |
|                                  |                                                                                                                                                |             |
| Item 5.                               | Other Information                                                                                                                                   | 49               |
|                                  |                                                                                                                                                |             |
| Item 6.                               | Exhibits                                                                                                                                            | 50               |
|                                  |                                                                                                                                                |             |
| Signatures                            |                                                                                                                                                | 51               |
|                                  |                                                                                                                                                |             |
| Exhibit  Index                        | 52                                                                                                                                                  |

 

2

----

Table ofContents

 

**Part I—Financial Information**

 

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

 

**Phase Forward Incorporated**

**Condensed Consolidated BalanceSheets**

**(unaudited)**

**(in thousands, except share andper share amounts)**

 
| ** **                                                                                             | ** ** | **December  31, 2008** | ** ** | **September  30, 2009** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| **Assets**                                                                                             |       |                   | ** ** | ** **              | ** ** |
| Current assets:                                                                                        |       |                   |       |                    |       |
| Cash and cash equivalents                                                                              |       | $                      | 131,550    |                    | $          | 53,011 |   |
| Restricted cash, current portion                                                                       |       | 500                    |       | —                  |       |
| Short-term investments                                                                                 |       | 27,893                 |       | 59,490                  |       |
| Accounts receivable, net of allowance of $578 and  $856, respectively                                  |       | 39,999                 |       | 60,366                  |       |
| Acquired future billings, current portion                                                              |       | 1,129                  |       | 516                     |       |
| Deferred set up costs, current portion                                                                 |       | 2,393                  |       | 3,142                   |       |
| Prepaid commissions and royalties, current portion                                                     |       | 4,524                  |       | 5,613                   |       |
| Prepaid expenses and other current assets                                                              |       | 4,773                  |       | 6,429                   |       |
| Deferred income taxes, current portion                                                                 |       | 12,895                 |       | 12,973                  |       |
| Securities settlement agreement                                                                        |       | —                 |       | 4,838                   |       |
|                                                                                                   |       |                   |       |                    |       |
| Total current assets                                                                                   |       | 225,656                |       | 206,378                 |       |
|                                                                                                   |       |                   |       |                    |       |
| Acquired future billings, net of current portion                                                       |       | 962                    |       | 415                     |       |
| Property and equipment, net                                                                            |       | 36,615                 |       | 43,829                  |       |
| Deferred set up costs, net of current portion                                                          |       | 1,630                  |       | 2,039                   |       |
| Prepaid commissions and royalties, net of current  portion                                             |       | 4,277                  |       | 5,786                   |       |
| Intangible assets, net of accumulated amortization  of $3,624 and $6,157, respectively                 |       | 27,586                 |       | 45,118                  |       |
| Goodwill                                                                                               |       | 39,125                 |       | 59,441                  |       |
| Deferred income taxes, net of current portion                                                          |       | 7,107                  |       | 1,693                   |       |
| Restricted cash, non-current portion                                                                   |       | 962                    |       | 962                     |       |
| Long-term investments                                                                                  |       | 18,022                 |       | 34,725                  |       |
| Securities settlement agreement                                                                        |       | 5,322                  |       | —                  |       |
| Other assets                                                                                           |       | 626                    |       | 879                     |       |
|                                                                                                   |       |                   |       |                    |       |
| Total assets                                                                                           |       | $                      | 367,890    |                    | $          | 401,265 |   |
|                                                                                                   |       |                   |       |                    |       |
| **Liabilities and Stockholders’  Equity**                                                         | ** ** | ** **             | ** ** | ** **              | ** ** |
| Current liabilities:                                                                                   |       |                   |       |                    |       |
| Accounts payable                                                                                       |       | $                      | 8,895      |                    | $          | 7,047 |   |
| Accrued expenses                                                                                       |       | 22,686                 |       | 23,969                  |       |
| Leasehold incentive obligation, current portion                                                        |       | 791                    |       | 791                     |       |
| Deferred revenues, current portion                                                                     |       | 79,918                 |       | 92,469                  |       |
|                                                                                                   |       |                   |       |                    |       |
| Total current liabilities                                                                              |       | 112,290                |       | 124,276                 |       |
|                                                                                                   |       |                   |       |                    |       |
| Deferred rent, net of current portion                                                                  |       | 564                    |       | 1,741                   |       |
| Leasehold incentive obligation, net of current  portion                                                |       | 7,248                  |       | 6,655                   |       |
| Deferred revenue, net of current portion                                                               |       | 8,600                  |       | 11,177                  |       |
| Other long-term liabilities                                                                            |       | 1,515                  |       | 1,614                   |       |
|                                                                                                   |       |                   |       |                    |       |
| Total liabilities                                                                                      |       | 130,217                |       | 145,463                 |       |
|                                                                                                   |       |                   |       |                    |       |
| Commitments and contingencies (Note 12)                                                                |       |                   |       |                    |       |
|                                                                                                   |       |                   |       |                    |       |
| **Stockholders’ equity:**                                                                         |       |                   |       |                    |       |
| Preferred stock, $0.01 par value; 5,000,000 shares  authorized, none issued                            |       | —                 |       | —                  |       |
| Common stock, $0.01 par value; 100,000,000 shares  authorized: 42,986,235 and 43,329,866, respectively |       | 430                    |       | 433                     |       |
| Additional paid-in capital                                                                             |       | 283,676                |       | 292,849                 |       |
| Treasury stock, 37,000 shares at cost                                                                  |       | (111                   | )          | (111                    | )          |
| Accumulated other comprehensive loss                                                                   |       | (672                   | )          | 167                     |       |
| Accumulated deficit                                                                                    |       | (45,650                | )          | (37,536                 | )          |
| Total stockholders’ equity                                                                        |       | 237,673                |       | 255,802                 |       |
|                                                                                                   |       |                   |       |                    |       |
| Total liabilities and stockholders’ equity                                                        |       | $                      | 367,890    |                    | $          | 401,265 |   |

 

See accompanying notes.

 

3

----

Table of Contents

 

**Phase Forward Incorporated**

**CondensedConsolidated Statements of Income**

**(unaudited)**

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

 
| ** **                                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                           | ** ** | **2008**                              | ** ** | **2009**                             | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                                                           | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                            | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| License                                                                              |       | $                                     | 12,974     |                                 | $          | 15,159 |   | $ | 38,675 |   | $ | 43,970 |   |
| Service                                                                              |       | 30,017                                |       | 37,960                               |       | 83,187 |   | 110,466 |   |
| Total revenues                                                                       |       | 42,991                                |       | 53,119                               |       | 121,862 |   | 154,436 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Costs of revenues:                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| License (2)                                                                          |       | 838                                   |       | 559                                  |       | 2,119 |   | 1,910 |   |
| Service (1), (2)                                                                     |       | 17,686                                |       | 23,076                               |       | 50,405 |   | 64,220 |   |
| Total cost of revenues                                                               |       | 18,524                                |       | 23,635                               |       | 52,524 |   | 66,130 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Gross margin:                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| License                                                                              |       | 12,136                                |       | 14,600                               |       | 36,556 |   | 42,060 |   |
| Service                                                                              |       | 12,331                                |       | 14,884                               |       | 32,782 |   | 46,246 |   |
| Total gross margin                                                                   |       | 24,467                                |       | 29,484                               |       | 69,338 |   | 88,306 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Sales and marketing (1), (2)                                                         |       | 7,024                                 |       | 8,678                                |       | 19,958 |   | 24,100 |   |
| Research and development (1)                                                         |       | 6,424                                 |       | 9,639                                |       | 18,003 |   | 27,244 |   |
| General and administrative (1), (2)                                                  |       | 6,629                                 |       | 8,796                                |       | 18,374 |   | 26,315 |   |
| Total operating expenses                                                             |       | 20,077                                |       | 27,113                               |       | 56,335 |   | 77,659 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Income from operations                                                               |       | 4,390                                 |       | 2,371                                |       | 13,003 |   | 10,647 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Other income:                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Interest income                                                                      |       | 1,483                                 |       | 331                                  |       | 4,770 |   | 1,473 |   |
| Other income                                                                         |       | (478                                  | )          | 120                                  |       | (229 | ) | 585 |   |
| Total other income                                                                   |       | 1,005                                 |       | 451                                  |       | 4,541 |   | 2,058 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Income before provision for income taxes                                             |       | 5,395                                 |       | 2,822                                |       | 17,544 |   | 12,705 |   |
| Provision for income taxes                                                           |       | 1,954                                 |       | 1,013                                |       | 6,407 |   | 4,591 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                                                           |       | $                                     | 3,441      |                                 | $          | 1,809 |   | $ | 11,137 |   | $ | 8,114 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net income per share applicable to common  stockholders:                             | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** |   | ** ** |
| Basic                                                                                |       | $                                     | 0.08       |                                 | $          | 0.04 |   | $ | 0.27 |   | $ | 0.19 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Diluted                                                                              |       | $                                     | 0.08       |                                 | $          | 0.04 |   | $ | 0.25 |   | $ | 0.18 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average number of common shares used in  net income per share calculations: |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                                                                |       | 42,194                                |       | 42,853                               |       | 42,020 |   | 42,637 |   |
|                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Diluted                                                                              |       | 44,065                                |       | 44,517                               |       | 43,879 |   | 44,338 |   |

 

----

| (1)  Amounts  include stock-based compensation expense, as follows:                   |   |   |   |   |   |
|--------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                                                       |   |   |   |   |   |   |   |   |   |
| Costs of service revenues                                                                  |   | $      | 437    |   | $      | 317 |   | $ | 1,278 |   | $ | 1,282 |   |
| Sales and marketing                                                                        |   | 393    |   | 426    |   | 1,075 |   | 1,303 |   |
| Research and development                                                                   |   | 329    |   | 1,139  |   | 931 |   | 2,465 |   |
| General and administrative                                                                 |   | 1,133  |   | 1,114  |   | 2,746 |   | 4,140 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |
| (2)  Amounts  include amortization expense of acquired intangible assets, as follows: |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |
| Costs of license revenues                                                                  |   | $      | 327    |   | $      | 208 |   | $ | 637 |   | $ | 557 |   |
| Cost of service revenues                                                                   |   | — |   | 282    |   | — |   | 804 |   |
| Sales and marketing                                                                        |   | 23     |   | 421    |   | 431 |   | 1,095 |   |
| General and administrative                                                                 |   | 7      |   | 26     |   | 7 |   | 78 |   |

 

See accompanying notes.

 

4

----

Table of Contents

 

**Phase Forward Incorporated**

**CondensedConsolidated Statements of Cash Flows**

**(unaudited)**

**(in thousands)**

 
| ** **                                                                                | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                | ** ** | **2008**                             | ** ** | **2009** | ** ** |
| ** **                                                                                | ** ** | ** **                           | ** ** | ** ** | ** ** |
| **Operating activities**                                                                  | ** ** | ** **                           | ** ** | ** ** | ** ** |
|                                                                                      |       |                                 |       |   |   |
| Net income                                                                                |       | $                                    | 11,137     |   | $ | 8,114 |   |
|                                                                                      |       |                                 |       |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:        |       |                                 |       |   |   |
| Depreciation and amortization                                                             |       | 7,149                                |       | 12,088 |   |
| Stock-based compensation expense                                                          |       | 6,030                                |       | 9,190 |   |
| Loss on disposal of fixed assets                                                          |       | 303                                  |       | 54 |   |
| Amortization of leasehold incentive obligation                                            |       | —                               |       | (593 | ) |
| Provision for allowance for doubtful accounts                                             |       | 55                                   |       | 386 |   |
| Deferred income taxes                                                                     |       | 5,739                                |       | 2,915 |   |
| Amortization of premiums or discounts on  investments                                     |       | (178                                 | )          | (178 | ) |
| Change in fair value of short-term investments                                            |       | —                               |       | (1,005 | ) |
| Change in fair value of securities settlement  agreement                                  |       | —                               |       | 484 |   |
| Changes in assets and liabilities:                                                        |       |                                 |       |   |   |
| Accounts receivable                                                                       |       | (502                                 | )          | (18,157 | ) |
| Deferred costs                                                                            |       | (1,524                               | )          | (3,453 | ) |
| Prepaid expenses and other current assets                                                 |       | 864                                  |       | (1,395 | ) |
| Accounts payable                                                                          |       | 3,843                                |       | (2,141 | ) |
| Accrued expenses                                                                          |       | 840                                  |       | (584 | ) |
| Deferred revenues                                                                         |       | 17,336                               |       | 11,304 |   |
| Deferred rent                                                                             |       | (386                                 | )          | 1,177 |   |
|                                                                                      |       |                                 |       |   |   |
| Net cash provided by operating activities                                                 |       | 50,706                               |       | 18,206 |   |
|                                                                                      |       |                                 |       |   |   |
| **Investing activities**                                                                  | ** ** | ** **                           | ** ** | ** ** | ** ** |
|                                                                                      |       |                                 |       |   |   |
| Increase (decrease) in restricted cash                                                    |       | (1,462                               | )          | 500 |   |
| Proceeds from maturities of short-term and  long-term investments                         |       | 50,325                               |       | 39,428 |   |
| Purchase of short-term and long-term investments                                          |       | (45,901                              | )          | (86,545 | ) |
| Purchase of property and equipment                                                        |       | (11,108                              | )          | (16,353 | ) |
| Cash paid for acquisitions, net of cash acquired                                          |       | (40,869                              | )          | (34,628 | ) |
|                                                                                      |       |                                 |       |   |   |
| Net cash used in investing activities                                                     |       | (49,015                              | )          | (97,598 | ) |
|                                                                                      |       |                                 |       |   |   |
| **Financing activities**                                                                  | ** ** | ** **                           | ** ** | ** ** | ** ** |
|                                                                                      |       |                                 |       |   |   |
| Proceeds from issuance of common stock                                                    |       | 1,795                                |       | 1,860 |   |
| Withholding taxes in connection with vesting of  restricted stock awards                  |       | (1,247                               | )          | (1,854 | ) |
|                                                                                      |       |                                 |       |   |   |
| Net cash provided by (used in) financing activities                                       |       | 548                                  |       | 6 |   |
|                                                                                      |       |                                 |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                             |       | (1,239                               | )          | 847 |   |
|                                                                                      |       |                                 |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                     |       | 1,000                                |       | (78,539 | ) |
| Cash and cash equivalents at beginning of period                                          |       | 133,401                              |       | 131,550 |   |
|                                                                                      |       |                                 |       |   |   |
| Cash and cash equivalents at end of period                                                |       | 134,401                              |       | 53,011 |   |
| Short-term and long-term investments at end of  period                                    |       | 43,719                               |       | 94,215 |   |
| Total cash, cash equivalents and short-term and  long-term investments at end of period   |       | $                                    | 178,120    |   | $ | 147,226 |   |
|                                                                                      |       |                                 |       |   |   |
| **Supplemental disclosure of  non-cash investing activities**                             |       |                                 |       |   |   |
| Purchase of leasehold improvements directly paid by  lessor of new facility               |       | $                                    | 6,125      |   | $ | — |   |
|                                                                                      |       |                                 |       |   |   |
| **Supplemental disclosure of cash  flows related to acquisitions of businesses (Note 5)** |       |                                 |       |   |   |
|                                                                                      |       |                                 |       |   |   |
| Cash paid for acquisition of Clarix LLC                                                   |       |                                 |       |   |   |
| Fair value of assets acquired                                                             |       | $                                    | 4,420      |   | $ | — |   |
| Liabilities assumed                                                                       |       | (3,030                               | )          | — |   |
| Acquired intangible assets                                                                |       | 22,110                               |       | — |   |
| Cost in excess of net assets acquired                                                     |       | 17,804                               |       | — |   |
| Cash paid                                                                                 |       | 41,304                               |       |   |   |
| Less cash acquired                                                                        |       | (435                                 | )          | — |   |
| Cash paid for Clarix LLC, net of cash acquired                                            |       | 40,869                               |       | — |   |
|                                                                                      |       |                                 |       |   |   |
| Cash paid for acquisition of Waban Software, Inc                                          |       |                                 |       |   |   |
| Fair value of assets acquired                                                             |       | $                                    | —     |   | $ | 990 |   |
| Liabilities assumed                                                                       |       | —                               |       | (4,032 | ) |
| Acquired intangible assets                                                                |       | —                               |       | 8,905 |   |
| Cost in excess of net assets acquired                                                     |       | —                               |       | 7,797 |   |
| Cash paid                                                                                 |       | —                               |       | 13,660 |   |
| Less cash acquired                                                                        |       | —                               |       | (32 | ) |
| Cash paid for Waban Software, Inc., net of cash  acquired                                 |       | $                                    | —     |   | $ | 13,628 |   |
|                                                                                      |       |                                 |       |   |   |
| Cash paid for acquisition of Maaguzi, LLC                                                 |       |                                 |       |   |   |
| Fair value of assets acquired                                                             |       | $                                    | —     |   | $ | 387 |   |
| Liabilities assumed                                                                       |       | —                               |       | (1,026 | ) |
| Acquired intangible assets                                                                |       | —                               |       | 5,368 |   |
| Cost in excess of net assets acquired                                                     |       | —                               |       | 6,271 |   |
| Cash paid                                                                                 |       | —                               |       | 11,000 |   |
| Less cash acquired                                                                        |       | —                               |       | — |   |
| Cash paid for Maaguzi, LLC, net of cash acquired                                          |       | $                                    | —     |   | $ | 11,000 |   |
|                                                                                      |       |                                 |       |   |   |
| Cash paid for acquisition of Covance IVRS/IWRS                                            |       |                                 |       |   |   |
| Fair value of assets acquired                                                             |       | $                                    | —     |   | $ | 1,414 |   |
| Liabilities assumed                                                                       |       | —                               |       | (2,762 | ) |
| Acquired intangible assets                                                                |       | —                               |       | 5,570 |   |
| Cost in excess of net assets acquired                                                     |       | —                               |       | 5,778 |   |
| Cash paid                                                                                 |       | —                               |       | 10,000 |   |
| Less cash acquired                                                                        |       | —                               |       | — |   |
| Cash paid for Covance IVRS/IWRS, net of cash  acquired                                    |       | $                                    | —     |   | $ | 10,000 |   |
|                                                                                      |       |                                 |       |   |   |
| Total cash paid for acquisitions of businesses, net  of cash acquired                     |       | $                                    | 40,869     |   | $ | 34,628 |   |

 

See accompanying notes.

 

5

----

Table of Contents

 

**Phase Forward Incorporated**

**Notes to Condensed ConsolidatedFinancial Statements**

**(unaudited)**

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

 

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

 

The accompanying unaudited condensed consolidated financial statementsincluded herein have been prepared by Phase Forward Incorporated (the“Company”) pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”). Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles in the United States have been condensed oromitted pursuant to such SEC rules and regulations. Management of theCompany believes that the disclosures herein are adequate to make theinformation presented not misleading. In the opinion of management, theunaudited condensed consolidated financial statements have been prepared on thesame basis as the audited consolidated financial statements and reflect allmaterial adjustments (consisting only of those of a normal and recurringnature) which are necessary to present fairly the consolidated financialposition of the Company as of September 30, 2009, the results of itsoperations for the three and nine months ended September 30, 2008 and 2009and its cash flows for the nine months ended September 30, 2008 and 2009.These unaudited condensed consolidated financial statements and notes theretoshould be read in conjunction with the audited consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008. The results of operations for theinterim periods are not necessarily indicative of the results of operations tobe expected for the year ending December 31, 2009.

 

Asof September 30, 2009, the Company’s significant accounting policies andestimates, which are detailed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008, have not changed except for theadoption or application of the accounting pronouncements applicable forsubsequent periods as set forth in Note 19.

 

OnApril 22, 2009, the Company acquired all of the outstanding common stockof Waban Software, Inc. (“Waban”), a provider of platform solutions forthe automation and compliance of clinical data analysis and reporting. Waban’s Statistical Computing Environment and Clinical Data Repository(SCE/CDR) solutions provide automation, traceability and control of the keyactivities involved in the integration, analysis and reporting on clinicaltrial data.  The results of Waban havebeen included in the Company’s unaudited condensed consolidated financialstatements since the date of acquisition (see Note 5).

 

OnJuly 27, 2009, the Company acquired Maaguzi LLC (“Maaguzi”), aprivately-held innovative provider of a Web-based product called *OutcomeLogix*, which is an electronic patient reportedoutcomes (ePRO) and late phase solution. The results of Maaguzi have been included in the Company’s unauditedcondensed consolidated financial statements since the date of acquisition (seeNote 5).

 

OnAugust 20, 2009, the Company acquired the Interactive Voice and WebResponse Services business (“Covance IVRS/IWRS”) of Covance Inc.  Theresults of Covance IVRS/IWRS have been included in the Company’s unauditedcondensed consolidated financial statements since the date of acquisition (seeNote 5).

 

TheCompany evaluates events and transactions that occur after the balance sheetdate as potential subsequent events.  TheCompany performed this evaluation through November 6, 2009, the date onwhich its financial statements were issued (see Note 20).

 

**2.****      Revenue Recognition and Deferred Set UpCosts**

 

The Company derives revenues from software licenses andservices. License revenues are derived principally from the sale of termlicenses for the following software products offered by the Company: *InFormTM, ClintrialTM,**Empirica*TM*Study*, *Empirica*TM*Trace*, *EmpiricaTMSignal,**CTSDTM, Waban CDR*TM*and WabanSCE*TM*.*Service revenues are derivedprincipally from the Company’s delivery of the hosted solutions of its *InForm,**ClarixTM,Empirica Signal,**CTSD, Empirica Study, OutcomeLogix**TM**and Covance IVRS/IWRS* software products, andconsulting services and customer support, including training, for all of theCompany’s products.

 

6

----

Table ofContents

 

Thecomponents of revenue are as follows:

 
| ** **                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                   | ** ** | **2008**                                             | ** ** | **2009**                                       | ** ** | **2008** | ** ** | **2009** | ** ** |
| License                      |       | $                                                    | 12,974     |                                           | $          | 15,159 |   | $ | 38,675 |   | $ | 43,970 |   |
| Application hosting services |       | 23,553                                               |       | 30,071                                         |       | 63,974 |   | 86,509 |   |
| Consulting services          |       | 3,488                                                |       | 4,495                                          |       | 9,703 |   | 14,056 |   |
| Customer support             |       | 2,976                                                |       | 3,394                                          |       | 9,510 |   | 9,901 |   |
| Total                        |       | $                                                    | 42,991     |                                           | $          | 53,119 |   | $ | 121,862 |   | $ | 154,436 |   |

 

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

 

TheCompany recognizes revenues when all of the following conditions are satisfied:(1) there is persuasive evidence of an arrangement; (2) the productor service has been provided to the customer; (3) the collection of feesis probable; and (4) the amount of fees to be paid by the customer isfixed or determinable.

 

TheCompany generally enters into software term licenses for its*InForm*,*Clintrial, Empirica Trace, Waban CDR*and*Waban SCE* productswith its customers for 3 to 5 year periods. License agreements for otherlicensed products are generally for annual or multi-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.

 

TheCompany’s software license revenues are earned from the sale of off-the-shelfsoftware requiring no significant modification or customization subsequent todelivery to the customer. Consulting services, which can also be performed bythird-party consultants, are deemed to be non-essential to the functionality ofthe software and typically are for trial configuration, implementationplanning, loading of software, building simple interfaces and running test dataand documentation of procedures.

 

Customersupport includes training services, telephone support and softwaremaintenance.  The Company generally bundles customer support with thesoftware license for the entire term of the arrangement. As a result, theCompany generally recognizes revenues for all elements, including consultingservices, ratably over the term of the software license and supportarrangement. The Company allocates the revenues recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For its term-based licenses, the Companyallocates to consulting services, the anticipated service effort and valuethroughout the term of the arrangement at an amount that would have beenallocated had those services been sold separately to the customer. The value ofthe Company’s consulting services sold within a bundled arrangement is equal tothe value of consulting services sold on a stand-alone basis, as the activitiesperformed under both types of arrangements are similar in nature.  Theremaining value is allocated to license and support services, with 10% of thisamount allocated to support services. The customer support services rate of 10%for multi-year term-based licenses reflects a significant discount from therate for customer support services associated with perpetual licenses due tothe reduction in the time period during which the customer can utilize theupgrades and enhancements.  The Company believes this rate is substantiveand represents an amount it believes reasonable to be allocated.  TheCompany has allocated the estimated fair value to its multiple elementarrangements to provide meaningful disclosures about each of its revenuestreams. The costs associated with the consulting and customer support servicesare expensed as incurred. There are instances in which the Company sellssoftware licenses based on usage levels. These software licenses can be basedon estimated usage, in which case the license fee charged to the customer isfixed based on this estimate. When the fee is fixed, the revenues are generallyrecognized ratably over the contractual term of the arrangement. If the fee isbased on actual usage, and therefore variable, the revenues are recognized inthe period of use. Revenues from certain follow-on consulting services, whichare sold separately to customers with existing software licenses and are notconsidered part of a multiple element arrangement, are recognized as theservices are performed.

 

7

----

Table ofContents

 

TheCompany continues to sell additional perpetual licenses for the*Clintrial, Empirica Trace, Waban CDR*and*WabanSCE*software products in certain situations to its existingcustomers with the option to purchase customer support. The Company hasestablished vendor specific objective evidence of fair value for the customersupport. Accordingly, license revenues are recognized upon delivery of thesoftware and when all other revenue recognition criteria are met. Customersupport revenues are recognized ratably over the term of the underlying supportarrangement. The Company generates customer support and maintenance revenuesfrom its perpetual license customer base. Training revenues are recognized asearned.

 

Inaddition to making its software products available to customers throughlicenses, the Company offers its*InForm*,*Empirica Signal*,*CTSD*and*Empirica Study*softwaresolutions through a hosted application solution delivered through a standardWeb-browser.  The Company’s*Clarix, OutcomeLogix* and*Covance IVRS/IWRS* solutions are exclusively hostedapplications.

 

Revenuesresulting from*InForm *and*OutcomeLogix*application hosting services consist of threestages for each clinical trial: the first stage involves application set up,including design of electronic case report forms and edit checks, installationand server configuration of the system; the second stage involves applicationhosting and related support services; and the third stage involves servicesrequired to close out, or lock, the database for the clinical trial. Revenuesresulting from *Clarix*and *CovanceIVRS/IWRS* application hosting services also consist of three stagesfor each clinical trial: the first stage involves application set up, includingdesign and set up for the subject randomization and medication inventorymanagement, installation and server configuration of the system; the secondstage involves application hosting and related support services; and the thirdstage involves services required to close out, or lock, the database for theclinical trial.  Services provided forthe *InForm, Clarix, OutcomeLogix* and *Covance IVRS/IWRS* products for the first and third stagesare provided on a fixed-fee basis based upon the complexity of the trial andsystem requirements. Services for the second stage are charged separately as afixed monthly fee. The Company recognizes revenues from all stages of the*InForm, Clarix,**OutcomeLogix*and *Covance IVRS/IWRS* hosting servicesratably over the hosting period. Fees charged and costs incurred for the trialsystem design, set up and implementation are deferred until the start of thehosting period and are amortized and recognized ratably over the estimatedhosting period. The deferred costs include incremental direct costs with thirdparties and certain internal direct costs related to the trial and applicationset up. These costs include salary and benefits associated with direct laborcosts incurred during trial set up, as well as third-party subcontract fees andother contract labor costs. Work performed outside the original scope of workis contracted for separately as an additional fee and is generally recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the service are billed based upon milestones. Fees forapplication hosting and related services in the second stage are generallybilled quarterly in advance. Bundled into this revenue element are revenues attributableto the software license used by the customer.

 

Revenuesresulting from hosting services for the*Empirica Signal*,*CTSD*and*Empirica Study* productsconsist of installation and server configuration, application hosting andrelated support services.  Services for this offering are generallycharged a monthly fixed fee.  Revenues are recognized ratably over theperiod of the service.

 

Inthe event that an application hosting customer cancels its related statement ofwork, all deferred revenues are recognized and all deferred set up costs areexpensed.  In addition, certain termination related fees may be chargedand if so, such fees are recognized in the period of termination.

 

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

 

Onecustomer, GlaxoSmithKline, accounted for approximately 12% of the Company’stotal revenues in the three months ended September 30, 2008 and 12% of theCompany’s total revenues in the nine months ended September 30, 2008. Thesame customer accounted for $863 or 2% of accounts receivable outstanding as ofDecember 31, 2008.  In the three andnine months ended September 30, 2009, no customer accounted for 10% ormore of the Company’s total revenues for the period.

 

The Company deferred$1,318 and $1,355 of set up costs and amortized $858 and $885 of set up costsin the three months ended September 30, 2008 and 2009, respectively, anddeferred $3,597 and $3,945 of set up costs and amortized $2,541 and $2,787 ofset up costs in the nine months ended September 30, 2008 and 2009,respectively.  The amortization ofdeferred set up costs is a component of cost of service revenues.

 

8

----

Table of Contents

 

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

 

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

 

The Company included $304and $191 of out-of-pocket expenses in service revenues and cost of servicerevenues in the three months ended September 30, 2008 and 2009,respectively, and included $647 and $569 of out-of-pocket expenses in servicerevenues and cost of service revenues in the nine months ended September 30,2008 and 2009, respectively.

 

**Internal Use Software and WebsiteDevelopment Costs**

 

TheCompany capitalizes qualifying computer software costs which are incurredduring the application development stage, and amortizes them over thesoftware’s estimated useful life. The Company capitalized $141 and $555 duringthe three months ended September 30, 2008 and 2009, respectively, and $337and $933 during the nine months ended September 30, 2008 and 2009respectively, related to Company-wide financial systems, which becameoperational in September 2009, and outside software development costsassociated with the Company’s hosting operation, which became operational in March 2009.  Capitalized amounts are classified as “Propertyand Equipment, net” in the accompanying unaudited condensed consolidatedfinancial statements.  The Company-wide financial system is beingamortized over five years while the outside software development costsassociated with the Company’s hosting operation is being amortized over threeyears.  Amortization expense was $17 and$48 during the three months ended September 30, 2008 and 2009,respectively, and $65 and $86 during the nine months ended September 30,2008 and 2009, respectively.

 

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

 

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

 

**3.      Prepaid Sales Commissionsand Royalties**

 

For arrangements where revenues are recognized over therelevant contract period, the Company defers related commissions paid to itsdirect sales force and software license royalties paid to third parties, andamortizes these expenses over the period in which the related revenues arerecognized.

 

Commission payments are nonrefundable unless the salesrepresentatives do not achieve their specific quota, amounts due from acustomer are determined to be uncollectible or if the customer subsequentlychanges or terminates the level of service, in which case commissions paid arerecoverable by the Company. The Company deferred $1,930 and $3,157 ofcommissions and amortized to sales and marketing expense $2,358 and $2,231 inthe three months ended September 30, 2008 and 2009, respectively, anddeferred $6,301 and $8,264 of commissions and amortized to sales and marketingexpense $6,167 and $5,940 in the nine months ended September 30, 2008 and2009, 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 $605 and $564 of royalties and amortized to cost of revenues$672 and $537 in the three months ended September 30, 2008 and 2009,respectively, and deferred $2,174 and $2,291 of royalties and amortized to costof revenues $2,012 and $2,017 in the nine months ended September 30, 2008and 2009, respectively.

 

9

----

Table ofContents

 

**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 theCompany’s product documentation under normal use and circumstances. TheCompany’s arrangements also include certain provisions for indemnifyingcustomers against liabilities if its products or services infringe a thirdparty’s intellectual property rights.

 

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

 

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

 

**5.      Acquisitions**

 

*Covance IVRS/IWRS*

 

On August 20, 2009, the Company acquired theInteractive Voice and Web Response Services business of Covance Inc.  The aggregate purchase price was $10,000 in cash, ofwhich $5,778 has been recorded as goodwill. Theacquisition of Covance IVRS/IWRS has been accounted for as a purchase, andaccordingly, all of the assets acquired and liabilities assumedin the transaction are recognized at their acquisition-date fair values, whiletransaction costs associated with the transaction are expensed as incurred.

 

*Preliminary Allocations ofAssets and Liabilities. *For thepurposes of the unaudited condensed consolidated balance sheets, the Companyhas made preliminary allocations of the purchase price for Covance IVRS/IWRS tothe net tangible assets and intangible assets, goodwill and deferred revenue.However, the Company is in the process of completing its valuations of certainintangible assets and deferred revenue. The difference between the aggregatepurchase price and the fair value of assets acquired and liabilities assumed,if any, is allocated to goodwill. The final allocations of the purchase priceto intangible assets, goodwill and deferred revenue may differ materially fromthe information presented in these unaudited condensed consolidated financialstatements. The following table summarizes the preliminary estimated fairvalues of the assets acquired and liabilities assumed at the acquisition date:

 
| ** **          | ** ** | **Preliminary Estimated   Fair Values as of   September 30, 2009** | ** ** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Current Assets      |       | $                                                                                                     | 1,414      |   |
| Intangible assets   |       | 5,570                                                                                                 |       |
| Goodwill            |       | 5,778                                                                                                 |       |
| Current liabilities |       | (2,762                                                                                                | )          |
| Net assets acquired |       | $                                                                                                     | 10,000     |   |

 

Based on preliminary allocations, $5,570 of theintangible assets acquired from Covance IVRS/IWRS relate to customerrelationships which will be amortized over a period of 15 years.  The acquired intangible assets were valued using thediscounted cash flows and relief-from royalty approaches.  If an allocated asset becomes impaired or isabandoned, the carrying value of the related intangible asset will be writtendown to its fair value and an impairment charge will be taken in the period inwhich the impairment occurs.  The acquired intangible assets aresubject to review for impairment as indicators of impairment develop and,otherwise, at least annually.

 

The difference between the consideration transferred toacquire the business and the fair value of assets acquired and liabilitiesassumed is allocated to goodwill. None of the goodwill is expected to bedeductible for income tax purposes.

 

*Covance IVRS/IWRS FinancialInformation. *The resultsof operations of Covance IVRS/IWRS have been included in the unaudited condensedconsolidated financial statements since the acquisition date. Covance IVRS/IWRShad $1,113 in revenues in the period from the acquisition date (August 20,2009) to September 30, 2009, and Covance IVRS/IWRS’s net operating loss inthe period from the acquisition date to September 30, 2009 was immaterialto the Company’s unaudited condensed consolidated financial results.

 

10

----

Table ofContents

 

*Maaguzi, LLC*

 

On July 27, 2009, the Company acquired MaaguziLLC (“Maaguzi”), a privately-held innovative provider of a Web-based productcalled *OutcomeLogix*, which is an electronicpatient reported outcomes (ePRO) and late phase solution.  The aggregate purchase price was $11,000 in cash, ofwhich $6,271 has been recorded as goodwill. The acquisition of Maaguzi extends the Company’s integrated clinicalresearch suite and marks the Company’s entry into the ePRO and observationalstudies markets.  The acquisition of Maaguzi has beenaccounted for as a purchase, and accordingly, all of the assets acquired andliabilities assumed in the transaction are recognized at their acquisition-datefair values, while transaction costs associated with the transaction areexpensed as incurred.

 

*Preliminary Allocations ofAssets and Liabilities. *For thepurposes of the unaudited condensed consolidated balance sheets, the Companyhas made preliminary allocations of the purchase price for Maaguzi to the nettangible assets and intangible assets, goodwill and deferred revenue. However,the Company is in the process of completing its valuations of certainintangible assets and deferred revenue. The difference between the aggregatepurchase price and the fair value of assets acquired and liabilities assumed,if any, is allocated to goodwill. The final allocations of the purchase priceto intangible assets, goodwill and deferred revenue may differ materially fromthe information presented in these unaudited condensed consolidated financialstatements. The following table summarizes the preliminary estimated fairvalues of the assets acquired and liabilities assumed at the acquisition date:

 
| ** **                    | ** ** | **Preliminary Estimated   Fair Values as of   September 30, 2009** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Current Assets                |       | $                                                                                                     | 190        |   |
| Property, plant and equipment |       | 197                                                                                                   |       |
| Intangible assets             |       | 5,368                                                                                                 |       |
| Goodwill                      |       | 6,271                                                                                                 |       |
| Current liabilities           |       | (339                                                                                                  | )          |
| Deferred revenues             |       | (687                                                                                                  | )          |
| Net assets acquired           |       | $                                                                                                     | 11,000     |   |

 

Based on preliminary allocations, $1,229, $2,002, $2,087and $50 of the intangible assets acquired from Maaguzi relate to developedtechnology, customer relationships, in-process research and development, andtradenames, respectively.  The acquiredintangible assets were valued using the discounted cash flows and relief-fromroyalty approaches.  Developedtechnology, customer relationships and tradenames will be amortized over aperiod of 8 years, 20 years and 1 year, respectively.  If an allocated asset becomes impaired or isabandoned, the carrying value of the related intangible asset will be writtendown to its fair value and an impairment charge will be taken in the period inwhich the impairment occurs. The acquired intangible assets are subject toreview for impairment as indicators of impairment develop and, otherwise, atleast annually.

 

The difference between the consideration transferred toacquire the business and the fair value of assets acquired and liabilitiesassumed is allocated to goodwill. None of the goodwill is expected to bedeductible for income tax purposes.

 

*Maaguzi FinancialInformation. *The resultsof operations of Maaguzi have been included in the unaudited condensedconsolidated financial statements since the acquisition date. Maaguzi had $344in revenues in the period from the acquisition date (July 27, 2009) to September 30,2009, and Maaguzi’s net operating loss in the period from the acquisition dateto September 30, 2009 was immaterial to the Company’s unaudited condensedconsolidated financial results.

 

11

----

Table ofContents

 

*Waban Software, Inc.*

 

On April 22,2009, the Company acquired all of the outstanding common stock of WabanSoftware, Inc. (“Waban”), a provider of platform solutions for theautomation and compliance of clinical data analysis and reporting. Waban’s Statistical Computing Environment and Clinical Data Repository(SCE/CDR) solutions provide automation, traceability and control of the keyactivities involved in the integration, analysis and reporting on clinicaltrial data.  The aggregate purchase price was $13,764 in cash, of which$7,797 has been recorded as goodwill.  The Company acquired the technologyof Waban to allow it to penetrate the market for statistical computing andclinical data repository solutions.  The acquisition of Waban has beenaccounted for as a purchase, and accordingly, all of the assets acquired andliabilities assumed in the transaction are recognized at their acquisition-datefair values, while transaction costs and restructuring costs associated withthe transaction are expensed as incurred.

 

*Purchase Price. *The $13,764 purchase price forWaban is based on the acquisition-date fair value of the considerationtransferred, which was calculated based on the initial cash paid followingpost-acquisition working capital adjustments. The purchase price excludestransaction fees which the Company paid on Waban’s behalf on the acquisitiondate. Working capital adjustments have been classified as “Accrued expenses” inthe accompanying unaudited condensed consolidated balance sheet for the periodended September 30, 2009. The acquisition-date fair value of theconsideration consisted of the following:

 
| ** **                         | ** ** | **Preliminary Estimated**            | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **Fair Values as of** | ** ** |
| ** **                         | ** ** | **September 30,  2009**         | ** ** |
| Cash paid                          |       | $                                    | 13,660     |   |
| Accrued working capital adjustment |       | 104                                  |       |
| Total purchase price               |       | $                                    | 13,764     |   |

 

*Preliminary Allocations ofAssets and Liabilities. *For thepurposes of the condensed unaudited consolidated balance sheets, the Companyhas made preliminary allocations of the purchase price for Waban to the nettangible assets and intangible assets, goodwill, deferred income taxes anddeferred revenue. However, the Company is in the process of completing itsvaluations of certain intangible assets and deferred revenue. The differencebetween the aggregate purchase price and the fair value of assets acquired andliabilities assumed, if any, is allocated to goodwill. The final allocations ofthe purchase price to intangible assets, goodwill, deferred income taxes anddeferred revenue may differ materially from the information presented in theseunaudited condensed consolidated financial statements. The following tablesummarizes the preliminary estimated fair values of the assets acquired andliabilities assumed at the acquisition date:

 
| ** **                    | ** ** | **Preliminary Estimated   Fair Values as of   September 30, 2009** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Current Assets                |       | $                                                                                                     | 825        |   |
| Property, plant and equipment |       | 135                                                                                                   |       |
| Other assets                  |       | 30                                                                                                    |       |
| Intangible assets             |       | 8,905                                                                                                 |       |
| Goodwill                      |       | 7,797                                                                                                 |       |
| Current liabilities           |       | (479                                                                                                  | )          |
| Deferred Income Taxes         |       | (2,421                                                                                                | )          |
| Deferred revenues             |       | (1,028                                                                                                | )          |
| Net assets acquired           |       | $                                                                                                     | 13,764     |   |

 

Based on preliminary allocations, $4,758, $3,174 and $973of the intangible assets acquired from Waban relate to developed technology,customer relationships and tradenames, respectively.  The acquired intangible assets were valuedusing the discounted cash flows and relief-from royalty approaches.  Developed technology, customer relationshipsand tradenames will be amortized over a period of 15 years, 15 years and 8years, respectively.  If an allocatedasset becomes impaired or is abandoned, the carrying value of the relatedintangible asset will be written down to its fair value and an impairmentcharge will be taken in the period in which the impairment occurs. The acquiredintangible assets are subject to review for impairment as indicators ofimpairment develop and, otherwise, at least annually.

 

The difference between the consideration transferred toacquire the business and the fair value of assets acquired and liabilitiesassumed is allocated to goodwill. None of the goodwill is expected to bedeductible for income tax purposes. As of September 30, 2009, there wereno changes in the recognized amounts of goodwill resulting from the acquisitionof Waban.

 

12

----

Table ofContents

 

*Waban FinancialInformation. *The resultsof operations of Waban have been included in the unaudited condensedconsolidated financial statements since the acquisition date. Waban had $605 inrevenues in the period from the acquisition date (April 22, 2009) to September 30,2009, and Waban’s net operating loss in the period from the acquisition date toSeptember 30, 2009 was immaterial to the Company’s unaudited condensedconsolidated financial results.

 

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

 

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

 

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

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                             | ** ** | **2009**                                       | ** ** | **2008** | ** ** | **2009** | ** ** |
| **Numerator:**                                                             |       |                                                 |       |                                           |       |   |   |   |   |
| Net income                                                                 |       | $                                                    | 3,441      |                                           | $          | 1,809 |   | $ | 11,137 |   | $ | 8,114 |   |
|                                                                       |       |                                                 |       |                                           |       |   |   |   |   |
| **Denominator:**                                                           |       |                                                 |       |                                           |       |   |   |   |   |
| Weighted-average common shares outstanding                                 |       | 42,823,272                                           |       | 43,235,883                                     |       | 42,780,615 |   | 43,139,958 |   |
| Less weighted-average unvested restricted common  stock awards outstanding |       | (629,650                                             | )          | (383,016                                       | )          | (760,272 | ) | (503,099 | ) |
| Basic weighted-average common shares outstanding                           |       | 42,193,622                                           |       | 42,852,867                                     |       | 42,020,343 |   | 42,636,859 |   |
| Dilutive effect of common stock options                                    |       | 1,334,814                                            |       | 1,027,927                                      |       | 1,314,622 |   | 1,064,590 |   |
| Dilutive effect of unvested restricted common  stock awards and units      |       | 536,779                                              |       | 636,107                                        |       | 544,115 |   | 636,747 |   |
| Diluted weighted-average common shares outstanding                         |       | 44,065,215                                           |       | 44,516,901                                     |       | 43,879,080 |   | 44,338,196 |   |
|                                                                       |       |                                                 |       |                                           |       |   |   |   |   |
| Net income per share applicable to common  stockholders:                   |       |                                                 |       |                                           |       |   |   |   |   |
| Basic                                                                      |       | $                                                    | 0.08       |                                           | $          | 0.04 |   | $ | 0.27 |   | $ | 0.19 |   |
|                                                                       |       |                                                 |       |                                           |       |   |   |   |   |
| Diluted                                                                    |       | $                                                    | 0.08       |                                           | $          | 0.04 |   | $ | 0.25 |   | $ | 0.18 |   |

 

Dilutedweighted average common shares outstanding do not include options, awards andunits outstanding to purchase 13,252 and 432,835 common equivalent shares forthe three months ended September 30, 2008 and 2009, respectively, and donot include options, awards, and units outstanding to purchase 310,299 and162,813 common equivalent shares for the nine months ended September 30,2008 and 2009, respectively, as their effect would have been anti-dilutive.

 

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

 

Thefinancial statements of the Company’s foreign subsidiaries are translated intoU.S. dollars, which is the Company’s reporting currency. The functionalcurrency of the Company’s subsidiaries in Australia, Belgium, France, India,Japan, Romania and the United Kingdom are the local currencies of thosecountries. Accordingly, the assets and liabilities of the Company’s foreignsubsidiaries are translated into U.S. dollars using the exchange rate in effectat each balance sheet date. Revenue and expense accounts are translated usingan average rate of exchange during the period. Gains and losses arising fromtransactions denominated in foreign currencies are primarily related tointercompany accounts that have been determined to be temporary in nature andcash accounts and accounts receivable denominated in non-functional currencies.

 

13

----

Table ofContents

 

TheCompany recorded foreign currency gains/(losses) of $(459) and $77 in the threemonths ended September 30, 2008 and 2009, respectively, and $(444) and $50in the nine months ended September 30, 2008 and 2009, respectively.  Such gains/(losses) are included in otherincome in the accompanying unaudited condensed consolidated statements ofincome.

 

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

 

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

 

Securitiesthat the Company has the intent and ability to hold to maturity are reported atamortized cost, which approximates market value, and are classified asheld-to-maturity. Securities for which it is not the Company’s intent to holdto maturity are classified as either available-for-sale securities or tradingsecurities. Available-for-sale securities are reported at fair value, withtemporary unrealized gains/(losses) excluded from earnings and reported in aseparate component of stockholders’ equity and other than temporary unrealizedlosses included in earnings. Trading securities are reported at fair value,with unrealized gains/(losses) included in earnings. The Company considers allhighly liquid investments with original maturities of 90 days or less at thetime of purchase to be cash equivalents and investments with originalmaturities of between 91 days and one year to be short-term investments. TheCompany considers investments with maturities greater than one year to belong-term investments.  All securities, with the exception of auction ratesecurities (“ARS”), are classified as held-to-maturity securities. The ARS aredebt instruments issued by various municipalities throughout the UnitedStates. In prior periods and up through the executionof the signed settlement agreement with UBS AG (“UBS”) in November 2008 asfurther discussed below, the ARS were classified as available-for-sale becauseit was the Company’s intent not to hold them to maturity. Upon the execution ofthe settlement agreement with UBS, the Company elected to make a one-timetransfer of the ARS from available-for-sale securities to tradingsecurities.  Accordingly, on aprospective basis, all unrealized gains/(losses) for these trading securitieshave been included in earnings.

 

Cash,cash equivalents, short-term and long-term investments as of December 31,2008 and September 30, 2009 consist of the following:

 
| ** **                      | ** ** | **December 31,  2008** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **Contracted**              | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**                 | ** ** | **Maturity**                | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash                            |       | Demand                      |       | $ | 22,487 |   | $ | 22,487 |   | $ | 22,487 |   |
| Money market funds              |       | Demand                      |       | 109,063 |   | 109,063 |   | 109,063 |   |
| Total cash and cash equivalents |       |                        |       | $ | 131,550 |   | $ | 131,550 |   | $ | 131,550 |   |
|                            |       |                        |       |   |   |   |   |   |   |
| U.S. agency notes               |       | 236 days                    |       | $ | 2,000 |   | $ | 2,000 |   | $ | 2,000 |   |
| Municipal bonds                 |       | 1 day                       |       | 1,000 |   | 1,000 |   | 1,000 |   |
| Corporate bonds                 |       | 127 days                    |       | 24,893 |   | 24,884 |   | 24,893 |   |
| Total short-term investments    |       |                        |       | $ | 27,893 |   | $ | 27,884 |   | $ | 27,893 |   |
|                            |       |                        |       |   |   |   |   |   |   |
| Auction rate securities         |       | 26 years                    |       | $ | 24,050 |   | $ | 18,022 |   | $ | 18,022 |   |
| Total long-term investments     |       |                        |       | $ | 24,050 |   | $ | 18,022 |   | $ | 18,022 |   |

 

14

----

Table of Contents

 
| ** **                      | ** ** | **September 30, 2009** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **Contracted**              | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**                 | ** ** | **Maturity**                | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash                            |       | Demand                      |       | $ | 22,269 |   | $ | 22,269 |   | $ | 22,269 |   |
| Money market funds              |       | Demand                      |       | 30,742 |   | 30,742 |   | 30,742 |   |
| Total cash and cash equivalents |       |                        |       | $ | 53,011 |   | $ | 53,011 |   | $ | 53,011 |   |
|                            |       |                        |       |   |   |   |   |   |   |
| U.S. agency notes               |       | 126 days                    |       | $ | 21,979 |   | $ | 21,982 |   | $ | 21,979 |   |
| Corporate bonds                 |       | 202 days                    |       | 18,634 |   | 18,792 |   | 18,634 |   |
| Auction rate securities         |       | 273 days                    |       | 23,900 |   | 18,877 |   | 18,877 |   |
| Total short-term investments    |       |                        |       | $ | 64,513 |   | $ | 59,651 |   | $ | 59,490 |   |
|                            |       |                        |       |   |   |   |   |   |   |
| U.S. agency notes               |       | 521 days                    |       | $ | 15,827 |   | $ | 15,945 |   | $ | 15,827 |   |
| Corporate bonds                 |       | 497 days                    |       | 18,898 |   | 19,116 |   | 18,898 |   |
| Total long-term investments     |       |                        |       | $ | 34,725 |   | $ | 35,061 |   | $ | 34,725 |   |

 

TheCompany has had no realized gains or losses from the sale of cash equivalentsor short-term investments.

 

Asof December 31, 2008 and September 30, 2009, the Company held ARStotaling $24,050 and $23,900, respectively, at par value, which were classifiedas long-term investments and short-term investments, respectively, in theaccompanying unaudited condensed consolidated balance sheets, and which arerecorded at fair value.  These ARS aredebt instruments issued by various states throughout the United States tofinance student loans.  The types of ARS that the Company owns are backedby student loans, 95% of which are guaranteed under the Federal FamilyEducation Loan Program, and all have credit ratings of AAA (or equivalent) froma recognized rating agency.  Historically, the carrying value of ARSapproximated fair value due to the frequent resetting of the interest rates.With the liquidity issues experienced in the global credit and capital markets,the Company’s ARS have experienced multiple failed auctions. While the Companycontinues to earn and receive interest on these investments at the maximumcontractual rate, the estimated fair value of these ARS no longer approximatespar value.

 

InNovember 2008, the Company accepted an offer from and entered into anagreement (the “Agreement”) with UBS with respect to all of the Company’s ARSheld at that time.  As a UBS client who holds ARS, the Company willreceive certain rights, which will entitle the Company to sell ARS to UBSaffiliates during the period from June 30, 2010 to July 2, 2012 for aprice equal to par value.  In accepting the Agreement, the Company grantedUBS the authority to sell or auction the ARS at par at any time up until theexpiration date of the Agreement and released UBS from any claims relating tothe marketing and sale of ARS.  UBS obligations under the Agreement arenot secured by its assets and do not require UBS to obtain any financing tosupport its performance obligations under the Agreement.  UBS hasdisclaimed any assurance that it will have sufficient financial resources tosatisfy its obligations under the Agreement.  If UBS has insufficientfunding to buy back the ARS and the auction process continues to fail, theCompany may incur further losses on the carrying value of the ARS.

 

TheCompany performed a fair value calculation of these ARS as of December 31,2008 and September 30, 2009.  Fair value was determined using asecondary market indications method (direct discounts) and a discounted cashflow method as recent auctions of these securities were not successful,resulting in the Company continuing to hold these securities and issuers payinginterest at the maximum contractual rate. This valuation technique considersthe following: time left to maturity, the rate of interest paid on thesecurities, the amount of principal to be repaid to the holders of thesecurities; the credit worthiness of the issuer and guarantors (if any) and thesufficiency of the collateral; trading characteristics of the securities;ability to borrow against the ARS; evidence from secondary market sales; andthe market-clearing yield for the securities. Based upon the valuationperformed, the Company concluded that the fair value of these ARS at December 31,2008 was $18,022, a decline of $6,028 from par value. Since the Company’s signedAgreement with UBS indicates that the Company intends to sell the ARS to UBSaffiliates before their stated maturity dates under the terms of the ARS, thedecline in fair value is deemed other-than-temporary. Accordingly, the Companyrecorded a loss on these securities of $6,028 in the condensed consolidatedstatement of income for the year ended December 31, 2008 as it was deemedto be other-than-temporary.

 

15

----

Table of Contents

 

Asof September 30, 2009, the Company concluded that the fair value of theseARS increased to $18,877, and therefore, recorded the change in fair value ofthese securities from December 31, 2008 of $855 in the accompanyingunaudited condensed consolidated statement of income for the nine months ended September 30,2009.  During the three months ended September 30,2009 the fair value of these ARS increased $441 and therefore, the Companyrecorded the change in fair value of these securities in the accompanyingunaudited condensed consolidated statement of income for the three months endedSeptember 30, 2009.  During the ninemonths ended September 30, 2009, $150 of the Company’s ARS were called bythe respective issuers at par value.  Asof September 30, 2009, it remained the Company’s intent to sell the ARS onJune 30, 2010 in accordance with its rights under the Agreement.  Accordingly, the ARS were reclassified fromlong-term investments to short-term investments in the accompanying unauditedcondensed consolidated balance sheets.

 

Fairvalue of the Company’s put option was determined using a discounted cash flowmethod, which considered the following factors: term of the agreement, theavailability to borrow against the ARS, the creditworthiness of UBS and currentmarket interest rates. Based on the valuation performed, the Company concludedthat the fair value of the put option was $5,322 as of December 31,2008.  Accordingly, a gain of $5,322 was recorded in the consolidatedstatement of income for the year ended December 31, 2008 with acorresponding long term asset, “securities settlement agreement”, in theconsolidated balance sheet at December 31, 2008.  Based on the valuation performed as of September 30,2009 the Company concluded that the fair market value of the securitiessettlement agreement was $4,838, resulting in a decrease in fair value of $498and $484 in the Company’s accompanying unaudited condensed consolidatedstatements of income for the three and nine months ended September 30,2009, respectively. As of September 30, 2009, it remained the Company’sintent to sell the ARS on June 30, 2010 in accordance with its rightsunder the settlement agreement and, accordingly, the Company reclassified thefair value of the “securities settlement agreement” from long-term-assets tocurrent assets in the accompanying unaudited condensed consolidated balancesheets.

 

Referto Note 18 for further discussion on the adoption of accounting pronouncementssurrounding Fair Value Measurements.

 

**9.       Goodwill andIntangible Assets**

 

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

 

Thegoodwill resulting from acquisitions is reviewed for impairment on an annualbasis*.*  Consistent with prior years, the Company willconduct its annual impairment test of goodwill during the fourth quarter of2009.  For the nine months ended September 30,2009, there have been no impairment indicators that would lead the Company towrite down an asset.

 

Arollforward of the net carrying amount of goodwill is as follows:

 
| ** **                                                              | ** ** | **Amount** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|
|                                                                    |       |       |       |
| Balance as of December 31, 2008                                    |       | $          | 39,125     |   |
|                                                                    |       |       |       |
| Purchase price adjustments associated with the  acquisition of Clarix   |       | 470        |       |
| Increase associated with the acquisition of Waban  (Note 5)             |       | 7,797      |       |
| Increase associated with the acquisition of  Maaguzi (Note 5)           |       | 6,271      |       |
| Increase associated with the acquisition of  Covance IVRS/IWRS (Note 5) |       | 5,778      |       |
| Balance as of September 30, 2009                                   |       | $          | 59,441     |   |

 

16

----

Table ofContents

 

Finite-livedintangible assets consist of the following:

 
| ** **                           | ** ** | ** **                      | ** ** | **As of December 31, 2008** | ** ** | **As of September 30, 2009** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|
| **Description**                      | ** ** | **Estimated  Useful Life** | ** ** | **Gross  Carrying  Value**                      | ** ** | **Accumulated  Amortization**               | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed technology and know-how    |       | 5-15 years                      |       | $                                               | 15,460     |                                        | $          | 1,743 |   | $ | 21,447 |   | $ | 3,103 |   |
| Customer relationships               |       | 5-20 years                      |       | 10,010                                          |       | 1,309                                       |       | 20,978 |   | 2,143 |   |
| Non-compete agreements               |       | 2-3 years                       |       | 610                                             |       | 335                                         |       | 610 |   | 412 |   |
| Tradename (1)                        |       | 1-8 years                       |       | 300                                             |       | 157                                         |       | 1,323 |   | 239 |   |
| In process research and  development |       | 8 years                         |       | —                                          |       | —                                      |       | 2,087 |   | — |   |
| Customer backlog                     |       | 3 years                         |       | 720                                             |       | 80                                          |       | 720 |   | 260 |   |
| Total                                |       |                            |       | $                                               | 27,100     |                                        | $          | 3,624 |   | $ | 47,165 |   | $ | 6,157 |   |

 

----

| (1) |   | In  connection with the acquisition of Clarix LLC (“Clarix”), the Company  identified certain acquired intangible assets which were determined to have  an indefinite life.  The assets, which  relate to the tradename of Clarix, totaled $4,110. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Amortizationexpense related to intangible assets for the three months ended September 30,2008 and 2009 was $565 and $937, respectively, and $1,075 and $2,534 for thenine months ended September 30, 2008 and 2009, respectively.

 

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

 
| **Year ended December 31,**       | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| 2009 (nine months ended  December 31, 2009) |       | $          | 1,070      |   |
| 2010                                             |       | 5,253      |       |
| 2011                                             |       | 4,604      |       |
| 2012                                             |       | 4,532      |       |
| 2013                                             |       | 4,274      |       |
| 2014 and thereafter                              |       | 21,275     |       |
| Total                                            |       | $          | 41,008     |   |

 

**10.  Accrued Expenses**

 

Accruedexpenses consist of the following:

 
| ** **                           | ** ** | **As of  December 31,** | ** ** | **As of  September 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2008**                          | ** ** | **2009**                           | ** ** |
| Accrued payroll and related benefits |       | $                                 | 14,108     |                               | $          | 15,692 |   |
| Accrued royalties                    |       | 1,839                             |       | 1,858                              |       |
| Loss on foreign exchange contracts   |       | 1,059                             |       | 46                                 |       |
| Lease exit costs                     |       | 527                               |       | —                             |       |
| Accrued other expenses               |       | 5,153                             |       | 6,373                              |       |
|                                 |       |                              |       |                               |       |
| Total                                |       | $                                 | 22,686     |                               | $          | 23,969 |   |

 

**11.**    **Restricted Cash**

 

Asof December 31, 2008, the Company had a $500 collateral obligation for itsprior corporate headquarters facility lease, which was secured by a certificateof deposit.  The certificate of deposit was classified as “Restrictedcash, current portion” in the accompanying unaudited condensed consolidatedbalance sheet.  In connection with therelocation of the Company’s corporate headquarters, the $500 collateralobligation was terminated and, as such, this amount is no longer classified as“Restricted cash, current portion” as of September 30, 2009.

 

17

----

Table ofContents

 

Inconnection with the signing of a lease on February 13, 2008 to secureoffice space for the Company’s new corporate headquarters at 77 Fourth Avenue,Waltham, Massachusetts, the Company deposited with the landlord anunconditional, irrevocable letter of credit in the landlord’s favor in theamount of $962, secured by a certificate of deposit. The certificateof deposit has been classified as “Restricted cash, net of current portion” inthe accompanying unaudited condensed consolidated balance sheets as of December 31,2008 and September 30, 2009.  See Note 12 for further discussionregarding this lease.

 

**12.    Commitments andContingencies**

 

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

 

On August 17, 2009,the Company entered into a lease (“Clarix Lease”) with KBS Five Tower Bridge,L.L.C. to secure office space for the Company’s Interactive Response Technologybusiness operations at 300 Barr Harbor Drive, West Conshocken, Pennsylvania.The commencement date for occupancy under the Clarix Lease was September 2009.  The Clarix Lease provides for the rental of44,907 square feet of space and has an initial term of 10 years and one month.The Company can, subject to certain conditions, extend this term by exercisingup to two consecutive five-year options. The annual rent under the Clarix Lease for the first year is $1,325, orapproximately $110 per month, with annual escalations in rent for eachsubsequent year in the amount of $22, or fifty cents per rentable squarefoot.  The total base rent payable in theinitial term is $14,258.

 

On February 13,2008, the Company entered into a lease (“Lease”) with BP Fourth Avenue, L.L.C.(the “Landlord”) to secure office space for the Company’s current corporateheadquarters at 77 Fourth Avenue, Waltham, Massachusetts. The commencement datefor occupancy under the Lease was December 2008. The lease for theCompany’s previous corporate headquarters at 880 Winter Street in Waltham,Massachusetts expired in February 2009.  The Lease provides for therental of 165,129 square feet of space and has an initial term of 10 years andthree months. The Company can, subject to certain conditions, extend this termby exercising up to two consecutive five year options. The Company is notrequired to pay any rent for the first three months of the initial Leaseterm.  After the initial three months, the annual rent under the Lease foryears one through five is $6,600, or approximately $548 per month.  Foryears six through ten, the annual rent will be $7,200, or approximately $603per month.  The total base rent payable in the initial term is $69,100. In connection with the signing of the Lease, the Company has deposited with theLandlord an unconditional, irrevocable letter of credit in Landlord’s favor inthe amount of $962.

 

**13.    Leasehold Incentive Obligation**

** **

In conjunction with the February 2008lease agreement for the Company’s current headquarters, the landlord agreed toreimburse the Company for leasehold improvements totaling $8,104, which wasreceived in 2008.  The leasehold improvements are recognized in propertyand equipment on the consolidated balance sheet, with the correspondingreimbursement recognized as “leasehold incentive obligation” on theconsolidated balance sheet.  The amount of the incentive will be amortizedon a straight-line basis over the lease term as a reduction of rental expense atthe beginning of occupancy.  The leasehold improvements in property andequipment will be amortized over the shorter of the lease term or the estimateduseful life of the asset.  The Company amortized the leasehold incentiveobligation as a reduction to rent expense of $198 and 594 in the three and ninemonths ended September 30, 2009, respectively.  In the three and nine months ended September 30,2008 there were no amounts expensed relating to the amortization of theleasehold incentive obligation.

 

18

----

**Table of Contents**

*** ***

**14.    Stockholders’ Equity and Stock-BasedCompensation**

** **

*Stock-basedCompensation Expense*

 

Forstock options issued under the Company’s 2004 Stock Option and Incentive Plan(the “2004 Plan”), the fair value of each option grant is estimated on the dateof grant using the Black-Scholes pricing model, and an estimated forfeiturerate is used when calculating stock-based compensation expense for theperiod.  For restricted stock awards andunits issued under the Company’s 2004 Plan, the fair value of each grant iscalculated based on the Company’s stock price on the date of grant and anestimated forfeiture rate when calculating stock-based compensation expense forthe period.  During the three monthsended September 30, 2008 and 2009, the Company recorded $2,292 and $2,996of aggregate stock-based compensation expense, respectively, and $6,030 and$9,190 in the nine months ended September 30, 2008 and 2009,respectively.  As of September 30,2009, there was $26,546 of unrecognized stock-based compensation expenserelated to stock-based awards that is expected to be recognized over a weightedaverage period of 2.35 years.

 

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

 
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                             | ** ** | **2009**                                       | ** ** | **2008** | ** ** | **2009** | ** ** |
| Restricted stock units and awards |       | 5.00                                                 | %          | 5.25                                           | %          | 5.00 | % | 5.25 | % |
| Service-based stock options       |       | 8.00                                                 | %          | 9.00                                           | %          | 8.00 | % | 9.00 | % |
| Milestone options                 |       | 12.00                                                | %          | 12.00                                          | %          | 12.00 | % | 12.00 | % |

 

*Common Stock*

 

In the three and ninemonths ended September 30, 2009, the Company issued 54,148 and 292,427shares of common stock, respectively, in connection with the exercise of stockoptions resulting in proceeds of $378 and $1,619, respectively.  In the three and nine months ended September 30,2009, the Company issued zero and 18,415 shares of common stock under the 2004Employee Stock Purchase Plan resulting in proceeds of $0 and $241,respectively.  In the three and ninemonths ended September 30, 2009, the Company released 34,052 and 374,585 sharesof common stock, respectively, in connection with the vesting of restrictedstock awards and units and retired 10,095 and 133,056 of these shares,respectively, to cover withholding taxes in the amount of $136 and $1,854,respectively.

 

19

----

Table ofContents

 

*Stock Option Activity*

 

Asummary of stock option activity under the Phase Forward Incorporated 1997Stock Option Plan, the Phase Forward Incorporated 2004 Stock Option andIncentive Plan and the 2003 Non-Employee Director Stock Option Plan as ofSeptember 30, 2009, and changes during the nine months ended September 30,2009, is as follows:

 
| ** **                                                         | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price  per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate Intrinsic  Value (2)** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------|------------|
| Outstanding as of December 31, 2008                           |       | 2,187,123                  |       | $                                                          | 4.84       |                                                             | 4.77       |                               |       |   |
| Granted                                                            |       | —                     |       | —                                                     |       |                                                             |       |                               |       |
| Exercised                                                          |       | (292,427                   | )          | 5.54                                                       |       |                                                             |       | $                                  | 2,591      |   |
| Canceled                                                           |       | 281                        |       | 6.53                                                       |       |                                                             |       |                               |       |
|                                                               |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Outstanding as of September 30, 2009                          |       | 1,894,977                  |       | $                                                          | 4.73       |                                                             | 3.94       |                               | $          | 17,645 |   |
|                                                               |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Exercisable as of September 30, 2009                          |       | 1,815,018                  |       | $                                                          | 4.66       |                                                             | 3.87       |                               | $          | 17,027 |   |
|                                                               |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Vested or expected to vest as of  September 30, 2009 (1) |       | 1,888,294                  |       | $                                                          | 4.72       |                                                             | 3.93       |                               | $          | 17,594 |   |

 

----

| (1)    |   | The  vested or expected to vest options at September 30, 2009 include both  the vested options and the number of options expected to vest calculated  after applying an estimated forfeiture rate to the unvested options.                                                                                                      |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                 |
| (2)    |   | The  aggregate intrinsic value for shares outstanding, exercisable and vested is  calculated based on the positive difference between the fair value per share  of the Company’s common stock on September 30, 2009 of $14.04, or the  date of exercise, as applicable, and the exercise price of the underlying  options. |

 

*Restricted Stock Awards and Unit Activity*

 

Asummary of activity related to restricted common stock awards and unit awardsas of September 30, 2009 and changes during the nine months ended September 30,2009, is as follows:

 
| ** **                                   | ** ** | **Number  of  Shares** | ** ** | **Market  Price  Per Share** | ** **    | **Weighted  Average  Grant Date  Fair Value  Per Share** | ** ** | **Weighted  Average  Remaining  contractual  Term  (years)** | ** ** | **Aggregate Intrinsic  Value (2)** | ** ** |
|----------------------------------------------|------------|------------------------|------------|------------------------------|---------------|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------|------------|
| Unvested at December 31, 2008           |       | 2,139,964              |       | $                            | 10.85 - 23.20 |                                                     | $          | 15.66                                                        |       |                               |       |   |   |
| Granted                                      |       | 967,294                |       | 11.10 - 15.73                |          |                                                     |       |                                                         |       |                               |       |
| Vested                                       |       | (374,585               | )          | 12.12 - 18.72                |          |                                                     |       |                                                         |       |                               |       |
| Forfeited                                    |       | (45,687                | )          | 10.85 - 23.03                |          |                                                     |       |                                                         |       |                               |       |
| Unvested at September 30, 2009          |       | 2,686,986              |       | $                            | 10.85 - 23.20 |                                                     | $          | 15.36                                                        |       | 2.36                               |       | $ | 37,725 |   |
|                                         |       |                   |       |                         |          |                                                     |       |                                                         |       |                               |       |
| Expected to be free of restrictions (1) |       | 2,195,589              |       | $                            | 10.85 - 23.20 |                                                     | $          | 15.36                                                        |       | 2.35                               |       | $ | 30,826 |   |

 

----

| (1)    |   | The  expected to be free of restrictions at September 30, 2009 was calculated  by applying an estimated forfeiture rate to the unvested shares.     |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                     |
| (2)    |   | The  aggregate intrinsic value is calculated based on the fair value per share of  the Company’s common stock on September 30, 2009 of $14.04. |

 

20

----

**Table of Contents**

*** ***

**15.   Comprehensive Income**

** **

TheCompany’s other comprehensive income relates to foreign currency translationadjustments and unrealized losses on its ARS that were classified asavailable-for-sale in 2008.  For thethree and nine months ended 2009 there were no unrealized gains or losses onARS as the Company elected to make a one-time transfer of the ARS fromavailable-for-sale to trading securities for the fiscal period ended December 31,2008.  Accumulated other comprehensive income is presented separately onthe balance sheet as required.

 

Comprehensiveincome consisted of the following:

 
| ** **                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                             | ** ** | **2009**                                       | ** ** | **2008** | ** ** | **2009** | ** ** |
| Net income                                                  |       | $                                                    | 3,441      |                                           | $          | 1,809 |   | $ | 11,137 |   | $ | 8,114 |   |
| Cumulative Translation adjustment                           |       | (1,138                                               | )          | 245                                            |       | (621 | ) | 839 |   |
| Impairment of auction rate securities, net of tax  (Note 8) |       | 14                                                   |       | —                                         |       | (782 | ) | — |   |
| Comprehensive income                                        |       | $                                                    | 2,317      |                                           | $          | 2,054 |   | $ | 9,734 |   | $ | 8,953 |   |

 

**16.   ForwardForeign Exchange Contracts**

 

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

 

Thefollowing table summarizes the outstanding forward foreign exchange contractsheld by the Company as of December 31, 2008 and September 30, 2009:

 
| ** **    | ** ** | ** **          | ** ** | **As of December 31, 2008** | ** ** | **As of September 30, 2009**         | ** ** |
|---------------|------------|---------------------|------------|-------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Currency**  | ** ** | **Hedge Type** | ** ** | **Local  Currency********Amount**               | ** ** | **Approximate********U.S. Dollar  Equivalent** | ** ** | **Local********Currency********Amount** | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       | Buy                 |       | 1,200                                           |       | $                                                   | 1,765      |   | — |   | $ | — |   |
| British pound |       | Sale                |       | —                                          |       | —                                              |       | 1,800 |   | 2,873 |   |
| Euro          |       | Sale                |       | 7,500                                           |       | 10,454                                              |       | 2,000 |   | 2,924 |   |
| Japanese yen  |       | Sale                |       | 45,000                                          |       | 477                                                 |       | — |   | — |   |
|          |       |                |       |                                            |       |                                                |       |   |   |   |   |
|          |       |                |       |                                            |       | $                                                   | 12,696     |   |   |   | $ | 5,797 |   |

 

The forward foreign exchange contracts areshort-term and generally mature within one month of origination.

 

Realizedand unrealized foreign currency gains and losses, net of hedging, are accountedfor in other income.  The Companyrecorded foreign currency gains/(losses) of $(459) and $77 in the three monthsended September 30, 2008 and 2009. The Company recorded foreign currency gains/(losses) of $(444) and $50in the nine months ended September 30, 2008 and September 30, 2009,respectively.  The Company settlesforward foreign exchange contracts in cash.

 

21

----

Table ofContents

 

**17.**          IncomeTaxes

 

TheCompany’s effective tax rate for the three months ended September 30, 2008and 2009 was 36%. For the nine months ended September 30, 2008 and 2009,the Company’s effective tax rates were 37% and 36%, respectively.  In the three months ended September 30,2008 and 2009, the Company’s effective tax rate was lower than its statutoryrate of 37% primarily due to the tax benefits related to the sale of incentivestock options within the period.  In thenine months ended September 30, 2009, the Company’s effective tax rate waslower than its statutory rate of 37% primarily due to the release of a portionof its unrecognized tax benefits as a result of the closing of a statute oflimitation in a foreign tax jurisdiction.

 

Asof September 30, 2009, the Company had a liability of $1,524 for netunrecognized tax benefits, all of which would favorably impact the Company’seffective tax rate if recognized.  The Company recognizes interest andpenalties related to uncertain tax positions as a component of income taxexpense.  As of September 30, 2009, the Company had approximately $51and $40, respectively, of accrued interest and penalties related tounrecognized tax benefits.  The Company anticipates a reduction ofapproximately $291 to the amount of unrecognized tax benefits over the nexttwelve months associated with lapsing statutes of limitations.  The unrecognizedtax liability of $1,524 and accrued interest and penalties of $91 areclassified as other long-term liabilities on the unaudited condensedconsolidated balance sheet.

 

**18.     Fair Value Measurements**

 

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

 

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

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

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

 

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

 

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

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

*Costapproach* - Based on the amount that currently would berequired to replace the service capacity of an asset (replacement cost)

 

22

----

Table ofContents

 

Thefollowing table sets forth the Company’s financial instruments carried at fairvalue and using the lowest level of input as of September 30, 2009:

 
| ** **                                 | ** ** | **Quoted  Prices**       | ** ** | **Significant  Other** | ** ** | **Significant**  | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|------------------------|------------|------------------|------------|------------|------------|
| ** **                                 | ** ** | **in  Active Markets**   | ** ** | **Observable**         | ** ** | **Unobservable** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **for  Identical Items** | ** ** | **Inputs**             | ** ** | **Inputs**       | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Level  1)**           | ** ** | **(Level  2)**         | ** ** | **(Level  3)**   | ** ** | **Total**  | ** ** |
|                                       |       |                     |       |                   |       |             |       |       |       |
| Assets:                                    |       |                     |       |                   |       |             |       |       |       |
|                                       |       |                     |       |                   |       |             |       |       |       |
| Money market funds                         |       | $                        | 30,742     |                   | $          | —           |       | $          | —     |   | $ | 30,742 |   |
| Restricted cash                            |       | 962                      |       | —                 |       | —           |       | 962        |       |
| Total cash equivalents and restricted cash |       | $                        | 31,704     |                   | $          | —           |       | $          | —     |   | $ | 31,704 |   |
|                                       |       |                     |       |                   |       |             |       |       |       |
| U.S. agency notes                          |       | $                        | —     |                   | $          | 21,979           |       | $          | —     |   | $ | 21,979 |   |
| Corporate bonds                            |       | —                   |       | 18,634                 |       | —           |       | 18,634     |       |
| Securities settlement agreement (1)   |       | —                   |       | —                 |       | 4,838            |       | 4,838      |       |
| Auction rate securities (1)                |       | —                   |       | —                 |       | 18,877           |       | 18,877     |       |
| Total short-term investments               |       | $                        | —     |                   | $          | 40,613           |       | $          | 23,715     |   | $ | 64,328 |   |
|                                       |       |                     |       |                   |       |             |       |       |       |
| U.S. agency notes                          |       | $                        | —     |                   | $          | 15,827           |       | $          | —     |   | $ | 15,827 |   |
| Corporate bonds                            |       | —                   |       | 18,898                 |       | —           |       | 18,898     |       |
| Total Long-term investments                |       | $                        | —     |                   | $          | 34,725           |       | $          | —     |   | $ | 34,725 |   |
|                                       |       |                     |       |                   |       |             |       |       |       |
| Total Assets                               |       | $                        | 31,704     |                   | $          | 75,338           |       | $          | 23,715     |   | $ | 130,757 |   |

 

----

| (1) |   | The Company’s investments  in ARS and the securities settlement agreement with UBS are classified within  Level 3 because there are currently no active markets for ARS and the  Company is unable to obtain independent valuations from market sources.  Therefore, the ARS were primarily valued based on an income approach using an  estimate of future cash flows.  For additional information regarding  ARS, see Note 8. |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Thefollowing table sets forth a summary of changes in the fair value of theCompany’s Level 3 financial assets for the nine months ended September 30,2009:

 
| ** **                                                  | ** ** | **Level 3 Financial** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **Assets**                      | ** ** |
| Balance, beginning of period                                |       | $                               | 23,344     |   |
| Transfers in (out) of Level 3                               |       | —                          |       |
| Sales                                                       |       | (150                            | )          |
| Realized gains/(losses)                                     |       | —                          |       |
| Unrealized gains/(losses) on securities held at  period end |       | 521                             |       |
| Balance, end of period                                      |       | $                               | 23,715     |   |

 

Realizedgains and losses from sales of the Company’s investments are included in “Otherincome” and unrealized gains and losses are included as a separate component ofequity, net of tax, unless the loss is determined to be other-than-temporary.

 

TheCompany measures eligible assets and liabilities at fair value with changes invalue recognized in earnings. Fair value treatment may be elected either uponinitial recognition of an eligible asset or liability or, for an existing assetor liability, if an event triggers a new basis of accounting. The Company didnot elect to re-measure any of its existing financial assets or liabilities,and did not elect the fair value option for any financial assets andliabilities transacted in the year-ended December 31, 2008, except for theput option related to the Company’s ARS that was recorded in conjunction with asettlement agreement with UBS as more fully described in Note 8.

 

23

----

Table ofContents

 

**19.****      ****Recently Issued AccountingPronouncements**

 

***Newly Adopted AccountingPronouncements***

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007),*Business Combinations* (“SFAS No. 141(R)”)(subsequently this standard has been codified under FASB ASC Topic 805), which requiresan acquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree at the acquisition date, measured attheir fair values as of that date, with limited exceptions.  This methodreplaces the cost-allocation method, which required the cost of an acquisitionto be allocated to the individual assets acquired and liabilities assumed basedon their estimated fair values.  The revised authoritative guidance willnow require the following: acquisition costs to be expensed as incurred,restructuring costs associated with a business combination must be expensedprior to the acquisition date and changes in deferred tax asset valuationallowances and income tax uncertainties after the acquisition date generallywill affect income tax expense.  The revised authoritative guidance appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008, which is the Company’s 2009 fiscal year.  Earlier adoption isprohibited.  The adoption of this revisedauthoritative guidance has and is expected to have a significant impact onthe Company’s accounting for prior and future acquisitions.

 

In April 2009, theFASB issued FASB Staff Position No. 141(R)-1 (“FSP FAS 141(R)-1”*), Accounting for Assets Acquired and LiabilitiesAssumed in a Business Combination That Arise from Contingencies*(subsequently this standard has beencodified under FASB ASC Topic 805). The revised authoritative guidance provides additionalclarification on the initial recognition and measurement of assets acquired andliabilities assumed in a business combination that arise fromcontingencies.  The revised authoritative guidance is effective for all fiscalyears beginning on or after December 15, 2008.  To date, the revised authoritativeguidance has not had a significant impact on the accounting for any businessesacquired.  However, it may have amaterial impact on how we account for future acquisitions. 

 

In April 2009, theFASB issued FASB Staff Position No. 107-1 (“FSP FAS 107-1”) and APB 28-1(“APB 28-1”),*Interim Disclosures about FairValue of Financial Instruments,* (subsequently these standards havebeen codified under FASB ASC Topic 825) which provide additional application guidanceand enhance disclosures regarding fair value measurements and impairments ofsecurities. The guidance is effective for interim reportingperiods ending after June 15, 2009. The adoption of this guidance did nothave a material effect on the Company’s consolidated financial position andresults of operations.

 

In April 2009, theFASB issued FASB Staff Position No. 115-2 (“FSP FAS 115-2”) and FASB StaffPosition No. 124-2 (“FSP FAS 124-2”),*Recognition and Presentation of Other-Than-Temporary Impairments*(subsequently these standards have beencodified under FASB ASC Topic 320), which amends theother-than-temporary impairment guidance for debt and equity securities. Theguidance is effective for interim and annual reporting periods ending after June 15,2009.  The adoption of this guidance didnot have a material effect on the Company’s consolidated financial position andresults of operations.

 

In April 2009, theFASB issued FSP Issue No. FAS No. 157-4 (“FSP FAS 157-4”),*Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions that are not Orderly*. FSP FASNo. 157-4, (subsequently these standards have been codified under FASB ASCTopic 820), which provide guidance on determining fair value when the volume and levelof activity for the asset or liability have significantly decreased and identifying transactions that are notorderly. The guidance providesfurther assistance in estimating fair value. The guidance is effective inreporting periods ending after June 15, 2009. The adoption of thisguidance did not have a material effect on the Company’s consolidated financialposition and results of operations.

 

InJune 2009, the Financial Accounting Standards Board (“FASB”) issued Statementof Financial Accounting Standard (“SFAS”) No. 168, *The FASB Accounting Standards Codification and the Hierarchy ofGenerally Accepted Accounting Principles, a replacement of FASB Statement No.162*.  This statement modifies the Generally Accepted AccountingPrinciples (“GAAP”) hierarchy by establishing only two levels of GAAP:authoritative and nonauthoritative accounting literature. Effective September2009, the FASB Accounting Standards Codification (“ASC”), also knowncollectively as the “Codification,” is considered the single source ofauthoritative U.S. accounting and reporting standards, except for additionalauthoritative rules and interpretive releases issued by the SEC. Nonauthoritative guidance and literature would include, among other things,FASB Concepts Statements, American Institute of Certified Public AccountantsIssue Papers and Technical Practice Aids and accounting textbooks. TheCodification was developed to organize GAAP pronouncements by topic so thatusers can more easily access authoritative accounting guidance.  It isorganized by topic, subtopic, section, and paragraph, each of which isidentified by a numerical designation.  This statement appliesbeginning in the third quarter of 2009.  All accounting referenceshave been updated, and therefore SFAS references have been replaced with ASCreferences.

 

***Recent Accounting PronouncementsNot Yet Adopted***

 

In October 2009, theFASB issued Accounting Standards Update (“ASU”) No. 2009-13, “RevenueRecognition (Topic 605) — Multiple-Deliverable Revenue Arrangements.” ASUNo. 2009-13 addresses the accounting for multiple-deliverable arrangementsto enable vendors to account for products or services(deliverables) separately rather than as a combined unit. This guidanceestablishes a selling price hierarchy for determining the selling price of adeliverable, which is based on: (a) vendor-specific objective evidence;(b) third-party evidence; or (c) estimates. This guidance alsoeliminates the residual method of allocation and requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU No. 2009-13 is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010 and early adoption ispermitted. A company may elect, but will not be required, to adopt the amendmentsin ASU No. 2009-13 retrospectively for all prior periods. The Company iscurrently evaluating the effect that adoption of this update will have, if any,on the Company’s financial position or results of operation.

 

24

----

Table ofContents

 

**20.****      ****Subsequent Event**

 

*CommonStock Repurchase (Non-recognized subsequent event)*

 

On November 3,2009, the Company’s board of directors authorized the repurchase of up to$40,000 of its common stock, par value $0.01 per share, through a sharerepurchase program. As authorized by the program, shares may be purchased inthe open market or through privately negotiated transactions in a manner consistentwith applicable securities laws and regulations, including pursuant to a Rule 10b5-1plan maintained by the Company. This share repurchase program does not obligatethe Company to acquire any specific number of shares and may be extended, suspendedor discontinued at any time. All repurchases are expected to be funded from theCompany’s cash and investment balances. While the Company’s board of directorshas approved the share purchasing guidelines, the timing of the repurchases andthe exact number of shares of common stock to be purchased will be determinedat the Company management’s discretion, and will depend upon on marketconditions and other factors, including price, corporate and regulatoryrequirements and alternative investment opportunities. The repurchase programis currently scheduled to terminate on November 9, 2010.

 

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

** **

*The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our unaudited condensed consolidated financial statements and relatednotes thereto that appear elsewhere in this Quarterly Report on Form 10-Qand the audited financial statements and related notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year ended December 31,2008, which has been filed with the Securities and Exchange Commission (“SEC”).*

 

**Overview**

 

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

 

**Acquisitions**

 

Fromtime to time we have expanded our product and service offerings through theacquisition of other businesses or technologies; transactions occurring withinthe last year are described below.

 

*Covance IVRS/IWRS*

 

On August 20, 2009, we acquired the InteractiveVoice and Web Response Services IVRS/IWRS business (“Covance”) of CovanceInc.   The aggregate purchase price was$10.0 million in cash.  The acquisitionwill be accounted for as a purchase with all of the assets acquired and liabilities assumedin the transaction recognized at their acquisition-date fair values, whiletransaction costs associated with the transaction are expensed as incurred. Accordingly, the results of the acquired Covance IVRS/IWRS business have beenincluded in our consolidated financial statements since the date ofacquisition.

 

25

----

Table ofContents

 

*Maaguzi*

 

On July 27, 2009, we acquired Maaguzi LLC(“Maaguzi”), a privately-held innovative provider of a Web-based product called*OutcomeLogix*, which is an electronicpatient reported outcomes (ePRO) and late phase solution.  The aggregate purchase price was $11.0million in cash.  The acquisition ofMaaguzi extends our integrated clinical research suite and marks our entry intothe ePRO and observational studies markets. The acquisition of Maaguzi will be accounted for as a purchase with all of the assets acquired andliabilities assumed in the transaction recognized at their acquisition-datefair values, while transaction costs associated with the transaction areexpensed as incurred.  Accordingly,the results of Maaguzi have been included in our consolidated financialstatements since the date of acquisition.

 

*Waban*

 

On April 22, 2009, we acquired all of theoutstanding common stock of Waban Software, Inc. (“Waban”), a provider ofplatform solutions for the automation and compliance of clinical data analysis. Waban’s Statistical ComputingEnvironment and Clinical Data Repository (SCE/CDR) solutions provideautomation, traceability and control of the key activities involved in theintegration, analysis and reporting on clinical trial data.  The aggregate purchase price was $13.8 millionin cash.  We acquired the technology ofWaban to allow us to penetrate the market for statistical computing andclinical data repository solutions.  Theacquisition of Waban has been accounted for as a purchase with all of the assets acquired andliabilities assumed in the transaction recognized at their acquisition-datefair values, while transaction costs associated with the transaction areexpensed as incurred. Accordingly, the results of Waban have beenincluded in our consolidated financial statements since the date ofacquisition.

 

**Subsequent Event**

 

On November3, 2009, our board of directors authorized the repurchase of up to $40.0million of our common stock, par value $0.01 per share, through a sharerepurchase program. As authorized by the program, shares may be purchased inthe open market or through privately negotiated transactions in a mannerconsistent with applicable securities laws and regulations, including pursuantto a Rule 10b5-1 plan maintained by us. This share repurchase program does notobligate us to acquire any specific number of shares and may be extended, suspendedor discontinued at any time. All repurchases are expected to be funded from ourcash and investment balances. While our board of directors has approved theshare purchase guidelines, the timing of the repurchase and the exact number ofshares of common stock to be purchased will be determined at our management’sdiscretion, and will depend upon on market conditions and other factors,including price, corporate and regulatory requirements and alternativeinvestment opportunities. The repurchase program is currently scheduled toterminate on November 9, 2010.

 

**Sources of Revenues**

 

Wederive our revenues from software licenses and services.  Our product line is comprised of four generalcategories that include the following software products:

 

·*Electronic Data Capture (EDC)*

 

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

 

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

 

·*       **OutcomeLogix*, our ePRO and late phase solution for**data capture which supports data entryvia web interface and/or mobile interface for handheld devices.

 

·*Clinical Data Management*

 

·*       **Clintrial*, our clinicaldata management solution; and

 

26

----

Table of Contents

 

·        *EmpiricaStudy*, our system for validating and reviewing clinical trial datarepresented in formats meeting industry standards, such as those established bythe Clinical Data Interchange Standards Consortium, or CDISC.

 

·*Drug Safety*

 

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

 

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

 

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

 

·*Interactive Response Technology(IRT)*

 

·        *Clarix*, ourWeb-integrated interactive response technology; and

 

·        *Covance**IVRS/IWRS*, our phone-integrated interactive responsetechnology.

 

·*Clinical Data Analysis Systems*

 

·        *WabanCDR*, our controlled clinical data repository product for storing andmanaging clinical trials data (both data and metadata); and

 

·        *WabanSCE*, our metadata-driven controlledclinical data repository product for automation and tracking of routineand repetitious statistical programming and analysis.

 

Licenserevenues are derived principally from the sale of term licenses for oursoftware products other than*Clarix, OutcomeLogix*and*Covance IVRS/IWRS,* which arepresently available only on a hosted application basis.  Service revenues are derived principally fromour delivery of the hosted solution of our*InForm, Clarix, Empirica Signal*,*CTSD, Empirica Study,**OutcomeLogix*and*Covance IVRS/IWRS* software products, and consultingservices and customer support, including training, for all of our products. Wegenerally recognize revenues ratably over the life of a license or servicecontract.

 

Onecustomer, GlaxoSmithKline, accounted for approximately 12% of our totalrevenues in the three months ended September 30, 2008 and 12% of our totalrevenues in the nine months ended September 30, 2008. The same customeraccounted for $863 or 2% of accounts receivable outstanding as of December 31,2008.  In the three and nine months endedSeptember 30, 2009, no customer accounted for 10% or more of our total revenuesfor the period.  Our top 20 customersaccounted for approximately 62% and 60% of our total revenues, net ofreimbursable out-of-pocket expenses, in the three months ended September 30,2008 and 2009, respectively, and 63% and 61% of our total revenues, net ofreimbursable out-of-pocket expenses, in the nine months ended September 30,2008 and 2009, respectively.

 

*License Revenues*

 

Wederive our license revenues principally from the sale of term licenses for thefollowing software products:*InForm*,our Internet-based electronic data capture, or EDC, solution;*Clintrial* and*Empirica Study*, our clinical data management solutions; ourdrug safety solutions, including our*Empirica Trace*,*Empirica Signal*and*CTSD* products; our*LabPas* Phase I clinic automation solution;and our *Waban CDR* and *Waban SCE*products for clinical data analysis.  Although each of our software solutions is availableas a stand-alone enterprise application, we offer integrated enterprisesolutions incorporating certain of our electronic data capture, data managementand analysis, and drug safety products.

 

Licenserevenues for our*InForm*electronicdata capture software solution, either on a stand-alone or integrated basis,are determined primarily by the number, complexity and duration of the clinicaltrials and the number of participants in each clinical trial. License revenuesfor our*Clintrial, Empirica Study, EmpiricaTrace, Empirica Signal*,*CTSD*and*LabPas* software solutions aredetermined primarily by the number of users accessing the software solution. 

 

27

----

Table of Contents

 

Exceptas discussed below, we enter into software license agreements for our*InForm*,*Clintrial* and*Empirica Trace*products with terms generally of three to five years with payment termsgenerally annually in advance. License agreements for our other licensedproducts are generally annual or multi-year with payment terms generallyannually in advance.  License revenuesare recognized ratably over the duration of the software term licenseagreement, to the extent that amounts are fixed or determinable andcollectable.

 

Followingour acquisition of Clinsoft Corporation (“Clinsoft”) in August 2001, we beganconverting holders of Clinsoft perpetual software licenses to our software termlicense arrangements. We continue to sell additional perpetual licenses ofthese products in certain situations to our existing customers with the optionto purchase customer support, and may in the future do so for new customersbased on customer requirements or market conditions. We recognize revenues onthe perpetual licenses upon delivery of the software when all other revenuerecognition criteria are met. We continue to provide and charge for maintenanceand support on our products to those customers who do not convert to oursoftware term license arrangements.  Wewill continue our efforts to convert the remaining former Clinsoft customerbase to software term license arrangements. However, we anticipate that somecustomers will not convert and instead will continue to make annual customersupport payments.

 

*Service Revenues*

 

*Application Hosting Services.*  In addition to making our software productsother than*Clarix,**OutcomeLogix*and*Covance IVRS/IWRS*availableto customers through licenses, we offer our*InForm*,*Empirica Signal, CTSD*and*Empirica Study* software ashosted application solutions delivered through a standard Web-browser, withcustomer support and training services.  Our*Clarix,OutcomeLogix*and*Covance IVRS/IWRS*solutions arepresently available only on a hosted application basis.  Service revenues from application hostingservices are derived principally from our*InForm*hosted solution.

 

Revenuesresulting from the*InForm*and *OutcomeLogix*hosting service consist of three stages for each clinicaltrial:

 

·                      *Firststage—*trial and application set up, including design of electronic casereport forms and edit checks, installation and server configuration of thesystem;

 

·                      *Secondstage—*application hosting and related support services; and

 

·                      *Thirdstage—*services required to close out, or lock, the database for the clinicaltrial.

 

Revenues resulting from the*Clarix* and *CovanceIVRS/IWRS*hosting service also consist of three stages for eachclinical trial:

 

·                      *Firststage*—trial and application set up, including design and set up of thesubject randomization and medication inventory management, installation andserver configuration of the system;

 

·                      *Secondstage*—application hosting and related support services; and

 

·                      *Thirdstage*—services required to close out, or lock, the clinical trial.

 

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

 

28

----

Table of Contents

 

Inthe event that an application hosting customer cancels a clinical trial and itsrelated statement of work, all deferred revenues are recognized and alldeferred set up costs are expensed.  Inaddition, certain termination-related fees may be charged and if so, such feesare recognized in the period of termination.

 

Revenuesresulting from hosting services for our*Empirica Signal*,*CTSD*and*Empirica Study* productsconsist of installation and server configuration, application hosting andrelated support services.  Services forthese offerings are charged monthly as a fixed fee. Revenues are recognizedratably over the period of the service.

 

Inaddition, application hosting service revenues include hosting servicesassociated with term license customers and reimbursable out-of-pocket expenses.

 

*Consulting Services. *Consulting services include the design and documentation of theprocesses related to our customers’ use of our products and services in theirclinical trials and safety monitoring activities. 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.  Consulting services can besold on a stand-alone basis or as part of a bundled arrangement.  In some circumstances, we sell additionalfollow on consulting services to a customer at a later date even if thecustomer purchased consulting services at the time of the initial licensepurchase under a bundled arrangement.  Revenues from consulting services included ineither a multiple element software license agreement or in an applicationhosting agreement are recognized ratably over the term of the arrangement. Thevalue of our consulting services sold within a bundled arrangement is equal tothe value of consulting services sold on a stand-alone basis, as the activitiesperformed under both types of arrangements are similar in nature.  The associated costs are expensed as incurred. We may also enter into arrangements toprovide consulting services separate from a license arrangement. In thesesituations, revenue is recognized on either a time-and-materials basis or usingthe proportional performance method. If we are not able to produce reasonablydependable estimates, revenue is recognized upon completion of the project andfinal acceptance from the customer. If significant uncertainties exist aboutproject completion or receipt of payment, the revenue is deferred until theuncertainty is resolved. Provisions for estimated losses on contracts arerecorded during the period in which they are resolved. Provisions for estimatedlosses on contracts are recorded during the period in which they areidentified.

 

*Customer Support.*  We have a multinational services organizationto support our software products and hosted solutions worldwide. Customersupport includes multilingual training services, telephone support and softwaremaintenance. We bundle customer support in our software term licenses andallocate 10% of the value of the license to customer support revenues. Thecustomer support services rate of 10% for multi-year term-based licensesreflects a significant discount from the rate for customer support servicesassociated with perpetual licenses due to the reduction in the time periodduring which the customer can utilize the upgrades and enhancements. We believethis rate is substantive and represents an amount we believe reasonable to beallocated.  Our customer support revenuesalso consist of customer support fees paid by perpetual license customers.Customer support revenues are recognized ratably over the period of thecustomer support or term license agreement, with payment terms generallyannually in advance.

 

**Cost of Revenues and Operating Expenses**

 

Weallocate overhead expenses such as rent and occupancy charges and employeebenefit costs to all departments based on headcount. As such, general overheadexpenses are reflected in costs of service revenues and in the sales andmarketing, research and development, and general and administrative expensecategories.

 

*Costs of Revenues.*  Costs of license revenues consist primarilyof the amortization of royalties paid for certain modules within our*Clintrial* software product as well as our*InForm*software product. In addition,costs of revenues include expense for the amortization of acquired technologiesassociated with the acquisitions of Lincoln Technology, Inc. (“Lincoln”) in2005, Green Mountain Logic, Inc. (“Green Mountain”) in 2007, Clarix in 2008 andWaban and Maaguzi in 2009.  The costs oflicense revenues vary based upon the mix of revenues from software licenses forour products. We operate our service organization on a global basis as onedistinct unit, and do not segment costs for our various service revenueelements. These services include performing application hosting, consulting andcustomer support services. Costs for these services consist primarily ofemployee-related costs associated with these services, amortization of thedeferred clinical trial set up costs, allocated overhead, outside contractors,royalties associated with providing customer support for use with the*Clintrial* and *InForm*software products and reimbursable out-of-pocketexpenses. Costs of services also include hosting costs that primarily consist ofhosting facility fees and server depreciation and amortization of acquiredtechnologies associated with the acquisition of Clarix and Maaguzi.

 

29

----

Table of Contents

 

Thecosts of service revenues vary based upon the number of employees in theservice organization, 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 costs ofservice revenues is significantly higher as a percentage of revenues ascompared to our costs of license revenues primarily due to the employee-relatedand outside contractor expenses associated with providing services.

 

*Gross Margin.*  Our gross margin on license revenues variesbased on the mix of royalty- and non-royalty-bearing license revenues and theamount of amortization of acquired technologies. Our gross margin on servicerevenues varies primarily due to variations in the utilization levels of theprofessional service team and the timing of expense and revenue recognitionunder our service arrangements. In situations where the service revenues arerecognized ratably over the software license term, our costs associated withdelivery of the services are recognized as the services are performed, which istypically during the first 6 to 12 months of the contract period. Accordingly,our gross margin on service revenues will vary significantly over the life of acontract due to the timing, amount and type of service required in deliveringcertain projects. In addition, consolidated gross margin will vary dependingupon the mix of license and service revenues.

 

*Sales and Marketing.*  Sales and marketing expenses consistprimarily of employee-related expenses, including travel, marketing programswhich include product marketing expenses such as trade shows, workshops andseminars, corporate communications, other brand building and advertising,allocated overhead and the amortization of commissions. In addition, sales andmarketing include expense for the amortization of acquired technologiesassociated with the acquisition of Lincoln, Green Mountain, Clarix, Waban,Maaguzi and Covance IVRS/IWRS.  We expectthat sales and marketing expenses 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.

 

*Research and Development.*  Research and development expenses consistprimarily of employee-related expenses, allocated overhead and outsidecontractors. We focus our research and development efforts on increasing thefunctionality, performance and integration of our software products. We expectthat in the future, research and development expenses will increase in absolutedollars as we continue to add features and functionality to our products,introduce additional integrated software solutions to our product suite andexpand our product and service offering.

 

*General and Administrative.*  General and administrative expenses consistprimarily of employee-related expenses, professional fees, primarily consistingof expenses for accounting, compliance with the Sarbanes-Oxley Act of 2002, andlegal services, including litigation, information technology and othercorporate expenses and allocated overhead. We expect that in the future ourgeneral and administrative expenses will increase in absolute dollars as we addpersonnel and incur additional costs related to the growth of our business andoperations.

 

*Stock-Based Compensation Expenses.*Our cost ofservice revenues, sales and marketing, research and development, and generaland administrative expenses include stock-based compensation expense.Stock-based compensation expense is based on the fair value of outstandingstock options and restricted stock awards and units, which are recognized overthe respective stock option and award or unit service periods. During the threemonths ended September 30, 2008 and 2009, we recorded $2.3 million and $3.0million of stock-based compensation expense, respectively.  During the nine months ended September 30,2008 and 2009, we recorded $6.0 million and $9.2 million of stock-basedcompensation expense, respectively.

 

**Foreign Currency Translation**

 

Withregard to our international operations, we frequently enter into transactionsin currencies other than the U.S. dollar. As a result, our revenues, expensesand cash flows are subject to fluctuations due to changes in foreign currencyexchange rates, particularly changes in the euro, British pound, Australiandollar, Indian rupee, Japanese yen and Romanian leu. In the three months ended September30, 2008 and 2009, approximately 43% and 39%, respectively, of our revenueswere generated in locations outside the United States.  In the nine months ended September 30, 2008and 2009, approximately 45% and 39%, respectively, of our revenues weregenerated in locations outside the United States.  

 

30

----

Table of Contents

 

Themajority of these revenues are in currencies other than the U.S. dollar, as aremany of the associated expenses. In periods when the U.S. dollar declines invalue as compared to the foreign currencies in which we conduct business, ourforeign currency-based revenues and expenses generally increase in value whentranslated into U.S. dollars.

 

**Critical Accounting Policies and Estimates**

 

Ourunaudited condensed consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andassumptions that affect the reported amounts of assets, liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. On an ongoing basis, we evaluate our estimates andassumptions with our audit committee, including those related to revenuerecognition, deferred set up costs, commissions and royalties, accountsreceivable reserves, stock-based compensation expenses, long-lived assets,intangibles assets and goodwill, income taxes, restructuring, contingencies andlitigation. We base our estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.There have been no material changes to these estimates for the periodspresented in this Quarterly Report on Form 10-Q. Our actual results may differfrom these estimates under different assumptions or conditions.

 

Webelieve that of our significant accounting policies, which are described inNote 1 and Note 2 of the notes to our consolidated financial statementsincluded in our Annual Report on Form 10-K for the year ended December 31,2008, the following condensed accounting policies involve a greater degree ofjudgment and complexity. Accordingly, these are the policies we believe are themost critical to aid in fully understanding and evaluating our consolidatedfinancial condition and results of operations.

 

*Revenue Recognition and Deferred Set Up Costs. *Customers generally have theability to terminate application hosting, consulting and training serviceagreements upon 30 days notice. License agreements, multiple element arrangements,including license and services agreements and certain application hostingservices can generally be terminated by either party for material breach ofobligations not corrected within 30 days after notice of the breach.

 

Werecognize revenues when all of the following conditions are satisfied: (1) thereis persuasive evidence of an arrangement; (2) the product or service has beenprovided to the customer; (3) the collection of our fees is probable; and (4) theamount of fees to be paid by the customer is fixed or determinable.

 

Wegenerally enter into software term licenses for our*InForm*,*Clintrial,Empirica Trace Waban CDR and Waban SCE* products with our customersfor 3- to 5-year periods. License agreements for our*Empirica Signal, CTSD* and*Empirica Study* products are generally annual or multi-year terms.  We do not license our*Clarix, OutcomeLogix*and*Covance IVRS/IWRS* products, which are presently offered onlyon a hosted application basis.  Thesearrangements typically include multiple elements: software license, consultingservices and customer support. We bill our customers in accordance with theterms of the underlying contract. Generally, we bill license fees annually inadvance for each year of the license term. Our payment terms are generally net30 days.

 

Oursoftware 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.

 

Customersupport includes training services, telephone support and software maintenance.We generally bundle customer support with the software license for the entireterm of the arrangement. As a result, we generally recognize revenues for allelements, including consulting services, ratably over the term of the softwarelicense and support arrangement. We allocate the revenues recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For our term-based licenses, we allocateto consulting services the anticipated service effort and value throughout theterm of the arrangement at an amount that would have been allocated had thoseservices been sold separately to the customer. 

 

31

----

Table of Contents

 

Thevalue of our consulting services sold within a bundled arrangement is equal tothe value of consulting services sold on a stand-alone basis, as the activitiesperformed under both types of arrangements are similar in nature.  The remaining value is allocated to licenseand support services, with 10% of this amount allocated to support services.The customer support services rate of 10% for multi-year term-based licensesreflects a significant discount from the rate for customer support servicesassociated with perpetual licenses due to the reduction in the time periodduring which the customer can utilize the upgrades and enhancements. We believethis rate is substantive and represents a reasonable basis of allocation. Wehave allocated the estimated fair value to our multiple element arrangements toprovide meaningful disclosures about each of our revenue streams. The costsassociated with the consulting and customer support services are expensed asincurred. There are instances in which we sell software licenses based on usagelevels. These software licenses can be based on estimated usage, in which casethe license fee charged to the customer is fixed based on this estimate. Whenthe fee is fixed, the revenues are generally recognized ratably over thecontractual term of the arrangement. If the fee is based on actual usage, andtherefore variable, the revenues are recognized in the period of use. Revenuesfrom certain follow-on consulting services, which are sold separately tocustomers with existing software licenses and are not considered part of amultiple element arrangement, are recognized as the services are performed.

 

Wecontinue to sell additional perpetual licenses for the*Clintrial, Empirica Trace, Waban CDR*and*WabanSCE*software products in certain situations to our existingcustomers with the option to purchase customer support and may in the future doso for new customers based on customer requirements or market conditions. Wehave established vendor specific objective evidence of fair value for thecustomer support. Accordingly, license revenues are recognized upon delivery ofthe software and when all other revenue recognition criteria are met.  Customer support revenues are recognizedratably over the term of the underlying support arrangement. We continue togenerate customer support and maintenance revenues from our perpetual licensecustomer base. Training revenues are recognized as earned.

 

Inaddition to making our software products other than*Clarix,**OutcomeLogix*and*Covance IVRS/IWRS* available to customers through licenses,we offer our*InForm, Empirica Signal*,*CTSD*and*Empirica Study*software solutions as a hosted application solution delivered through astandard Web-browser.  Our*Clarix,**OutcomeLogix*and*Covance IVRS/IWRS* solutions arepresently available only on a hosted application basis.

 

Revenuesresulting from*InForm*and*OutcomeLogix*application hosting services consist of threestages for each clinical trial: the first stage involves application set up,including design of electronic case report forms and edit checks, installationand server configuration of the system; the second stage involves applicationhosting and related support services; and the third stage involves servicesrequired to close out, or lock, the database for the clinical trial. Revenuesresulting from *Clarix*and *CovanceIVRS/IWRS* application hosting services also consist of three stagesfor each clinical trial: the first stage involves application set up, includingdesign and set up for the subject randomization and medication inventorymanagement, installation and server configuration of the system; the secondstage involves application hosting and related support services; and the thirdstage involves services required to close out, or lock, the database for theclinical trial.  Services provided *InForm, Clarix, OutcomeLogix* and *CovanceIVRS/IWRS* for the first and third stages are provided on a fixed feebasis based upon the complexity of the trial and system requirements. Servicesfor the second stage are charged separately as a fixed monthly fee. Werecognize revenue from all stages of the*InForm, Clarix,**OutcomeLogix*and *Covance IVRS/IWRS* hosting serviceratably over the hosting period. Fees charged and costs incurred for the trialsystem design, set up and implementation are deferred as applicable, until thestart of the hosting period and then amortized and recognized, as applicable,ratably over the estimated hosting period. The deferred costs includeincremental direct costs with third parties and certain internal direct costsrelated to the trial and application set up. 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.

 

Revenuesresulting from hosting services for our*Empirica Signal*,*CTSD*and*Empirica Study* productsconsist of installation and server configuration, application hosting andrelated support services.  Services for theseofferings are charged monthly as a fixed fee.  Revenues are recognized ratably over theperiod of the service.

 

32

----

Table of Contents

 

Inthe event that an application hosting customer cancels its related statement ofwork, all deferred revenues are recognized and all deferred set up costs areexpensed.  In addition, certain terminationrelated fees may be charged and if so, such fees are recognized in the periodof termination.

 

Wedeferred $1.3 million and $1.4 million of set up costs and amortized $0.9million and $0.9 million in the three months ended September 30, 2008 and 2009,respectively, and deferred $3.6 million and $4.0 million of set up costs andamortized $2.5 million and $2.8 million in the nine months ended September 30,2008 and 2009, respectively.  Theamortization of deferred set up costs is a component of cost of services.

 

Wemay also enter into arrangements to provide consulting services separate from alicense arrangement. In these situations, revenue is recognized on either atime-and-materials basis or using the proportional performance method. If weare not able to produce reasonably dependable estimates, revenue is recognizedupon completion of the project and final acceptance from the customer. Ifsignificant uncertainties exist about project completion or receipt of payment,the revenue is deferred until the uncertainty is resolved. Provisions forestimated losses on contracts are recorded during the period in which they areidentified.

 

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

 

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

 

Duringthe three months ended September 30, 2008 and 2009, we deferred $1.9 millionand $3.1 million, respectively, of commissions and amortized $2.4 million and$2.2 million, respectively, to sales and marketing expense.  During the nine months ended September 30,2008 and 2009, we deferred $6.3 million and $8.2 million, respectively, ofcommissions and amortized $6.2 million and $5.9 million, respectively, to salesand marketing expense.  Royalties arepaid on a percentage of billings basis for certain of our products, and we havethe right to recover royalties in the event an arrangement is cancelled. Duringthe three months ended September 30, 2008 and 2009, we deferred $0.6 millionand $0.6 million, respectively, of royalty expenditures and amortized $0.7million and $0.5 million, respectively, to cost of license and servicerevenues.  During the nine months ended September30, 2008 and 2009, we deferred $2.2 million and $2.3 million, respectively, ofroyalty expenditures and amortized $2.0 million and $2.0 million, respectively,to cost of license and service revenues.

 

*Accounts Receivable Reserve.*  We maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments. We regularly evaluate the collectability of our tradereceivables based on a combination of factors, which may include dialogue withthe customer to determine the cause of non-payment, the use of collectionagencies, and/or the use of litigation. In the event it is determined that thecustomer may not be able to meet its full obligation to us, we record aspecific allowance to reduce the related receivable to the amount that weexpect to recover given all information available to us. We continuouslymonitor collections from our customers and maintain a provision for estimatedcredit losses based upon our historical experience and any specific customercollection issues that we have identified. While such credit losses havehistorically been within our expectations and the provisions established, wecannot guarantee that we will continue to experience the same credit loss ratesin the future. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required.  Our accountsreceivable reserves were $0.6 million and $0.9 million as of December 31, 2008and September 30, 2009, respectively.

 

*Accounting for Income Taxes.*  We are subject to income taxes in both theUnited States and foreign jurisdictions, and we use estimates in determiningour provision for income taxes.  Weaccount for income taxes using the asset and liability method for accountingand reporting for income taxes.  Underthis method, deferred tax assets and liabilities are recognized based ontemporary differences between the financial reporting and income tax bases ofassets and liabilities using statutory rates. This process requires that weproject our current tax liability and estimate our deferred tax assets andliabilities, including net operating loss and tax credit carryforwards. Inassessing the need for a valuation allowance, we have considered our recentoperating results, future taxable income projections and all prudent andfeasible tax planning strategies.

 

33

----

Table of Contents

 

*Accounting for Stock-Based Awards.* On January 1, 2006, we started to recognizeexpense related to the fair value of stock-based compensation awards. Forservice-based options, we recognize compensation expense on a straight-linebasis over the requisite service period of the award.  For performance-based options, we recognizeexpense over the estimated performance period. In addition the benefits of taxdeductions in excess of recognized stock-based compensation is reported as afinancing activity rather than an operating activity in the statements of cashflows. This requirement can have the effect of reducing our net operating cashflows and increasing our net financing cash flows in certain periods.  To date, we have not recorded these benefitsas they have not been realized.

 

Weuse the Black-Scholes option pricing model to determine the weighted averagefair value of options granted.

 

Duringthe three months ending September 30, 2008 and 2009, we recorded $2.3 million and$3.0 million of aggregate stock-based compensation expense, respectively.  During the nine months ending September 30,2008 and 2009, we recorded $6.0 million and $9.2 million of aggregatestock-based compensation expense, respectively.  For the three months ending September 30, 2008and 2009, stock-based compensation expense reduced basic earnings per share by$0.03 and $0.04, respectively, and diluted earnings per share by $0.03 and$0.04, respectively.  For the nine monthsending September 30, 2008 and 2009, stock-based compensation expense reducedbasic earnings per share by $0.09 and $0.14, respectively, and diluted earningsper share by $0.09 and $0.13, respectively. As of September 30, 2009, we had $26.5 million of unrecognizedstock-based compensation expense related to options and awards that we expectto recognize over a weighted average period of 2.35 years.

 

*Other Significant Estimates*

 

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

 

**Overview of Results of Operations in the Three Months Ended September30, 2008 and 2009**

 

Totalrevenues increased by 24%, or $10.1 million, in the three months ended September30, 2009 compared to the same period in 2008, primarily due to an increase inservice revenues of $7.9 million, or 26%. In addition, license revenues increased by $2.2 million, or 17%.

 

Ourgross margin increased by 21%, or $5.0 million, in the three months ended September30, 2009 compared to the same period in 2008, primarily due to the increases inboth service revenues and license revenues.

 

Operatingincome for the three months ended September 30, 2009 of $2.4 million decreased46%, or $2.0 million, compared to the same period in 2008.  The operating income for the three monthsended September 30, 2008 and 2009 included $2.3 million and $3.0 million ofstock-based compensation expense and $0.6 million and $0.9 million ofamortization expense, respectively.

 

Theresults for the three months ended September 30, 2009 when compared to the sameperiod in 2008 were impacted by foreign exchange rate fluctuations, resultingin decreases in revenue of $1.2 million, or 3%, and decreases in expense of$1.1 million, or 3%.

 

As of September 30, 2009, we had $112.5 million of unrestricted cash,cash equivalents and short-term investments, a decrease of $46.9 million from$159.4 million at December 31, 2008. This decrease was primarily related to our acquisitions of Waban,Maaguzi and Covance IVRS/IWRS for $34.6 million.  As of September 30, 2009, we had $34.7million of long-term investments, an increase of $16.7 million from $18.0million at December 31, 2008.  As of September30, 2009, we had no outstanding debt.

 

34

----

Table of Contents

 

*Revenues*

 
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** | ** **                   | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2008**                             | ** ** | **2009**                     | ** ** | **Change** | ** ** |
| **Revenues  by Product Line (in thousands) (1)** | ** ** | **Amount**                           | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                             |       |                                 |       |                         |       |       |       |   |   |   |   |   |   |
| Electronic data capture                          |       | $                                    | 32,819     |                         | 76         | %          | $          | 38,563 |   | 73 | % | $ | 5,744 |   | 18 | % |
| Clinical data management                         |       | 5,827                                |       | 14                           |       | 5,611      |       | 10 |   | (216 | ) | (4 | ) |
| Safety                                           |       | 4,007                                |       | 9                            |       | 5,378      |       | 10 |   | 1,371 |   | 34 |   |
| Interactive Response  Technology                 |       | 338                                  |       | 1                            |       | 3,567      |       | 7 |   | 3,229 |   | 955 |   |
| Total                                            |       | $                                    | 42,991     |                         | 100        | %          | $          | 53,119 |   | 100 | % | $ | 10,128 |   | 24 | % |

 

----

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

 

Theincrease in electronic data capture revenues is primarily due to increases inapplication hosting services and license revenues of $2.8 million and $1.6million, respectively, and to a lesser extent, the introduction of our *OutcomeLogix* product offering following the acquisition ofMaaguzi in July 2009.  The decrease inclinical data management revenues is primarily due to a $0.3 million decreasein professional services revenues.  Theincrease in safety was due to increases in consulting revenues, licenserevenues and application hosting services revenues of $0.6 million, $0.5million and $0.2 million, respectively. The increase in interactive response technology revenues is primarilyrelated to the 2009 period including a full quarter of application hostingservices revenues relating to the acquisition of Clarix in September 2008,while the 2008 period only includes one month of revenue related to thatacquisition.  To a lesser extent theincrease is attributable to revenues related to the acquisition of CovanceIVRS/IWRS in August 2009.

 
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** | ** **                  | ** ** | ** ** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|------------|------------|
| ** **                          | ** ** | **2008**                             | ** ** | **2009**                    | ** ** | **Change** | ** ** |
| **Revenues by Type (in thousands)** | ** ** | **Amount**                           | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                |       |                                 |       |                        |       |       |       |   |   |   |   |   |   |
| License                             |       | $                                    | 12,974     |                        | 30         | %          | $          | 15,159 |   | 29 | % | $ | 2,185 |   | 17 | % |
| Application hosting services        |       | 23,553                               |       | 55                          |       | 30,071     |       | 57 |   | 6,518 |   | 28 |   |
| Consulting services                 |       | 3,488                                |       | 8                           |       | 4,495      |       | 8 |   | 1,007 |   | 29 |   |
| Customer support                    |       | 2,976                                |       | 7                           |       | 3,394      |       | 6 |   | 418 |   | 14 |   |
| Total                               |       | $                                    | 42,991     |                        | 100        | %          | $          | 53,119 |   | 100 | % | $ | 10,128 |   | 24 | % |

 

Totalrevenues increased in the three months ended September 30, 2009 as compared tothe same period in 2008, primarily due to increases in application hosting andlicense revenues.  The increase inrevenues associated with our application hosting services in the three monthsended September 30, 2009 was partially due to an approximately 16% increase inproduction trials under management from approximately 870 as of September 30,2008 to approximately 1,012 as of September 30, 2009, which include bothapplication hosting services trials as well as trials hosted for our*InForm*license customers.  The increase in production trials relates tocustomers who purchase all trial-related services from us, customers wholicense *Inform* and build their own studies andan increase in the average fee per trial. Our application hosting services also increased due to the impact ofadditional trials under management as a result of our recent acquisitions ofClarix, Maaguzi and Covance IVRS/IWRS. In particular, Clarix production trials increased approximately 77% from64 as of September 30, 2008 to approximately 113 as of September 30, 2009.  The increase in license revenues wasprimarily the result of additional*InForm*revenuefrom new and existing customers and, to a lesser extent, growth in salesrelating to our safety products.  Theincrease in consulting revenues was primarily attributable to an increase inconsulting revenue related to safety and electronic data capture, primarily *InForm,* revenue which was related to both new and existingcustomers, partially offset by a decrease in consulting revenue related toclinical data management revenue.  Theincrease in customer support revenues in the three months ended September 30,2009 was due primarily to an increase in support revenues related to electronicdata capture, primarily*InForm*,partially offset by a decrease in customer support revenue related to clinicaldata management revenue.  Our revenueswere not significantly impacted by price increases or decreases.  Inflation had only a nominal impact on ourrevenues.

 

35

----

Table ofContents

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **2008**                                                 | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Revenues by Geography  (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                     |       |                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| North America                                            |       | $                                                        | 24,303     |                             | 57         | % | $ | 32,404 |   | 61 | % | $ | 8,101 |   | 33 | % |
|                                                     |       |                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| United Kingdom                                           |       | 12,893                                                   |       | 30                               |       | 14,982 |   | 28 |   | 2,089 |   | 16 |   |
| France                                                   |       | 3,586                                                    |       | 8                                |       | 3,672 |   | 7 |   | 86 |   | 2 |   |
| Asia Pacific                                             |       | 2,209                                                    |       | 5                                |       | 2,061 |   | 4 |   | (148 | ) | (7 | ) |
| International subtotal                                   |       | 18,688                                                   |       | 43                               |       | 20,715 |   | 39 |   | 2,027 |   | 11 |   |
| Total                                                    |       | $                                                        | 42,991     |                             | 100        | % | $ | 53,119 |   | 100 | % | $ | 10,128 |   | 24 | % |

 

Theincrease in revenues worldwide was primarily due to an increase in electronicdata capture revenues, as well as increases in safety revenues and the introduction of our new interactive response technology revenue following theacquisitions of Clarix and Covance IVRS/IWRS. The increase in U.S. revenues isprimarily due to an increase in electronic data capture revenues of $3.9million, as well as an increase in interactive response technology revenues of$3.2 million.  The increase ininteractive response technology revenues is primarily a result of the 2009period including a full quarter of application hosting services revenuesrelating to the acquisition of Clarix in September 2008, while the 2008period only included one month of revenue related to that acquisition.  To a lesser extent the increase is attributableto revenues related to the acquisition of Covance IVRS/IWRS in August 2009.    Increases in U.S. revenue were also due toan increase in safety revenues of $0.9 million. The increase in internationalrevenues is primarily the result of electronic data capture revenues and safetyrevenue of $1.9 million and $0.5 million, respectively.  These increases were slightly offset by adecrease in clinical data management revenue of $0.3 million.

 

*Cost of Revenues*

 
| ** **                                           | ** ** | **Three Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **2008**                                                 | ** ** | **2009**                                  | ** ** | **Change** | ** ** |
| **Costs of Revenues  (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                 |       |                                                     |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                              |       | $                                                        | 838        |                                      | 6          | %          | $          | 559 |   | 4 | % | $ | (279 | ) | (33 | )% |
| Services                                             |       | 17,686                                                   |       | 59                                        |       | 23,076     |       | 61 |   | 5,390 |   | 30 |   |
| Total                                                |       | $                                                        | 18,524     |                                      | 43         | %          | $          | 23,635 |   | 44 | % | $ | 5,111 |   | 28 | % |

 

Thecost of license revenues decreased in the three months ended September 30,2009 primarily due to a less than $0.1 million decrease in the cost ofroyalties associated with our*InForm *softwareproduct and in amortization of intangible assets.  The increase in cost ofservices in the three months ended September 30, 2009 was primarily due toincreases in employee-related expense of $2.2 million related to a headcountincrease of 136 people, and increases in facilities expense and contractorexpense of $1.4 million and $0.7 million, respectively.

 

*Gross Margin*

 
| ** **                                 | ** ** | **Three Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **2008**                                                 | ** ** | **2009**                                  | ** ** | **Change** | ** ** |
| **Gross Margin  (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                       |       |                                                     |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                    |       | $                                                        | 12,136     |                                      | 94         | %          | $          | 14,600 |   | 96 | % | $ | 2,464 |   | 20 | % |
| Services                                   |       | 12,331                                                   |       | 41                                        |       | 14,884     |       | 39 |   | 2,553 |   | 21 |   |
| Total                                      |       | $                                                        | 24,467     |                                      | 57         | %          | $          | 29,484 |   | 56 | % | $ | 5,017 |   | 21 | % |

 

36

----

Table ofContents

 

Thelicense gross margin percentage increased slightly in the three months ended September 30,2009 as compared to the three months ended September 30, 2008 due toincreased license sales in products that do not carry an associated royaltyexpense.  The services gross margin percentage decreased slightly during2009 due to higher services expenses as a percentage of related revenues, aswell as the inclusion of our *OutcomeLogix*product from the acquisition of Maaguzi in July 2009 and the acquisitionof Covance IVRS/IWRS in August 2009.  The overall gross marginpercentage decreased in three months ended September 30, 2009 due to thelower services gross margin percentage.  It is likely that gross margin,as a percentage of revenues, will fluctuate quarter by quarter due to thetiming and mix of license and service revenues, and the type, amount and timingof service required in delivering certain projects.

 

*Operating Expenses*

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                      | ** ** | **2008**                                                 | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Operating Expenses (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                            |       |                                                     |       |                             |       |       |       |   |   |   |   |   |   |
| Sales and marketing                             |       | $                                                        | 7,024      |                             | 16         | %          | $          | 8,678 |   | 16 | % | $ | 1,654 |   | 24 | % |
| Research and development                        |       | 6,424                                                    |       | 15                               |       | 9,639      |       | 18 |   | 3,215 |   | 50 |   |
| General and administrative                      |       | 6,629                                                    |       | 16                               |       | 8,796      |       | 17 |   | 2,167 |   | 33 |   |
| Total                                           |       | $                                                        | 20,077     |                             | 47         | %          | $          | 27,113 |   | 51 | % | $ | 7,036 |   | 35 | % |

 

*Sales and Marketing.*    Salesand marketing expenses increased in the three months ended September 30,2009 primarily due to increases in employee-related expense of $1.0 millionrelated to a headcount increase of 25 people, as well as increases infacilities expense of $0.3 million.  Weexpect that our sales and marketing expense will continue to increase inabsolute dollars as commission expense increases with our revenues and as wecontinue to expand sales coverage and to build brand awareness through what webelieve are the most cost effective channels available.  We expect thatsuch increases may fluctuate, however, due to the timing of marketing programs.

 

*Research and Development.*    Researchand development expenses increased in the three months ended September 30,2009 primarily due to employee-related expenses of $2.0 million related to aheadcount increase of 58 people.  We also had expense increases related tofacilities expense and stock-based compensation of $0.8 million and $0.8million, respectively.  We expect that our research and development costswill continue to increase in absolute dollars as we continue to add featuresand functionality to our products, introduce additional integrated softwaresolutions to our product suite and expand our product and service offerings.

 

*General and Administrative.*    Generaland administrative expenses increased in the three months ended September 30,2009 primarily due to increases related to facilities expense of $1.8 millionas well as increases in employee-related expenses of $0.9 million related to aheadcount increase of 35 people. We expect that in the future our general andadministrative expenses will increase in absolute dollars as we add personneland incur additional costs related to the growth of our business andoperations.

 

*Other Income*

 
| ** **                            | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                            | ** ** | **2008**                                                 | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Other income  (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                  |       |                                                     |       |                             |       |       |       |   |   |   |   |   |   |
| Interest income                       |       | $                                                        | 1,483      |                             | 3          | %          | $          | 331 |   | 1 | % | $ | (1,152 | ) | (78 | )% |
| Other, net                            |       | (478                                                     | )          | 1                                |       | 120        |       | — |   | 598 |   | (125 | ) |
| Total other income                    |       | $                                                        | 1,005      |                             | 2          | %          | $          | 451 |   | 1 | % | $ | (554 | ) | (55 | )% |

 

Thedecrease in interest income in the three months ended September 30, 2009was primarily due to the net decrease in cash and cash equivalents and shortand long term investments as well as a decline in interest rates.  The increase in other, net in the threemonths ended September 30, 2009 was primarily due to increases in the fairvalue associated with our auction rate securities, partially offset by decreasein the change in fair value of our securities settlement agreement with UBS.

 

37

----

Table ofContents

 

*Provision for Income Taxes*

 
| ** **                                          | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                          | ** ** | **2008**                                                 | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Provision for income taxes  (in thousands)** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                |       |                                                     |       |                             |       |       |       |   |   |   |   |   |   |
| Provision for income taxes                          |       | $                                                        | 1,954      |                             | 5          | %          | $          | 1,013 |   | 2 | % | $ | (941 | ) | (48 | )% |
|                                                     |            |                                                          |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

Oureffective tax rate for the three months ended September 30, 2008 and 2009was 36%.  In the three months ended September 30, 2008 and 2009, oureffective tax rate was lower than our statutory rate of 37% primarily due tothe tax benefits related to the sale of incentive stock options within theperiod.

 

**Overview of Results of Operations in the Nine months Ended September 30,2008 and 2009**

 

Totalrevenues increased by 27%, or $32.6 million, in the nine months ended September 30,2009 compared to the same period in 2008 primarily due to an increase inservice revenues of 33%, or $27.3 million. Additionally, license revenues increased by 14%, or $5.3 million, in thenine months ended September 30, 2009 compared to the same period in 2008.

 

Ourgross margin increased by 27%, or $19.0 million, in the nine months ended September 30,2009 compared to the same period in 2008, primarily due to the increase inservices revenues.

 

Operatingincome in the nine months ended September 30, 2009 of $10.6 milliondecreased 18%, or $2.4 million, compared to the same period in 2008.  The operating income in the nine months endedSeptember 30, 2008 and 2009 included $6.0 million and $9.2 million ofstock-based compensation expense and $1.1 million and $2.5 million ofamortization expense, respectively.

 

Theresults for the nine months ended September 30, 2009 were impacted byforeign exchange rate fluctuations, resulting in decreases in revenue of $3.1million, or 3%, and decreases in expenses of $5.3 million, or 5%.

 

*Revenues*

 
| ** **                                       | ** ** | **Nine months Ended September 30,** | ** ** | ** **                   | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2008**                                 | ** ** | **2009**                     | ** ** | **Change** | ** ** |
| **Revenues by Product Line (in  thousands) (1)** | ** ** | **Amount**                               | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                             |       |                                     |       |                         |       |       |       |   |   |   |   |   |   |
| Electronic data capture                          |       | $                                        | 93,173     |                         | 77         | %          | $          | 113,467 |   | 73 | % | $ | 20,294 |   | 22 | % |
| Clinical data management                         |       | 16,999                                   |       | 14                           |       | 17,050     |       | 11 |   | 51 |   | NM* |   |
| Safety                                           |       | 11,352                                   |       | 9                            |       | 16,840     |       | 11 |   | 5,488 |   | 48 |   |
| Interactive Response Technology                  |       | 338                                      |       | —                       |       | 7,079      |       | 5 |   | 6,741 |   | 1,994 |   |
| Total                                            |       | $                                        | 121,862    |                         | 100        | %          | $          | 154,436 |   | 100 | % | $ | 32,574 |   | 27 | % |

 

----

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

 

* Not meaningful

 

Theincrease in electronic data capture revenues is primarily due to an increase inapplication hosting services of $14.9 million, and to a lesser extent, theintroduction of our *OutcomeLogix*product offering following the acquisition of Maaguzi in July 2009. In addition, there were increases in license revenues and consulting servicesrevenues of $3.3 million and $1.5 million, respectively.  The increase insafety was primarily due to increases in consulting services, license revenueand application hosting services of $3.3 million, $1.3 million and $0.6million, respectively. The increase in interactive response technology revenuesis due to the 2009 period including a full nine months of application hostingservices revenues relating to the acquisition of Clarix in September 2008,while the 2008 period only includes one month of revenue related to thatacquisition. To a lesser extent, the increase is attributable to revenuesrelated to the acquisition of Covance IVRS/IWRS in August 2009.

 

38

----

Table ofContents

 
| ** **                               | ** ** | **Nine  months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                               | ** ** | **2008**                                            | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Revenues by Type (in thousands)** | ** ** | **Amount**                                          | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                     |       |                                                |       |                             |       |       |       |   |   |   |   |   |   |
| License                                  |       | $                                                   | 38,675     |                             | 32         | %          | $          | 43,970 |   | 29 | % | $ | 5,295 |   | 14 | % |
| Application  hosting services            |       | 63,974                                              |       | 52                               |       | 86,509     |       | 56 |   | 22,535 |   | 35 |   |
| Consulting  services                     |       | 9,703                                               |       | 8                                |       | 14,056     |       | 9 |   | 4,353 |   | 45 |   |
| Customer  support                        |       | 9,510                                               |       | 8                                |       | 9,901      |       | 6 |   | 391 |   | 4 |   |
| Total                                    |       | $                                                   | 121,862    |                             | 100        | %          | $          | 154,436 |   | 100 | % | $ | 32,574 |   | 27 | % |

 

Totalrevenues increased in the nine months ended September 30, 2009 as comparedto the same period in 2008, primarily due to increases in application hostingand license revenues.  The increase in revenues associated with ourapplication hosting services in the nine months ended September 30, 2009was partially due to the approximately 16% increase in production trials undermanagement from approximately 870 as of September 30, 2008 toapproximately 1,012 as of September 30, 2009, which include bothapplication hosting services trials as well as trials hosted for our*InForm *license customers.  Theincrease in production trials relates to customers who purchase alltrial-related services from us, customers who license *Inform*and build their own studies and an increase in average fee per trial.  Ourapplication hosting services also increased due to the impact of additionaltrials under management as a result of our recent acquisitions of Clarix,Maaguzi and Covance IVRS/IWRS, with Clarix production trials increasingapproximately 77% from 64 as of September 30, 2008 to approximately 113 asof September 30, 2009.  The increase in license revenues wasprimarily the result of additional electronic data capture revenues from bothnew and existing customers, and to a lesser extent, growth in sales relating toour safety products.  The increase in consulting services was primarilyattributable to additional revenue related to consulting services provided forour safety products for both new and existing customers, and to a lesserextent, growth in sales relating to our electronic data capture products. The increase in customer support revenues was primarily due to increases inelectronic data capture revenue and safety product.  Our revenues were notsignificantly impacted by price increases or decreases.  Inflation hadonly a nominal impact on our revenues.

 
| ** **                                               | ** ** | **Nine  months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **2008**                                            | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Revenues by Geography  (in thousands)** | ** ** | **Amount**                                          | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                     |       |                                                |       |                             |       |       |       |   |   |   |   |   |   |
| North  America                                           |       | $                                                   | 66,812     |                             | 55         | %          | $          | 94,469 |   | 61 | % | $ | 27,657 |   | 41 | % |
|                                                     |       |                                                |       |                             |       |       |       |   |   |   |   |   |   |
| United  Kingdom                                          |       | 37,721                                              |       | 31                               |       | 41,802     |       | 27 |   | 4,081 |   | 11 |   |
| France                                                   |       | 10,601                                              |       | 9                                |       | 11,608     |       | 8 |   | 1,007 |   | 9 |   |
| Asia  Pacific                                            |       | 6,728                                               |       | 5                                |       | 6,557      |       | 4 |   | (171 | ) | (3 | ) |
| International  subtotal                                  |       | 55,050                                              |       | 45                               |       | 59,967     |       | 39 |   | 4,917 |   | 9 |   |
| Total                                                    |       | $                                                   | 121,862    |                             | 100        | %          | $          | 154,436 |   | 100 | % | $ | 32,574 |   | 27 | % |

 

Theincrease in revenues worldwide was primarily due to an increase in electronicdata capture revenues, interactive response technology revenues and safetyrevenues of $20.0 million, $6.7 million and $5.5 million, respectively.  The increase in U.S. revenues is primarilyrelated to an increase in electronic data capture revenues, interactiveresponse technology revenues and safety revenues of $16.1 million, $6.7 millionand $4.2 million, respectively.  Theincrease in interactive response technology revenues is primarily a result of the2009 period including a full nine months of application hosting servicesrevenues relating to the acquisition of Clarix in September 2008, whilethe 2008 period only includes one month of revenue related to that acquisition.To a lesser extent, the increase is attributable to revenues related to theacquisition of Covance IVRS/IWRS in August 2009.  The increase in international revenues isprimarily the result of increases in electronic data capture revenues andsafety revenue of $4.2 million and $1.2 million, respectively.  These increases were partially offset by adecrease in clinical data management revenue of $0.5 million.

 

39

----

Table ofContents

 

*Costs of Revenues*

 
| ** **                                               | ** ** | **Nine months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **2008**                                           | ** ** | **2009**                                  | ** ** | **Change** | ** ** |
| **Costs of Revenues (in thousands)** | ** ** | **Amount**                                         | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                     |       |                                               |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                                  |       | $                                                  | 2,119      |                                      | 5          | %          | $          | 1,910 |   | 4 | % | $ | (209 | ) | (10 | )% |
| Services                                                 |       | 50,405                                             |       | 61                                        |       | 64,220     |       | 58 |   | 13,815 |   | 27 |   |
| Total                                                    |       | $                                                  | 52,524     |                                      | 43         | %          | $          | 66,130 |   | 43 | % | $ | 13,606 |   | 26 | % |

 

Thecost of license revenues decreased in the nine months ended September 30,2009 primarily due to a decrease in the cost of royalties associated with our*InForm *software product of $0.1million, and to a lesser extent, amortization of intangible assets of less than$0.1 million.  The increase in cost of services in the nine months ended September 30,2008 was primarily due to increases in employee-related expenses of $5.3million related to a headcount increase of 136 people, and increases infacility expense and contractor expense of $3.9 million and $1.6 million,respectively.  We also had expenseincreases for depreciation, amortization of intangible assets and hosting $1.3million, $0.8 million and $0.7 million, respectively.

 

*Gross Margin*

 
| ** **                                 | ** ** | **Nine months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **2008**                                           | ** ** | **2009**                                  | ** ** | **Change** | ** ** |
| **Gross Margin  (in thousands)** | ** ** | **Amount**                                         | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                       |       |                                               |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                    |       | $                                                  | 36,556     |                                      | 95         | %          | $          | 42,060 |   | 96 | % | $ | 5,504 |   | 15 | % |
| Services                                   |       | 32,782                                             |       | 39                                        |       | 46,246     |       | 42 |   | 13,464 |   | 41 |   |
| Total                                      |       | $                                                  | 69,338     |                                      | 57         | %          | $          | 88,306 |   | 57 | % | $ | 18,968 |   | 27 | % |

 

Theoverall gross margin percentage remained the same in 2009 as compared to2008.  The license gross margin percentage increased slightly in 2009 ascompared to 2008 due to increased license sales in products that do not carryan associated royalty expense. The services gross margin percentageincreased during 2009 due to lower services expenses as a percentage of relatedrevenues.  This was due to increased efficiencies resulting in a decreasein services expense per services employee.  It is likely that grossmargin, as a percentage of revenues, will fluctuate quarter by quarter due tothe timing and mix of license and service revenues, and the type, amount andtiming of service required in delivering certain projects.

 

*Operating Expenses*

 
| ** **                                           | ** ** | **Nine months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **2008**                                           | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Operating Expenses (in thousands)** | ** ** | **Amount**                                         | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                 |       |                                               |       |                             |       |       |       |   |   |   |   |   |   |
| Sales and marketing                                  |       | $                                                  | 19,958     |                             | 16         | %          | $          | 24,100 |   | 15 | % | $ | 4,142 |   | 21 | % |
| Research and development                             |       | 18,003                                             |       | 15                               |       | 27,244     |       | 18 |   | 9,241 |   | 51 |   |
| General and administrative                           |       | 18,374                                             |       | 15                               |       | 26,315     |       | 17 |   | 7,941 |   | 43 |   |
| Total                                                |       | $                                                  | 56,335     |                             | 46         | %          | $          | 77,659 |   | 50 | % | $ | 21,324 |   | 38 | % |

 

40

----

Table ofContents

 

*Sales and Marketing.*    Salesand marketing expenses increased in the nine months ended September 30,2009 primarily due to increases in employee-related expense of $1.7 millionrelated to a headcount increase of 25 people, as well as increases infacilities expense, amortization of intangible assets and marketing programsexpenses of $0.9 million, $0.7 million and $0.6 million, respectively.  We expect that our sales and marketingexpense will continue to increase in absolute dollars as commission expenseincreases with our revenues and as we continue to expand sales coverage and tobuild brand awareness through what we believe are the most cost effectivechannels available.  We expect that such increases may fluctuate, however,due to the timing of marketing programs.

 

*Research and Development.*    Researchand development expenses increased in the nine months ended September 30,2009 primarily due to employee-related expenses of $5.1 million related to aheadcount increase of 58 people.  We also had expense increases related tofacilities expense, stock-based compensation and contractor expense of $2.5million, $1.5 million and $0.3 million, respectively.  We expect that ourresearch and development costs will continue to increase in absolute dollars aswe continue to add features and functionality to our products, introduceadditional integrated software solutions to our product suite and expand ourproduct and service offerings.

 

*General and Administrative.*    Generaland administrative expenses increased in the nine months ended September 30,2009 primarily due to increases related to facilities expense of $5.3 million,as well as increases in employee-related expenses of $3.0 million related to aheadcount increase of 35 people. We expect that in the future our general and administrativeexpenses will increase in absolute dollars as we add personnel and incuradditional costs related to the growth of our business and operations.

 

*Other Income*

 
| ** **                                     | ** ** | **Nine months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                     | ** ** | **2008**                                           | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Other income (in thousands)** | ** ** | **Amount**                                         | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                           |       |                                               |       |                             |       |       |       |   |   |   |   |   |   |
| Interest income                                |       | $                                                  | 4,770      |                             | 4          | %          | $          | 1,473 |   | 1 | % | $ | (3,297 | ) | (69 | )% |
| Other, net                                     |       | (229                                               | )          | —                           |       | 585        |       | — |   | 814 |   | (355 | ) |
| Total other income                             |       | $                                                  | 4,541      |                             | 4          | %          | $          | 2,058 |   | 1 | % | $ | (2,483 | ) | (55 | )% |

 

Thedecrease in interest income in the nine months ended September 30, 2009was primarily due to the net decrease in cash and cash equivalents and shortand long term investments as well as a decline in interest rates.  The increase in other, net in the nine monthsended September 30, 2009 was primarily due to increases in the fair valueassociated with our auction rate securities, partially offset by decrease inthe change in fair value of our securities settlement agreement with UBS.

 

*Provision for Income Taxes*

 
| ** **                                         | ** ** | **Nine months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                         | ** ** | **2008**                                           | ** ** | **2009**                         | ** ** | **Change** | ** ** |
| **Provision for income taxes (in thousands)** | ** ** | **Amount**                                         | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                               |       |                                               |       |                             |       |       |       |   |   |   |   |   |   |
| Provision for income taxes                         |       | $                                                  | 6,407      |                             | 5          | %          | $          | 4,591 |   | 3 | % | $ | (1,816 | ) | (28 | )% |
|                                                    |            |                                                    |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

Oureffective tax rates for the nine months ended September 30, 2008 and 2009were 37% and 36%, respectively.  In thenine months ended September 30, 2009, our effective tax rate was lowerthan its statutory rate of 37% primarily due to the release of a portion of itsunrecognized tax benefits as a result of the closing of a statue of limitationin a foreign tax jurisdiction.

 

41

----

Table ofContents

 

**Liquidity and Capital Resources**

 

Ourprincipal sources of liquidity were unrestricted cash, cash equivalents, shortand long-term investments totaling $177.5 million and $147.2 million at December 31,2008 and September 30, 2009, respectively, and accounts receivable of$40.0 million and $60.4 million, respectively.

 

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

 

Netcash provided by operating activities was $18.2 million in the nine monthsended September 30, 2009, which was more than net income of $8.1 million.The difference is primarily due to non-cash adjustments of $12.1 million ofdepreciation and amortization expense, $9.2 million of stock-based compensationexpense, and $2.9 million of deferred income tax expense.  Cash used for working capital and otheractivities primarily reflected an increase in accounts receivable of $18.2million and deferred costs of $3.5 million and a decrease in accounts payableof $2.1 million.  These cash uses werepartly offset by increases in deferred revenues of $11.3 million and deferredrent of $1.2 million.

 

Netcash used in investing activities was $97.6 million during the nine monthsended September 30, 2009, which was primarily due to the purchase ofshort-term and long-term investments of $86.5 million, cash paid for theacquisitions of Waban, Maaguzi and Covance IVRS/IWRS of $34.6 million andcapital expenditures of $16.3 million.  These decreases were partiallyoffset by $39.4 million of proceeds from maturities of short-term and long-terminvestments.

 

Netcash used in financing activities was less than $0.1 million in the nine monthsended September 30, 2009, due to the payment of withholding taxesassociated with the vesting of restricted stock awards of $1.9 million, offsetby the proceeds received from the exercise of stock options of $1.9 million.

 

Substantiallyall of our long-lived assets at December 31, 2008 and September 30,2009 are located in the United States.

 

Wegenerally do not enter into long-term binding purchase commitments. Ourprincipal commitments consist of obligations under non-cancelable operatingleases for office space.

 

Thefollowing table of our material contractual obligations as of December 31,2008 summarizes the aggregate effect that these obligations are expected tohave on our cash flows in the periods indicated:

 
| ** **                                  | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations (in  thousands)** | ** ** | **Total**                  | ** ** | **1 year or less** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **More than  5 years** | ** ** |
|                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Operating lease obligations                 |       | $                          | 73,029     |   | $ | 7,357 |   | $ | 14,925 |   | $ | 13,424 |   | $ | 37,323 |   |
| Total                                       |       | $                          | 73,029     |   | $ | 7,357 |   | $ | 14,925 |   | $ | 13,424 |   | $ | 37,323 |   |

 

The above table does notinclude the following lease we entered into subsequent to December 31,2008.  On August 17, 2009, we entered into a lease with KBS FiveTower Bridge, L.L.C. to secure office space for our Clarix business operationsat 300 Barr Harbor Drive, West Conshocken, Pennsylvania. The commencement datefor occupancy under the lease was September 2009.  The new lease provides for the rental of44,907 square feet of space and has an initial term of 10 years and one month.We can, subject to certain conditions, extend this term by exercising up to twoconsecutive five year options.  Theannual rent under this lease for the first year is $1.3 million, orapproximately $0.1 million per month, with annual escalations in rent for eachsubsequent year in the amount fifty cents per square foot.  The total base rent payable in the initialterm is $14.2 million.

 

Inaddition to base rent, commencing on January 1, 2012, the lease for ourClarix operations requires us to pay our proportionate share of the amount bywhich defined operating expenses incurred by the landlord exceed the base year operatingexpenses, as defined in the lease. The lease also requires us to pay ourproportionate share of the amount by which real estate taxes paid or incurredby the landlord exceed the tax base year, as defined in the lease.

 

42

----

Table ofContents

 

AtDecember 31, 2008, we had $30.4 million of net operating losscarryforwards that may be used to offset future U.S. federal taxableincome.  These attributes may reduce our future cash tax liability. In addition, we had $18.3 million of net operating losses resulting from excesstax deductions related to stock-based compensation.  We will realize thebenefit of these excess tax deductions through increases to stockholders’equity in the periods in which the losses are utilized to reduce taxpayments.  In addition, we had $2.4 million of federal research and developmenttax credit carryforwards that may be utilized to offset future U.S.taxes.  The net operating loss and tax credit carryforward periods extendthrough 2028.  In addition, we had $1.2 million of foreign net operatingloss carryforwards that may be used to offset future foreign taxable income.These foreign net operating loss carryforwards have an unlimited carryforwardperiod. We also had $3.8 million of research and development tax creditcarryforwards that may be utilized to offset future Massachusetts state taxableincome.  The Massachusetts tax credit carryforward period extends through2023.  The federal and state net operating loss carryforwards and researchand development tax credits are subject to review and possible adjustment bythe taxing authorities.  Also, the Internal Revenue Code containsprovisions that may limit the net operating loss and tax credit carryforwardsavailable in any given year in the event of certain changes in the ownershipinterests of significant stockholders.  We currently expect to realize thebenefit of recorded deferred tax assets as of December 31, 2008 of $20.0million.  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.

 

Wemay be required to make cash outlays related to our unrecognized taxbenefits.  However, due to the uncertainty of the timing of future cashflows associated with our unrecognized tax benefits, we are unable to makereasonably reliable estimates of the period of cash settlement, if any, withthe respective taxing authorities.  Accordingly, unrecognized tax benefitsof $1.4 million as of December 31, 2008 have been excluded from thecontractual obligations table above.  For further information onunrecognized tax benefits, see Note 6 in the notes to our 2008 consolidatedfinancial statements included in our Annual Report on Form 10-K for theyear ended December 31, 2008.

 

Webelieve our existing cash, cash equivalents, short-term investments and cashprovided by operating activities will be sufficient to meet our working capitaland capital expenditure needs over at least the next 12 months. Our futurecapital requirements will depend on many factors, including our rate of revenuegrowth, the expansion of our marketing and sales activities, the timing andextent of spending to support product development efforts, the timing ofintroductions of new products and services and enhancements to existingproducts and services and the continuing market acceptance of our products andservices. From time to time, we may also enter into agreements with respect topotential investments in, or acquisitions of, businesses, services ortechnologies, which could also require us to seek additional equity or debtfinancing.  To the extent that existing cash and securities and cash fromoperations are insufficient to fund our future activities, we may need to raiseadditional funds through public or private equity or debt financing.

 

Includedwithin our investment portfolio at December 31, 2008 and September 30,2009 were $24.1 million and $23.9 million of auction rate securities, orARS, at par value, which are classified as long-term investments and short-terminvestments, respectively, on our unaudited condensed consolidated balancesheets, and recorded at fair market value. These ARS are debt instrumentsissued by various states throughout the United States to finance student loans.The types of ARS that we own are backed by student loans, 95% of which areguaranteed under the Federal Family Education Loan Program, and all had creditratings of AAA (or equivalent) from a recognized rating agency. Historically,the carrying value of ARS approximated fair value due to the frequent resettingof the interest rates. With the liquidity issues experienced in the globalcredit and capital markets, our ARS have experienced multiple failed auctions.While we continue to earn and receive interest on these investments at themaximum contractual rate, the estimated fair value of these ARS no longerapproximates par value.

 

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

 

43

----

Table ofContents

 

IfUBS has insufficient funding to buy back the ARS and the auction processcontinues to fail, then we may incur further losses on the carrying value ofthe ARS.

 

Inprior periods and up through the execution of our signed settlement agreementwith UBS in November 2008, the ARS were classified as available-for-salesecurities and were reported at fair value, with temporary unrealizedgains/(losses) excluded from earnings and reported in a separate component ofstockholders’ equity and other-than-temporary unrealized losses included inearnings. Upon the execution of the settlement agreement with UBS, we electedto make a one-time transfer of the ARS from available-for-sale securities to tradesecurities. Accordingly, on a prospective basis, all unrealized gains/(losses)for these trading securities will be included in earnings.

 

Weperformed a fair value calculation of our ARS as of December 31, 2008 and September 30,2009. Fair value was determined using a secondary market indications method(direct discounts) and a discounted cash flow method as recent auctions ofthese securities were not successful, resulting in our continuing to hold thesesecurities and issuers paying interest at the maximum contractual rate. Thisvaluation technique considers the following: time left to maturity, the rate ofinterest paid on the securities, the amount of principal to be repaid to theholders of the securities; the credit worthiness of the issuer and guarantors(if any) and the sufficiency of the collateral; trading characteristics of thesecurities; ability to borrow against the ARS; evidence from secondary marketsales; and the market-clearing yield for the securities. Based upon thevaluation performed, we concluded that the fair value of these ARS at December 31,2008 was $18.0 million, a decline of $6.0 million from par value. Asour settlement agreement with UBS indicates that we intend to sell our ARS toUBS affiliates before their stated maturity under the ARS terms, thedecline in fair value is deemed other-than-temporary. Accordingly, we recordeda loss on these securities of $6.0 million in our consolidated statementof income for the year ended December 31, 2008.  As of September 30,2009, it remained our intent to sell the ARS on June 30, 2010 inaccordance with our rights under the settlement agreement, and accordingly theywere reclassified from long-term investments to short-term investments in theunaudited condensed consolidated balance sheets.  As of September 30, 2009, we concludedthat the fair value of these ARS was $18.9 million and therefore, we recorded achange in fair value of the securities of $0.9 million in our unauditedcondensed consolidated statement of income for the nine months ended September 30,2009.

 

Weelected to measure the fair value of the settlement agreement (the “putoption”) under the fair value option*.* Fair value was determined using a discounted cash flow method whichconsidered the following factors: the term of the agreement, the availabilityto borrow against the ARS, the creditworthiness of UBS and current marketinterest rates. Based on the valuation performed, we concluded that the fairvalue of the put option was $5.3 million. Accordingly, we recorded a gainof $5.3 million in the consolidated statement of income for the year endedDecember 31, 2008 with a corresponding long term asset, “securitiessettlement agreement” in the consolidated balance sheet at December 31,2008.  As of September 30, 2009, it remainedour intent to sell the ARS on June 30, 2010 in accordance with our rightsunder the settlement agreement, and accordingly we reclassified the fair valueof the “securities settlement agreement” from long-term-assets to currentassets in the accompanying unaudited condensed consolidated balance sheets andconcluded that the fair market value of the securities settlement agreement was$4.8 million, resulting in a decrease of $0.5 million in fair value beingrecorded in our unaudited condensed consolidated statement of income for thethree and nine months ended September 30, 2009, respectively.

 

Webelieve that, based on our cash, cash equivalents and short-term marketablesecurities balances of $93.6 million at September 30, 2009, excluding fairmarket value of ARS of $18.9 million, the current lack of liquidity in thecredit and capital markets will not have a material impact on our liquidity,cash flow or the ability to fund our operations for the next 12 months.

 

44

----

Table ofContents

 

**Recently Issued AccountingPronouncements**

 

***Newly Adopted AccountingPronouncements***

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007),*Business Combinations* (“SFAS No. 141(R)”)(subsequently this standard has been codified under FASB ASC Topic 805), which requiresan acquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree at the acquisition date, measured attheir fair values as of that date, with limited exceptions.  This methodreplaces the cost-allocation method, which required the cost of an acquisitionto be allocated to the individual assets acquired and liabilities assumed basedon their estimated fair values.  The revised authoritative guidance willnow require the following: acquisition costs to be expensed as incurred,restructuring costs associated with a business combination must be expensedprior to the acquisition date and changes in deferred tax asset valuationallowances and income tax uncertainties after the acquisition date generallywill affect income tax expense.  The revised authoritative guidance appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008, which is our 2009 fiscal year.  Earlier adoption is prohibited.  The adoption of this revisedauthoritative guidance has and is expected to have a significant impact onour accounting for prior and future acquisitions.

 

In April 2009, theFASB issued FASB Staff Position No. 141(R)-1 (“FSP FAS 141(R)-1”*), Accounting for Assets Acquired and LiabilitiesAssumed in a Business Combination That Arise from Contingencies*(subsequently this standard has beencodified under FASB ASC Topic 805). The revised authoritative guidance provides additionalclarification on the initial recognition and measurement of assets acquired andliabilities assumed in a business combination that arise fromcontingencies.  The revised authoritative guidance is effective for all fiscalyears beginning on or after December 15, 2008.  To date, the revised authoritativeguidance has not had a significant impact on the accounting for any businessesacquired.  However, it may have amaterial impact on how we account for future acquisitions. 

 

In April 2009, theFASB issued FASB Staff Position No. 107-1 (“FSP FAS 107-1”) and APB 28-1(“APB 28-1”),*Interim Disclosures about FairValue of Financial Instruments,* (subsequently these standards havebeen codified under FASB ASC Topic 825) which provide additional application guidanceand enhance disclosures regarding fair value measurements and impairments ofsecurities. The guidance is effective for interim reportingperiods ending after June 15, 2009. The adoption of this guidance did nothave a material effect on our consolidated financial position and results ofoperations.

 

In April 2009, theFASB issued FASB Staff Position No. 115-2 (“FSP FAS 115-2”) and FASB StaffPosition No. 124-2 (“FSP FAS 124-2”),*Recognition and Presentation of Other-Than-Temporary Impairments*(subsequently these standards have beencodified under FASB ASC Topic 320), which amends theother-than-temporary impairment guidance for debt and equity securities. Theguidance is effective for interim and annual reporting periods ending after June 15,2009.  The adoption of this guidance didnot have a material effect on our consolidated financial position and resultsof operations.

 

In April 2009, theFASB issued FSP Issue No. FAS No. 157-4 (“FSP FAS 157-4”),*Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions that are not Orderly*. FSP FASNo. 157-4, (subsequently these standards have been codified under FASB ASCTopic 820), which provide guidance on determining fair value when the volume and levelof activity for the asset or liability have significantly decreased and identifying transactions that are notorderly. The guidance providesfurther assistance in estimating fair value. The guidance is effective inreporting periods ending after June 15, 2009. The adoption of thisguidance did not have a material effect on our consolidated financial positionand results of operations.

 

45

----

Table ofContents

 

InJune 2009, the Financial Accounting Standards Board (“FASB”) issued Statementof Financial Accounting Standard (“SFAS”) No. 168, *The FASB Accounting Standards Codification and the Hierarchy ofGenerally Accepted Accounting Principles, a replacement of FASB Statement No.162*.  This statement modifies the Generally Accepted AccountingPrinciples (“GAAP”) hierarchy by establishing only two levels of GAAP:authoritative and nonauthoritative accounting literature. Effective September2009, the FASB Accounting Standards Codification (“ASC”), also knowncollectively as the “Codification,” is considered the single source ofauthoritative U.S. accounting and reporting standards, except for additionalauthoritative rules and interpretive releases issued by the SEC. Nonauthoritative guidance and literature would include, among other things,FASB Concepts Statements, American Institute of Certified Public AccountantsIssue Papers and Technical Practice Aids and accounting textbooks. TheCodification was developed to organize GAAP pronouncements by topic so thatusers can more easily access authoritative accounting guidance.  It isorganized by topic, subtopic, section, and paragraph, each of which isidentified by a numerical designation.  This statement appliesbeginning in the third quarter of 2009.  All accounting referenceshave been updated, and therefore SFAS references have been replaced with ASCreferences.

 

***Recent Accounting PronouncementsNot Yet Adopted***

 

In October 2009, theFASB issued Accounting Standards Update (“ASU”) No. 2009-13, “RevenueRecognition (Topic 605) — Multiple-Deliverable Revenue Arrangements.” ASUNo. 2009-13 addresses the accounting for multiple-deliverable arrangementsto enable vendors to account for products or services(deliverables) separately rather than as a combined unit. This guidance establishesa selling price hierarchy for determining the selling price of a deliverable,which is based on: (a) vendor-specific objective evidence;(b) third-party evidence; or (c) estimates. This guidance alsoeliminates the residual method of allocation and requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU No. 2009-13 is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010 and early adoption ispermitted. A company may elect, but will not be required, to adopt theamendments in ASU No. 2009-13 retrospectively for all prior periods. Weare currently evaluating the effect that adoption of this update will have, ifany, on our financial position or results of operation.

 

**Off-BalanceSheet Arrangements**

 

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

 

**Special Note Regarding Forward-Looking Statements**

 

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

 

46

----

Table of Contents

 

Wemay not actually achieve the plans, intentions or expectations disclosed in ourforward-looking statements and you should not place undue reliance on our forward-lookingstatements. We have based these forward-looking statements on our currentexpectations and projections about future events. Although we believe that theexpectations underlying any of our forward-looking statements are reasonable,these expectations may prove to be incorrect, and all of these statements aresubject to risks and uncertainties. We discuss many of the risks that webelieve could cause actual results or events to differ materially from theseforward-looking statements in greater detail in the section entitled “RiskFactors” in our Annual Report on Form 10-K for the year ended December 31,2008.  We urge you to consider the risksand uncertainties described in Item 1A of our Annual Report on Form 10-K forthe year ended December 31, 2008 in evaluating our forward-looking statements.Should one or more of these risks and uncertainties materialize, or shouldunderlying assumptions, projections or expectations prove incorrect, actualresults, performance or financial condition may vary materially and adverselyfrom those anticipated, estimated or expected. Our forward-looking statementsdo not reflect the potential impact of any future acquisitions, mergers,dispositions, joint ventures or investments we may make.

 

Wecaution readers not to place undue reliance upon any such forward-lookingstatements, which speak only as of the date made. Except as otherwise requiredby the federal securities laws, we disclaim any obligation or undertaking topublicly release any updates or revisions to any forward-looking statementcontained herein (or elsewhere) to reflect any change in our expectations withregard thereto or any change in events, conditions or circumstances on whichany such statement is based.

 

**Item 3.       *Quantitative and Qualitative Disclosuresabout Market Risk***

 

*Foreign Currency Exchange Risk*

* *

Ourresults of operations and cash flows are subject to fluctuations due to changesin foreign currency exchange rates, particularly changes in the euro, Britishpound, Australian dollar, Indian rupee and Japanese yen.  During the nine months ended September 30,2008 and 2009, 45% and 39%, respectively, of our revenues were generated inlocations outside the United States. During the same periods, 32% and 24%, respectively, of revenues were incurrencies other than the U.S. dollar. During the nine months ended September 30, 2009, 13% of our revenueswere in euros, 7% were in the British pound and 3% in Japanese yen.  During the three months ended September 30,2008 and 2009, 32% and 25%, respectively, of revenues were in currencies otherthan the U.S. dollar.  During the threemonths ended September 30, 2009, 15% of our revenues were in euros, 7% were inthe British pound and 3% in Japanese yen. Except for revenue transactions inJapan, we enter into transactions directly with substantially all of ourforeign customers.  During the threemonths ended September 30, 2008 and 2009, 27% and23%, respectively, of expenses were in currencies other than the U.S. dollar.During the three months ended September 30, 2009, 13% of our expenses were inBritish pound, 5% in euro, 3% in Japanese yen and 1% in Australian dollar andIndian rupee, respectively.  During the ninemonths ended September 30, 2008 and 2009, 28% and22%, respectively, of expenses were in currencies other than the U.S.dollar.  During the nine months ended September30, 2009, 12% of our expenses were in British pound, 4% in euro and Japaneseyen, respectively, and 1% in Australian dollar and Indian rupee, respectively.

 

Asof September 30, 2009, we had $17.4 million of receivables denominated incurrencies other than the U.S. dollar. We also maintain cash accounts denominated in currencies other than thelocal currency which expose us to foreign exchange rate movements.

 

Inaddition, although our foreign subsidiaries have intercompany accounts thateliminate upon consolidation, such accounts expose us to foreign currency ratemovements. Exchange rate fluctuations on short-term intercompany accounts arerecorded in our consolidated statements of operations under “other income”,while exchange rate fluctuations on long-term intercompany accounts arerecorded in our consolidated balance sheets under “accumulated othercomprehensive loss” in stockholders’ equity, as they are considered part of ournet investment and hence do not give rise to gains or losses.

 

Wehave implemented a risk management program under which we measure foreigncurrency exchange risk monthly and manage those exposures through the use ofvarious operating strategies as more fully described in Note 16 in the notes tothe accompanying unaudited condensed consolidated financial statements includedin this Quarterly Report, we regularly purchase short-term foreign currencyforward contracts, designed to hedge fluctuation in the non-functionalcurrencies of the Company and its subsidiaries against the U.S. dollar. 

 

47

----

Table of Contents

 

Thisprocess is designed to minimize foreign currency translation exposures thatcould otherwise affect consolidated results of operations. The terms of thesecontracts are for periods generally for one month.

 

Currently,our largest foreign currency exposures are the British pound and euro,primarily because our European operations have a higher proportion of our localcurrency denominated expenses. Relative to foreign currency exposures existingat December 31, 2008 and September 30, 2009, a 10% unfavorable movement inforeign currency exchange rates would not expose us to significant losses inearnings or cash flows or significantly diminish the fair value of our foreigncurrency financial instruments. This is primarily due to the short lives of theaffected financial instruments that effectively hedge substantially all of ourperiod-end exposures against fluctuations in foreign currency exchange rates.

 

Asof September 30, 2009, we entered into forward foreign exchange contracts tohedge approximately $5.8 million of receivables, intercompany accounts and cashbalances denominated in currencies other than the U.S. dollar.  For the three and nine months ended September 30,2009, we recorded $0.1 million and $0.1 million, respectively,  of foreign exchange gains in other income andaccrued expenses as a result of the outstanding forward foreign exchangecontracts.

 

*Interest Rate Sensitivity*

 

Wehad unrestricted cash, cash equivalents, short-term and long-term investmentstotaling $147.2 million at September 30, 2009.  These amounts were invested primarily in moneymarket funds, corporate bonds and government agency securities, and are heldfor working capital purposes.  We do notuse derivative financial instruments in our investment portfolio.  We have established investment guidelinesrelative to credit quality, diversification, marketability and performancemeasurement designed to maintain safety and liquidity.  With the exception of auction rate securities,investments in securities are invested primarily in high quality securities ofa short duration and historically have not been materially affected byfluctuations in interest rates. With the exception of auction rate securities,which are recorded at fair value, investments are reported at amortized cost.  We considered the historical volatility ofshort-term and long-term interest rates and determined that, due to the sizeand duration of our investment portfolio, a 100-basis-point increase ininterest rates would not have any material exposure to changes in the fairvalue of our portfolio at September 30, 2009.  A decline in interest rates, however, wouldreduce future investment income.

 

Webelieve that, based on our unrestricted cash, cash equivalents and short-termmarketable securities balances of $112.5 million at September 30, 2009, whichexclude the fair market value of ARS of $18.9 million and the fair value of thesecurities settlement agreement with UBS of $4.8 million, the current lack ofliquidity in the credit and capital markets will not have a material impact onour liquidity, cash flow or our ability to fund our operations.

 

**Item 4.**                     *Controls andProcedures*

 

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

 

Asof September 30, 2009, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective at that reasonableassurance level in (i) enabling us to record, process, summarize and reportinformation required to be included in our periodic SEC filings within therequired time period and (ii) ensuring that information required to bedisclosed in the reports that we file or submit under the Securities ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officers and Chief Financial Officer, to allow timely decisionsregarding required disclosure.

 

48

----

Table of Contents

 

In connection with ourfocus on investing in infrastructure to enhance our ability to manage expectedfuture growth, we are in the process of implementing a number of Oracle®financial software modules.  Notwithstanding this ongoing implementation, there have beenno changes in our internal control over financial reporting that occurredduring the period covered by this report that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

**Part II—Other Information**

 

**Item 1.       *Legal Proceedings***

 

Fromtime to time and in the ordinary course of business, we are subject to variousclaims, charges and litigation.  Theoutcome of litigation cannot be predicted with certainty and some lawsuits,claims or proceedings may be disposed of unfavorably to us, which couldmaterially affect our financial condition or results of operations.

 

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

 

We operate in a rapidly changing environment thatinvolves a number of risks, some of which are beyond our control.  The risks and uncertainties that we believeare most important for you to consider are described under the title “Risk Factors”in our Annual Report on Form 10-K for the year ended December 31, 2008.  There are no material changes to the riskfactors described in the “Risk Factors” section in our Annual Report on Form 10-Kfor the year ended December 31, 2008.  Additional risks and uncertainties notpresently known to us, which we currently deem immaterial or which are similarto those faced by other companies in our industry or business in general, mayalso impair our business operations.  Ifany of the foregoing risks or uncertainties actually occurs, our business,financial condition and operating results would likely suffer.

 

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

 

Underthe terms of our 2004 Stock Option and Incentive Plan, or 2004 Plan, we haveissued shares of restricted stock and restricted stock units to our employees.  On the date that these restricted shares vest,we withhold, via a net exercise provision pursuant to our applicable restrictedstock agreements and the 2004 Plan, the number of vested shares (based on theclosing price of our common stock on such vesting date) equal to taxwithholdings required by us. The shares withheld from the grantees to settletheir tax liability are reallocated to the number of shares available for issuanceunder the 2004 Plan. For the nine month period ending September 30, 2009, wewithheld an aggregate of 133,056 common shares under restricted stock units ata price of $13.93 per share.

 

**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 Securities Exchange Actof 1934, as amended. We have been advised that our Senior Vice President, Legaland Regulatory Services, D. Ari Buchler, our Senior Vice President, Integrationand Product Strategy, Martin Young, and our Senior Vice President, Sales andMarketing, Stephen J. Powell, have each entered into a trading plan covering periodsafter the date of this Quarterly Report in accordance with Rule 10b5-1 and ourpolicy governing transactions in our securities.  Generally, under these trading plans, theindividual relinquishes control over the transactions once the trading plan isput into place.  Accordingly, sales underthese plans may occur at any time, including possibly before, simultaneouslywith, or immediately after significant events involving our company.

 

Weanticipate that, as permitted by Rule 10b5-1 and our policy governingtransactions in our securities, some or all of our officers, directors andemployees may establish trading plans in the future. We intend to disclose thenames of executive officers and directors who establish a trading plan incompliance with Rule 10b5-1 and the requirements of our policy governingtransactions in our securities in our future quarterly and annual reports on Form10-Q and 10-K filed with the Securities and Exchange Commission. However, weundertake no obligation to update or revise the information provided herein,including for revision or termination of an established trading plan, otherthan in such quarterly and annual reports.

 

49

----

Table of Contents

 

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

 
| **Exhibit** | ** ** | ** **                                                                                                               |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                          |
|        |       |                                                                                                                     |
| 31.1        | *          | Certification  of CEO pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange  Act of 1934.               |
| 31.2        | *          | Certification  of CFO pursuant to rules 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.              |
| 32.1        | *          | Certification  of CEO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2        | *          | Certification  of CFO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

----

*** Filedherewith.**

 

50

----

Table of Contents

 

**Signatures**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                    | **PHASE  FORWARD INCORPORATED** |
|-------------------------|---------------------------------|
|                    |                            |   |
|                    | By:                             | /s/  ROBERT K. WEILER |
|                    |                            | Robert  K. Weiler

*Chief  Executive Officer*

*(Duly  authorized officer)* |
|                    |                            |   |
|                    | By:                             | /s/  CHRISTOPHER A. MENARD |
|                    |                            | Christopher  A. Menard

*Chief  Financial Officer*

*(Duly  authorized officer and principal financial officer)* |
| Date:  November 6, 2009 |                            |   |

 

51

----

Table of Contents

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                               |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                          |
|        |       |                                                                                                                     |
| 31.1        | *          | Certification  of CEO pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange  Act of 1934.               |
| 31.2        | *          | Certification  of CFO pursuant to rules 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.              |
| 32.1        | *          | Certification  of CEO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2        | *          | Certification  of CFO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

----

* Filed herewith.

 

52

----