**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended March 31, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**CommissionFile Number: 000-50839**

**Phase Forward Incorporated**

(Exact name of registrantas specified in its charter)

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

 

**(888) 703-1122**

(Registrant’s telephonenumber, including area code)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.

Yes x    No o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act).

Yes o    No x

Asof May 1, 2005, the registrant had 32,739,890 shares of Common Stockoutstanding.

 

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**PHASE FORWARDINCORPORATEDQUARTERLY REPORT ON FORM 10-QFor the quarterly period ended March 31, 2005Table of Contents**
|                                            | ** **                                                                                                      | ** ** | **Page  Number** |
|--------------------------------------------|-----------------------------------------------------------------------------------------------------------------|------------|------------------|
| **Part I—Financial Information** |                                                                                                            |       |             |   |
| Item 1.                                    | Condensed  Consolidated Financial Statements (unaudited)                                                        |       |             | 3 |   |
|                                       | Condensed  Consolidated Balance Sheets as of December 31, 2004 and March 31,  2005                    |       |             | 3 |   |
|                                       | Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2004 and 2005  |       |             | 4 |   |
|                                       | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2004 and 2005  |       |             | 5 |   |
|                                       | Notes  to Condensed Consolidated Financial Statements                                                           |       |             | 6 |   |
| Item 2.                                    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |       |             | 17 |   |
| Item 3.                                    | Quantitative  and Qualitative Disclosures about Market Risk                                                     |       |             | 43 |   |
| Item 4.                                    | Controls  and Procedures                                                                                        |       |             | 43 |   |
| **Part II—Other Information**    |                                                                                                            |       |             |   |
| Item 1.                                    | Legal  Proceedings                                                                                              |       |             | 45 |   |
| Item 5.                                    | Other  Information                                                                                              |       |             | 45 |   |
| Item 6.                                    | Exhibits                                                                                                        |       |             | 46 |   |
| Signatures                                 |                                                                                                            |       | 47               |   |
| Exhibit Index                         |                                                                                                            |       | 48               |   |

 

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**Part I—Financial Information**

**Item1.**                        CondensedConsolidated Financial Statements (unaudited)

**Phase Forward Incorporated and SubsidiariesCondensed ConsolidatedBalance Sheets(unaudited)(in thousands, except per share amounts)**
| ** **                                                                             | ** ** | **As of  December 31,  2004** | ** ** | **As of  March 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------|------------|
| **Assets**                                                                             |       |                                    |       |                                 |       |   |   |
| Current assets:                                                                        |       |                                    |       |                                 |       |   |   |
| Cash and cash equivalents                                                              |       |                                    | $          | 53,485                               |       |   | $ | 61,009 |   |
| Short-term investments                                                                 |       |                                    | 4,735      |                                 |       | 4,327 |   |
| Accounts receivable, net  of allowance of $391 and $289 in 2004 and 2005, respectively |       |                                    | 19,682     |                                 |       | 14,875 |   |
| Deferred set up costs,  current portion                                                |       |                                    | 783        |                                 |       | 950 |   |
| Prepaid commissions and  royalties, current portion                                    |       |                                    | 3,035      |                                 |       | 3,289 |   |
| Prepaid expenses and  other current assets                                             |       |                                    | 2,335      |                                 |       | 2,518 |   |
| Total current  assets                                                                  |       |                                    | 84,055     |                                 |       | 86,968 |   |
| Property and  equipment, net                                                           |       |                                    | 5,717      |                                 |       | 5,508 |   |
| Deferred set up  costs, net of current portion                                         |       |                                    | 665        |                                 |       | 715 |   |
| Prepaid  commissions and royalties, net of current portion                             |       |                                    | 2,756      |                                 |       | 2,600 |   |
| Goodwill                                                                               |       |                                    | 21,817     |                                 |       | 21,354 |   |
| Other assets                                                                           |       |                                    | 240        |                                 |       | 192 |   |
| Total assets                                                                           |       |                                    | $          | 115,250                              |       |   | $ | 117,337 |   |
| **Liabilities and Stockholders’ Equity**                                          |       |                                    |       |                                 |       |   |   |
| Current Liabilities:                                                                   |       |                                    |       |                                 |       |   |   |
| Current portion of notes  payable                                                      |       |                                    | $          | 2,558                                |       |   | $ | — |   |
| Accounts payable                                                                       |       |                                    | 1,619      |                                 |       | 1,188 |   |
| Accrued expenses                                                                       |       |                                    | 11,658     |                                 |       | 9,362 |   |
| Restructuring accrual                                                                  |       |                                    | 344        |                                 |       | — |   |
| Deferred revenue, current  portion                                                     |       |                                    | 35,350     |                                 |       | 41,590 |   |
| Deferred rent, current  portion                                                        |       |                                    | 142        |                                 |       | 291 |   |
| Total current  liabilities                                                             |       |                                    | 51,671     |                                 |       | 52,431 |   |
| Notes payable, net  of current portion                                                 |       |                                    | 1,849      |                                 |       | — |   |
| Deferred revenue,  net of current portion                                              |       |                                    | 1,002      |                                 |       | 1,350 |   |
| Deferred rent, net  of current portion                                                 |       |                                    | 1,481      |                                 |       | 1,527 |   |
| Total liabilities                                                                      |       |                                    | 56,003     |                                 |       | 55,308 |   |
| Contingencies (Note 13)                                                                |       |                                    |       |                                 |       |   |   |
| Stockholders’ equity:                                                             |       |                                    |       |                                 |       |   |   |
| Preferred stock, $0.1 par value:                                                       |       |                                    |       |                                 |       |   |   |
| Authorized—5,000 shares                                                           |       |                                    |       |                                 |       |   |   |
| Issued—0 shares                                                                   |       |                                    | —     |                                 |       | — |   |
| Common stock, $.01 par value:                                                          |       |                                    |       |                                 |       |   |   |
| Authorized—100,000 shares                                                         |       |                                    |       |                                 |       |   |   |
| Issued—32,399 and 32,764  shares in 2004 and 2005, respectively                   |       |                                    | 324        |                                 |       | 328 |   |
| Additional paid-in  capital                                                            |       |                                    | 165,462    |                                 |       | 166,512 |   |
| Subscription receivable                                                                |       |                                    | (127       | )                                    |       | — |   |
| Deferred stock-based  compensation                                                     |       |                                    | (1,755     | )                                    |       | (1,456 | ) |
| Treasury stock, 37 shares  at cost                                                     |       |                                    | (111       | )                                    |       | (111 | ) |
| Accumulated other  comprehensive loss                                                  |       |                                    | (160       | )                                    |       | (326 | ) |
| Accumulated deficit                                                                    |       |                                    | (104,386   | )                                    |       | (102,918 | ) |
| Total  stockholders’ equity                                                       |       |                                    | 59,247     |                                 |       | 62,029 |   |
| Total liabilities and stockholders’ equity                                        |       |                                    | $          | 115,250                              |       |   | $ | 117,337 |   |

 

See accompanying notes.

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**Phase Forward Incorporated and SubsidiariesCondensed ConsolidatedStatements of Operations(unaudited)(in thousands, except per share amounts)**
| ** **                                                                                  | ** ** | **Three Months Ended  March 31,**                     | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **     2004     ** | ** ** | **     2005     ** | ** ** |
| Revenues:                                                                                   |       |                                                                 |       |   |   |   |   |   |   |
| License                                                                                     |       |                                                                 | $          | 6,166 |   |   |   | $ | 8,819 |   |   |
| Service                                                                                     |       |                                                                 | 10,796     |   |   |   | 11,743 |   |   |
| Total revenues                                                                              |       |                                                                 | 16,962     |   |   |   | 20,562 |   |   |
| Costs of revenues:                                                                          |       |                                                                 |       |   |   |   |   |   |   |
| License                                                                                     |       |                                                                 | 422        |   |   |   | 448 |   |   |
| Service(1)                                                                                  |       |                                                                 | 6,781      |   |   |   | 7,212 |   |   |
| Total cost of  revenues                                                                     |       |                                                                 | 7,203      |   |   |   | 7,660 |   |   |
| Gross margin:                                                                               |       |                                                                 |       |   |   |   |   |   |   |
| License                                                                                     |       |                                                                 | 5,744      |   |   |   | 8,371 |   |   |
| Service                                                                                     |       |                                                                 | 4,015      |   |   |   | 4,531 |   |   |
| Total gross margin                                                                          |       |                                                                 | 9,759      |   |   |   | 12,902 |   |   |
| Operating expenses:                                                                         |       |                                                                 |       |   |   |   |   |   |   |
| Sales and marketing(1)                                                                      |       |                                                                 | 3,305      |   |   |   | 3,951 |   |   |
| Research and  development(1)                                                                |       |                                                                 | 2,936      |   |   |   | 3,281 |   |   |
| General and  administrative(1)                                                              |       |                                                                 | 2,643      |   |   |   | 3,804 |   |   |
| Restructuring                                                                               |       |                                                                 | —     |   |   |   | (92 | ) |   |
| Total operating  expenses                                                                   |       |                                                                 | 8,884      |   |   |   | 10,944 |   |   |
| Income from  operations                                                                     |       |                                                                 | 875        |   |   |   | 1,958 |   |   |
| Other income (expense):                                                                     |       |                                                                 |       |   |   |   |   |   |   |
| Interest income                                                                             |       |                                                                 | 105        |   |   |   | 348 |   |   |
| Interest expense                                                                            |       |                                                                 | (82        | ) |   |   | (144 | ) |   |
| Other, net                                                                                  |       |                                                                 | (16        | ) |   |   | (130 | ) |   |
| Total other income                                                                          |       |                                                                 | 7          |   |   |   | 74 |   |   |
| Income before  provision for income taxes                                                   |       |                                                                 | 882        |   |   |   | 2,032 |   |   |
| Provision for  income taxes                                                                 |       |                                                                 | 499        |   |   |   | 564 |   |   |
| Net income                                                                                  |       |                                                                 | 383        |   |   |   | 1,468 |   |   |
| Accretion of  preferred stock and dividend declared                                         |       |                                                                 | 1,918      |   |   |   | — |   |   |
| Net income (loss)  applicable to common stockholders                                        |       |                                                                 | $          | (1,535 | ) |   |   | $ | 1,468 |   |   |
| Net income (loss) per  share applicable to common stockholders:                             |       |                                                                 |       |   |   |   |   |   |   |
| Basic                                                                                       |       |                                                                 | $          | (0.43 | ) |   |   | $ | 0.05 |   |   |
| Diluted                                                                                     |       |                                                                 | $          | (0.43 | ) |   |   | $ | 0.04 |   |   |
| Weighted average number  of common shares used in net income (loss) per share calculations: |       |                                                                 |       |   |   |   |   |   |   |
| Basic                                                                                       |       |                                                                 | 3,550      |   |   |   | 32,457 |   |   |
| Diluted                                                                                     |       |                                                                 | 3,550      |   |   |   | 34,536 |   |   |

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(1)    Amounts include stock-based expenses, asfollows:
| Costs of service revenues   |   |   | $   | 26     |   |   |   | $      | 25     |   |   |
|-----------------------------|--------|--------|-----|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and marketing         |   |   | 39  |   |   |   | (16    | )      |   |
| Research and development    |   |   | 96  |   |   |   | 55     |   |   |
| General and  administrative |   |   | 285 |   |   |   | 160    |   |   |
| Total stock-based expenses  |   |   | $   | 446    |   |   |   | $      | 224    |   |   |

 

See accompanying notes.

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**Phase Forward Incorporated and SubsidiariesCondensed ConsolidatedStatements of Cash Flows(unaudited)(in thousands)**
| ** **                                                                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| **Operating activities**                                                                          |       |                                             |       |   |   |
| Net income                                                                                        |       | $                                                | 383        |   | $ | 1,468 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:                |       |                                             |       |   |   |
| Depreciation and amortization                                                                     |       | 767                                              |       | 801 |   |
| Stock-based compensation                                                                          |       | 446                                              |       | 224 |   |
| Foreign currency exchange loss                                                                    |       | 16                                               |       | 112 |   |
| Non-cash income tax expense                                                                       |       | 447                                              |       | 463 |   |
| Changes in assets  and liabilities:                                                               |       |                                             |       |   |   |
| Accounts receivable                                                                               |       | 5,912                                            |       | 4,647 |   |
| Deferred costs                                                                                    |       | (789                                             | )          | (308 | ) |
| Prepaid expenses and other current assets                                                         |       | (788                                             | )          | (224 | ) |
| Accounts payable                                                                                  |       | (86                                              | )          | (438 | ) |
| Accrued expenses                                                                                  |       | (3,045                                           | )          | (2,430 | ) |
| Deferred revenue                                                                                  |       | (885                                             | )          | 6,688 |   |
| Deferred Rent                                                                                     |       | 335                                              |       | 197 |   |
| Net cash provided by operating activities                                                         |       | 2,713                                            |       | 11,200 |   |
| **Investing  activities**                                                                         |       |                                             |       |   |   |
| Purchase of  short-term investments                                                               |       | —                                           |       | (842 | ) |
| Proceeds from  maturities of short-term investments                                               |       | —                                           |       | 1,250 |   |
| Purchase of  property and equipment                                                               |       | (671                                             | )          | (611 | ) |
| Decrease  (increase) in other assets                                                              |       | (176                                             | )          | 9 |   |
| Net cash used in investing activities                                                             |       | (847                                             | )          | (194 | ) |
| **Financing  activities**                                                                         |       |                                             |       |   |   |
| Proceeds from  issuance of notes payable and borrowings under lines of credit                     |       | 1,484                                            |       | — |   |
| Payments on lines  of credit and notes payable                                                    |       | (605                                             | )          | (4,407 | ) |
| Proceeds from  issuance of common stock                                                           |       | 42                                               |       | 1,128 |   |
| Proceeds from  repayment of subscriptions receivable                                              |       | 514                                              |       | 127 |   |
| Net cash provided by (used in) financing activities                                               |       | 1,435                                            |       | (3,152 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                                     |       | 83                                               |       | (330 | ) |
| Net change in cash and cash equivalents                                                           |       | 3,384                                            |       | 7,524 |   |
| Cash and cash  equivalents at beginning of year                                                   |       | 19,046                                           |       | 53,485 |   |
| Cash and cash equivalents at end of period                                                        |       | $                                                | 22,430     |   | $ | 61,009 |   |
| **Non-cash  financing activities**                                                                |       |                                             |       |   |   |
| Accretion of  Series B, C, and D redeemable convertible preferred stock to redemption  value |       | $                                                | 1,918      |   | $ | — |   |

 

See accompanying notes.

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**Phase Forward Incorporated and SubsidiariesNotes to CondensedConsolidated Financial Statements(unaudited)(in thousands, except share and per share amounts)**

**1.   Basis of Presentation**

The accompanying unauditedcondensed consolidated financial statements included herein have been preparedby 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. Nevertheless, themanagement of the Company believes that the disclosures herein are adequate tomake the information presented not misleading. In the opinion of management,the unaudited condensed consolidated financial statements have been prepared onthe same 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 March 31, 2005, the results of itsoperations for the three months ended March 31, 2004 and 2005 and its cashflows for the three months ended March 31, 2004 and 2005. These unauditedcondensed consolidated financial statements and notes thereto should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s 2004 Annual Report on Form 10-K filedwith the SEC. The results of operations for the interim periods are notnecessarily indicative of the results of operations to be expected for the yearending December 31, 2005.

**2.   RevenueRecognition and Deferred Set up Costs**

The Company derives revenues from software licensesand services. License revenue is derived principally from the sale ofmulti-year software term licenses of the Company’s *InFormTM, ClintrialTM* and *ClintraceTM*software products. Service revenue is derived from the Company’s delivery ofthe hosted solution of its *InForm *software product,consulting services and customer support, including training.

Thecomponents of revenue are as follows:
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| License                       |       | $                                                | 6,166      |   | $ | 8,819 |   |
| Application hosting  services |       | 5,913                                            |       | 6,832 |   |
| Consulting services           |       | 1,564                                            |       | 1,394 |   |
| Customer support              |       | 3,319                                            |       | 3,517 |   |
| Total                         |       | $                                                | 16,962     |   | $ | 20,562 |   |

 

The Company recognizes software license revenue inaccordance with Statement of Position (“SOP”) No. 97-2, *Software Revenue Recognition,* as amended,issued by the American Institute of Certified Public Accountants, while revenueresulting from application hosting services are recognized in accordance withEmerging Issues Task Force (“EITF”) Issue No. 00-03, *Application of AICPA Statement of Position 97-2 toArrangements that include the Right to Use Software Stored on Another Entity’sHardware*, SEC Staff Accounting Bulletin (“SAB”) Nos. 101 and 104, *Revenue Recognition*, and EITF Issue No. 00-21,*RevenueArrangements with Multiple Deliverables.*

Customers generally have the ability to terminateapplication hosting, consulting and training service agreements upon30 days notice to the Company. License agreements, multiple elementarrangements, 

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including license andservices agreements, and certain application hosting services can generally beterminated by either party for material breach of obligations not correctedwithin 30 days after notice of the breach.

The Company recognizes revenue when all of thefollowing conditions are satisfied: (1) there is persuasive evidence of anarrangement; (2) the product or service has been provided to the customer;(3) the collection of fees is probable; and (4) the amount of fees tobe paid by the customer is fixed or determinable.

The Company generally enters into software termlicenses with its customers for three to five year periods. These arrangementstypically include multiple elements: a software license, consulting servicesand customer support. The Company bills its customers in accordance with theterms of the underlying contract. Generally, the Company bills the annuallicense fee for the first year of a multi-year contract in advance and billsthe license fees for the subsequent years in advance on the anniversary date.The Company’s payment terms are generally net 30 days.

The Company’s software license revenue is earned fromthe sale of off-the-shelf software requiring no significant modification orcustomization subsequent to delivery to the customer. Consulting services,which can also be performed by third-party consultants, are deemed to benon-essential to the functionality of the software and typically are for trialconfiguration, implementation planning, loading of software, building simpleinterfaces and running test data and documentation of procedures.

The Company generally bundles customer support withthe software license for the entire term of the license. As a result, theCompany generally recognizes revenue for all elements, including consultingservices, ratably over the term of the software license and supportarrangement. The Company allocates the revenue recognized for thesearrangements to the different elements based on management’s estimate of the relativefair value of each element. For its term-based licenses, the Company allocatesto consulting services the anticipated service effort and value throughout theterm of the arrangement at an amount that would have been allocated had thoseservices been sold separately to the customer. The remaining value is allocatedto license and support services, with 10% of this amount allocated to supportservices. The Company has allocated the estimated fair value to its multipleelement arrangements to provide meaningful disclosures about each of itsrevenue streams. The costs associated with the consulting and customer supportservices are expensed as incurred. There are instances in which the Companysells software licenses based on usage levels. These software licenses can bebased on estimated usage, in which case the license fee charged to the customeris fixed based on this estimate. When the fee is fixed, the revenue isrecognized ratably over the contractual term of the arrangement. If the fee isbased on actual usage, and therefore variable, the revenue is recognized in theperiod of use. Revenue from certain follow-on consulting services, which aresold separately to customers with existing software licenses and are notconsidered part of a multiple element arrangement, are recognized as theservices are performed.

The Company continues to sell the *Clintrial* and *Clintrace* software products to certainexisting customers as perpetual software licenses with the option to purchasecustomer support. The Company generally does not sell perpetual licenses to newcustomers. The Company has established vendor specific objective evidence offair value for the customer support in these arrangements. Accordingly, thelicense revenue is recognized upon delivery of the software and when all otherrevenue recognition criteria are met. The customer support is recognizedratably over the term of the underlying support arrangement. The Companycontinues to generate customer support and maintenance revenue from itsperpetual license customer base. Training revenue is recognized as earned.

In addition to making its software products availableto customers through licenses, the Company offers its *InForm *electronic data capturesoftware product through a fully-hosted, turnkey deployment. Revenue resultingfrom application hosting services consist of three stages for each clinicaltrial. The first stage includes trial and application set up, including designof electronic case report forms and edit checks, 

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implementation of thesystem and server configuration. The second stage consists of applicationhosting and related support services. The third stage, database lock, consistsof services required to close out, or lock, the database for the clinicaltrial. Services provided for the first and third stages are provided on a fixedfee based upon the complexity of the trial and system requirements. Servicesfor the second stage are charged separately as a fixed monthly fee. The Companyrecognizes revenue from application hosting and related services ratably overthe hosting period. Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred and capitalized as applicable,until the start of the hosting period. These revenues and costs are recognizedand amortized, as applicable, ratably over the estimated hosting period. Thecapitalized costs include incremental direct costs with third parties andcertain internal direct costs of the trial and application set up, as definedunder Statement of Financial Accounting Standards (SFAS) No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognizedratably over the remaining term of the hosting period.

In the event that an application hosting customercancels a clinical trial and its related statement of work, all deferredrevenue is recognized, all deferred set up costs are expensed and certaintermination related fees may be charged.

The Company capitalized $527 and $666 of deferred setup costs and amortized $496 and $449 during the three months ended March 31,2004 and 2005, respectively. The amortization of deferred set up costs is acomponent of cost of services.

Deferred revenue represents amounts billed or cashreceived in advance of revenue recognition.

Provisions for estimated losses on uncompletedcontracts are made on a contract-by-contract basis and are recognized in theperiod in which such losses become probable and can be reasonably estimated. Todate, the Company has not experienced any material losses on uncompletedapplication hosting contracts.

In accordance with EITFIssue No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred,* the Company included $297 and $197 of out of pocketexpenses in service revenue and cost of service revenue in the three monthsended March 31, 2004 and 2005, respectively.

**3.   PrepaidSales Commissions and Royalties**

For arrangements where revenue is recognized over therelevant contract period, the Company capitalizes related commissions paid tosales people and royalties paid to third parties, and recognizes these expensesover the period that the related revenue is recognized. Commission payments arenonrefundable unless amounts due from a customer are determined to beuncollectible or if the customer subsequently changes or terminates the levelof service, in which case commissions paid are recoverable by the Company. TheCompany capitalized $760 and $677 of commissions and amortized to sales andmarketing expense $568 and $830 during the three months ended March 31,2004 and 2005, respectively.

The Company’s royaltyobligation is based upon the license and customer support revenue earned forcertain products in an arrangement. The Company has the right to recover theroyalties in the event the arrangement is cancelled. The Company capitalized$1,150 and $822 of royalties and amortized to cost of revenues $585 and $571during the three months ended March 31, 2004 and 2005, respectively.

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**4.   Warranties and Indemnification**

The Company’s hosting service is typically warrantedto perform in a manner consistent with general industry standards that arereasonably applicable and substantially in accordance with the Company’s onlinehelp documentation under normal use and circumstances. The Company’sarrangements also include certain provisions for indemnifying customers againstliabilities if its products or services infringe a third party’s intellectualproperty rights. See the discussion of possible indemnification obligations inNote 13.

The Company has entered into service level agreementswith some of its hosted application customers warranting certain levels ofuptime reliability and permitting those customers to receive credits againstmonthly hosting fees or terminate their agreements in the event that theCompany fails to meet those levels.

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

**5.   Net Income (Loss) Per Share**

Basic and diluted net income (loss) per share ispresented in conformity with SFAS No. 128, *Earnings Per Share*. Basic net income (loss) per common sharewas determined by dividing net income (loss) applicable to common stockholdersby the weighted average number of common shares outstanding during the period.Weighted average shares outstanding exclude unvested restricted common stock.The Company’s potentially dilutive shares, which include outstanding commonstock options, redeemable convertible preferred stock and warrants also havenot been included in the computation of diluted net income (loss) per share forall periods in which the Company was in a loss position as the result would beanti-dilutive.

Thefollowing table reconciles the weighted average shares outstanding used tocalculate basic and diluted net income (loss) per share for the three monthsended March 31, 2004 and 2005:
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| Numerator:                                                               |       |                                             |       |   |   |
| Net income (loss)  applicable to common stockholders                     |       | $                                                | (1,535     | ) | $ | 1,468 |   |
| Denominator:                                                             |       |                                             |       |   |   |
| Weighted average  common shares outstanding                              |       | 3,591,048                                        |       | 32,456,501 |   |
| Less: Weighted  average unvested restricted common shares outstanding    |       | (41,128                                          | )          | — |   |
| Basic net income  (loss) per share—weighted average common shares   |       | 3,549,920                                        |       | 32,456,501 |   |
| Dilutive effect  of common stock options                                 |       | —                                           |       | 2,079,975 |   |
| Diluted net  income (loss) per share—weighted average common shares |       | 3,549,920                                        |       | 34,536,476 |   |
| Net income (loss) per  share applicable to common stockholders:          |       |                                             |       |   |   |
| Basic                                                                    |       | $                                                | (0.43      | ) | $ | 0.05 |   |
| Diluted                                                                  |       | $                                                | (0.43      | ) | $ | 0.04 |   |

 

9

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Thefollowing common share equivalents and unvested restricted shares have beenexcluded from the computation of diluted weighted average shares outstanding asof March 31, 2004 and 2005, respectively, as they would be anti-dilutive.
| ** **                              | ** ** | **Three Months ended  March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|
| ** **                              | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| Redeemable  convertible preferred stock |       | 22,841,157                                       |       | — |   |
| Options  outstanding                    |       | 4,588,751                                        |       | 295,000 |   |
| Unvested  restricted shares             |       | 35,764                                           |       | — |   |
| Warrant                                 |       | 34,330                                           |       | — |   |

 

**6.   Foreign Currency Translation**

The financial statementsof the Company’s foreign subsidiaries are translated in accordance with SFAS No. 52,*Foreign Currency Translation.* Thereporting currency for the Company is the U.S. dollar. The functional currencyof the Company’s subsidiaries in the United Kingdom, France, Germany, Japan andAustralia are the local currencies of those countries. Accordingly, the assetsand liabilities of the Company’s foreign subsidiaries are translated into U.S.dollars using the exchange rate in effect at each balance sheet date. Revenueand expense accounts are generally translated using an average rate of exchangeduring the period. Foreign currency translation adjustments are accumulated asa component of other comprehensive loss as a separate component of stockholders’equity. Gains and losses arising from transactions denominated in foreigncurrencies are primarily related to intercompany accounts that have beendetermined to be temporary in nature and cash and accounts receivabledenominated in non-functional currencies. The Company has recorded foreigncurrency losses of $16 and $112 for the three months ended March 31, 2004and 2005, respectively, and such losses are included in other income (expense)in the accompanying unaudited condensed consolidated statements of operations.

**7.   Cash,Cash Equivalents and Short-Term Investments**

The Company accounts for its investments in accordancewith SFAS No. 115, *Accounting forCertain Investments in Debt and Equity Securities*. Under SFAS No. 115,securities that the Company has the intent and ability to hold to maturity arereported at amortized cost, which approximates market value, and are classifiedas held-to-maturity. The Company considers all highly liquid investments withoriginal maturities of 90 days or less at the time of purchase to be cashequivalents and investments with original maturities of between 91 daysand one year to be short term investments. At March 31, 2004 cashequivalents primarily consisted of money market funds that were readilyconvertible to cash. At March 31, 2005, short-term investments consistedof U.S. agency notes and corporate debentures.

Cash,cash equivalents and short-term investments as of December 31, 2004 and March 31,2005 were as follows:
| ** **                                 | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|
| **Description**                            | ** ** | ** **                      | ** ** | **Contracted  Maturity** | ** ** | **Amortized  Cost** | ** ** | **Fair Market  Value** | ** ** |
| Cash and cash  equivalents                 |       | Demand                          |       |   | $ | 13,138 |   |   |   | $ | 13,138 |   |   |
| U.S. agency notes  and U.S. treasury bills |       | Less  than 90 days              |       |   | 3,390 |   |   |   | 3,390 |   |   |
| Money market  funds                        |       | Demand                          |       |   | 35,014 |   |   |   | 35,014 |   |   |
| Certificate of  deposit                    |       | 30  days                        |       |   | 1,943 |   |   |   | 1,943 |   |   |
| Total cash and cash equivalents            |       |                            |       |   | $ | 53,485 |   |   |   | $ | 53,485 |   |   |
| Short-term  investments                    |       | 147-356 days               |       |   | $ | 4,735 |   |   |   | $ | 4,728 |   |   |
|                                            |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                                 | ** ** | **March 31, 2005** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| **Description**                            | ** ** | ** **                   | ** ** | **Contracted  Maturity** | ** ** | **Amortized  Cost** | ** ** | **Fair Market  Value** | ** ** |
| Cash and cash  equivalents                 |       | Demand                       |       |   | $ | 20,128 |   |   |   | $ | 20,128 |   |   |
| U.S. agency notes  and U.S. treasury bills |       | Less  than 90 days           |       |   | 3,662 |   |   |   | 3,662 |   |   |
| Money market  funds                        |       | Demand                       |       |   | 35,429 |   |   |   | 35,429 |   |   |
| Certificate of  deposit                    |       | 30  days                     |       |   | 1,790 |   |   |   | 1,790 |   |   |
| Total cash and cash equivalents            |       |                         |       |   | $ | 61,009 |   |   |   | $ | 61,009 |   |   |
| Short-term  investments                    |       | 113-359 days                 |       |   | $ | 4,327 |   |   |   | $ | 4,316 |   |   |
|                                            |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company has had norealized or unrealized gains or losses to date on the sale of money marketfunds or short-term investments.

**8.   Stock-Based Compensation**

In January 2003, the FASB issued SFAS No. 148,*Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB Statement No. 123,*which provides alternative methods of transition for a voluntary change to afair-value-based method of accounting for stock-based employee compensation. Inaddition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123,*Accounting for Stock-Based Compensation,*to require prominent disclosures in annual financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company accounts for options grantedunder its stock-based compensation plans for employees under AccountingPrinciples Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employee*s, and has elected the disclosure-onlyalternative under SFAS No. 123 and the enhanced disclosures as required bySFAS No. 148. Under APB Opinion No. 25, when the exercise price ofoptions granted under these plans equals or exceeds the market price of theunderlying stock on the date of grant, no compensation expense is required.

The following tables illustrate the assumptions usedand the effect on net income (loss) if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to stock-based employeecompensation. The Company has computed the pro forma disclosures required underSFAS No. 123 for all employee stock options granted using theBlack-Scholes option pricing model prescribed by SFAS No. 123.

Theassumptions used and weighted average information are as follows:
| ** **                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| Average risk-free  interest rate           |       |                                             | 3.58       | % |   |   | 4.01 | % |   |
| Expected dividend  yield                   |       |                                             | —     |   |   |   | — |   |   |
| Expected life                              |       |                                             | 7 years    |   |   |   | 4 years |   |   |
| Expected  volatility                       |       |                                             | —     |   |   |   | 90 | % |   |
| Weighted average fair  value at grant date |       |                                             | $6.03      |   |   |   | $6.37 |   |   |

 

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TheCompany offers the 2004 Employee Stock Purchase Plan. Accordingly, the Companyhas calculated the SFAS No. 123 pro forma expense for shares purchasedunder the 2004 Employee Stock Purchase Plan using the following assumptions:
| ** **                       | ** ** | **Three Months Ended  March, 31 2005** | ** **      |
|----------------------------------|------------|-------------------------------------------------------|-----------------|
| Average risk-free  interest rate |       |                                                  | 2.40            | % |   |
| Expected dividend  yield         |       |                                                  | —          |   |   |
| Expected life                    |       |                                                  | 0.50 years |   |   |
| Expected volatility              |       |                                                  | 60              | % |   |

 

Hadcompensation costs been determined consistent with SFAS No. 123, theCompany’s net income (loss) would have been the following pro forma amounts:
| ** **                                                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| Net income (loss)  applicable to common stockholders, as reported                                                    |       | $                                                | (1,535     | ) | $ | 1,468 |   |
| Add: Stock-based  compensation expense included in reported net income (loss)                                        |       | 446                                              |       | 224 |   |
| Less: Total  stock-based employee compensation expense determined under fair-value-based  method for all awards |       | 598                                              |       | 657 |   |
| Pro forma net income (loss)                                                                                          |       | $                                                | (1,687     | ) | $ | 1,035 |   |
| Pro forma net  income (loss) per share applicable to common stockholders:                                            |       |                                             |       |   |   |
| Basic                                                                                                                |       | $                                                | (0.48      | ) | $ | 0.03 |   |
| Diluted                                                                                                              |       | $                                                | (0.48      | ) | $ | 0.03 |   |

 

**9.   Goodwill**

A rollforward of the netcarrying amount of goodwill is as follows:
| Balance as of December 31, 2004                                                        |   | $    | 21,817 |   |
|---------------------------------------------------------------------------------------------|--------|------|--------|--------|
| Utilization of acquired net operating losses in the three months ended  March 31, 2005 |   | (463 | )      |
| Balance as of March 31, 2005                                                           |   | $    | 21,354 |   |

 

The Company acquired Clinsoft Corporation, whichdeveloped and sold the *Clintrial* and *Clintrace*products, on August 14, 2001. The goodwillresulting from the acquisition is reviewed for impairment on an annual basis inaccordance with SFAS No. 142,*Goodwill and OtherIntangible Assets.*The Company performed its annual impairment testfor the year ended December 31, 2004 as of October 1, 2004 anddetermined that no impairment of goodwill existed.

The utilization ofacquired net operating losses reflects a reduction in cash payments to localtaxing authorities for income taxes that are not reflected as a benefit in theincome tax provision for financial statement purposes.

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**10.   Accrued Expenses**

Accruedexpenses consist of the following:
| ** **                            | ** ** | **As of  December 31,  2004** | ** ** | **As of  March 31,  2005** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|--------------------------------------|------------|
| Accrued payroll  and related benefits |       |                                    | $          | 4,791                                |       |   |   | $ | 4,144 |   |   |
| Accrued royalties                     |       |                                    | 2,378      |                                 |       |   | 937 |   |   |
| Accrued income  taxes                 |       |                                    | 1,289      |                                 |       |   | 690 |   |   |
| Accrued other  expenses               |       |                                    | 3,200      |                                 |       |   | 3,591 |   |   |
|                                  |       |                                    | $          | 11,658                               |       |   |   | $ | 9,362 |   |   |

 

**11.   Restructuring**

The Company recorded a $4,503 restructuring charge forthe year ended December 31, 2003 that related to the relocation of theCompany’s corporate headquarters in December 2003. Of this amount, $2,486represents the loss on a facilities lease and $2,017 is related to theabandonment of the related fixed assets and leasehold improvements. Thefacility lease loss represents 15 months of rent remaining under anexisting lease and related operating expenses. As of March 31, 2005,payment of all charge related expenses had occurred and as a result the Companyrecorded a benefit of $92 representing the elimination of accrued expensesassociated with the restructuring charge.

Therollforward of the restructuring charge is as follows:
| ** **                                                                              | ** ** | **Lease  Loss** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------|------------|
| Balance as of  December 31, 2003                                                   |       | $               | 2,486      |   |
| Payments made in  the twelve months ended December 31, 2004                        |       | (1,974          | )          |
| Reduction to  provision for lease loss in the three months ended December 31, 2004 |       | (168            | )          |
| Balance as of December 31, 2004                                                    |       | $               | 344        |   |
| Payments made in the  three months ended March 31, 2005                            |       | (252            | )          |
| Reduction to  provision for lease loss in the three months ended March 31, 2005    |       | (92             | )          |
| Balance as of  March 31, 2005                                                      |       | $               | —     |   |

 

**12.   Debt**

Between April 2000 and September 2004, theCompany had entered into several equipment lines of credit with a bank. Alladvances under these equipment lines of credit were payable in 30 to 36 equalmonthly installments of principal, plus accrued interest. The interest thataccrued under these notes ranges from prime rate (5.25% and 5.75% at December 31,2004 and March 31, 2005, respectively) to prime rate plus 1.0%. As of December 31,2004, there was a total of $4,407 outstanding under all of the Company’sequipment lines of credit. In March 2005, the Company paid in full alloutstanding debt related to its equipment lines of credit. The equipment lineof credit expired on March 31, 2005 and was not renewed.

Effective March 31, 2004, the Company renewed itsworking capital line of credit with a bank and increased the amount under whichit can borrow to $5,000. Interest accrues at prime rate. All advances madeunder the working capital line shall be immediately due and payable on March 31,2006. As of December 31, 2004 and March 31, 2005, $0 was outstandingunder the working capital line of credit. At March 31, 2005, there was$3,700 available under the line of credit, and $1,300 reserved under a letterof credit associated with the Company’s leased facilities.

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Borrowings under theworking capital line of credit are secured by substantially all assets of theCompany, excluding intellectual property. The Company has entered into anegative pledge agreement that, subject to certain exceptions, generallyprohibits the Company from pledging its intellectual property to others. Underthe working capital line of credit, as amended in March 2004, the Companyis required to comply with certain financial covenants, including attainment ofminimum revenue, minimum earnings and financial ratios. At March 31, 2005the Company was in compliance with all financial covenants.

**13.   Contingencies**

From time to time and in the ordinary course ofbusiness, the Company may be subject to various claims, charges and litigation.

Since 2004, the Company has been involved in a lawsuitfiled against it and one of its customers, Quintiles Inc., by Datasci, LLC (“Datasci”)and Dr. Mark L. Kozam, doing business under the name MLK Software. Thelawsuit alleges that the Company’s *InForm,Clintrial* and *ClintrialIntegration Solution* products and its services, and the products andservices of Quintiles, infringe a United States patent claimed to be owned byDatasci and Dr. Kozam. The Company has asserted numerous defenses and hasfiled counterclaims against Datasci and Dr. Kozam. This action is ongoingand the Company is prepared to vigorously defend the claims and pursue itscounterclaims and any other remedies available to the Company. Due to thepreliminary nature of this action, the Company is unable to assess whether itsoutcome will have a material adverse effect on its results of operations.

The Company acceptsstandard indemnification provisions in the ordinary course of business, wherebyit may be required to indemnify its customers for certain costs and damagesarising from third party claims in connection with alleged or actualinfringement of intellectual property, including the claim described above. Theterm of these indemnification provisions generally coincides with the customer’suse of the Company’s products. The Company has never incurred significant coststo settle claims related to these indemnification provisions. As a result, theCompany believes the estimated fair value of these provisions is minimal.

**14.   Stockholders’ Equity**

**Common Stock**

During the quarter ended March 31, 2005, theCompany issued 355,916 shares of common stock in connection with the exerciseof stock options resulting in proceeds of $1,128. The Company also issued 9,802shares in connection with the cashless exercise of a warrant to purchase commonstock.

During November and December 2001,the Company executed full recourse notes receivable in consideration for thepayment of the exercise of options. The notes are reflected as subscriptionsreceivable, a component of stockholders’ equity. There was $127 and $0 of thesenotes receivable outstanding at December 31, 2004 and March 31, 2005,respectively. In February 2005, all outstanding notes were paid in full.

**15.   Deferred Compensation**

The Company recordsdeferred stock-based compensation in the amount by which the exercise price ofan option is less than the deemed fair value of its common stock at the date ofgrant. Because there had been no public market for the Company’s stock prior tothe July 2004 initial public offering of its common stock (the “IPO”), theCompany’s Board of Directors had determined the fair value of the common stockon the date of grant based upon several factors, including, but not limited to,the Company’s operating and financial performance, the issuances of convertiblepreferred stock, the rights and preferences of all securities senior to commonstock and the anticipated offering price of the common stock in connection 

14

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with theCompany’s IPO. During 2003, all stock options were granted with an exerciseprice of $3.00 per share, while the estimated per share fair value of theCompany’s common stock ranged from $3.00 to $4.00 in the first quarter of 2003,$4.00 to $5.00 in the second quarter of 2003, $5.00 to $7.50 in the thirdquarter of 2003 and $7.50 to $9.00 in the fourth quarter of 2003. During thesix months ended June 30, 2004, options were granted at exercise pricesranging from $4.50 to $6.00 per share while the estimated fair value of theCompany’s common stock was $10 per share. During the six months ended December 31,2004 options were granted at a price of $7.55 per share, which was the fairmarket value of our common stock at the date of grant. During the quarter endedMarch 31, 2005, options to purchase 665,000 shares of common stock weregranted at exercise prices ranging from $6.30 to $6.62 per share, which was thefair market value of the common stock at the date of the grants. The Companyrecorded stock-based compensation of $446 and $224 in the quarters ended March 31,2004 and 2005, respectively. As of March 31, 2005, there was an aggregateof $1.5 million of deferred stock-based compensation remaining to beamortized, of which approximately $642 will be amortized in the remaining threequarters of 2005. The Company amortizes the deferred compensation charges overthe vesting period of the underlying option awards in accordance with FinancialInterpretation No. (“FIN”) 28. On January 1, 2006, the Company isrequired to adopt SFAS No. 123(R) which requires fair valueaccounting for stock based awards. See note 17.

**16.   Comprehensive Income**

The Company’s only item of other comprehensive incomerelates to foreign currency translation adjustments and is presented separatelyon the balance sheet as required.

Comprehensiveincome consisted of the following:
| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                         | ** ** | **2005** | ** ** |
| Net income                         |       |                                             | $          | 383 |   |   |   | $ | 1,468 |   |   |
| Cumulative  translation adjustment |       |                                             | (81        | ) |   |   | (165 | ) |   |
| Comprehensive  income              |       |                                             | $          | 302 |   |   |   | $ | 1,303 |   |   |

 

**17.   RecentlyIssued Accounting Pronouncements**

On December 16, 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accountingfor Stock-Based Compensation*. SFAS No. 123(R) supersedesAPB Opinion No. 25, *Accounting forStock Issued to Employees*, and amends SFAS No. 95, *Statement of Cash Flows*. Generally, theapproach in SFAS No. 123(R) is similar to the approach described inStatement 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grantsof employee stock options, to be recognized in the income statement based ontheir fair values. Pro forma disclosure is no longer an alternative.

SFAS No. 123(R) must be adopted no laterthan January 1, 2006 for calendar year-end companies. Early adoption willbe permitted in periods in which financial statements have not yet been issued.

SFAS No. 123(R) permitspublic companies to adopt its requirements using one of two methods:

·       A “modified prospective”method in which compensation cost is recognized beginning with the effectivedate (a) based on the requirements of SFAS No. 123(R) for allshare-based payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of SFAS No. 123(R) that remain unvested on theeffective date.

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·       A “modified retrospective”method which includes the requirements of the modified prospective methoddescribed above, but also permits entities to restate based on the amountspreviously recognized under SFAS No. 123 for purposes of pro formadisclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

The Company is continuing to review the twoalternative adoption methods and the resulting impact of fair valuing awards inits financial statements. The Company is also reviewing various optionvaluation techniques and may use a valuation method other than the BlackScholes model for new awards upon adoption of SFAS No. 123(R).

The adoption of SFAS No. 123(R)’sfair value method will likely have a significant impact on our results ofoperations, although it will have no impact on our overall financial position.The impact of adoption of SFAS No. 123(R) cannot be predicted at thistime because it will depend in part on levels of share-based payments grantedin the future. However, had we adopted SFAS No. 123(R) in priorperiods, the impact of that standard would have approximated the impact of SFASNo. 123 as described in the disclosure of pro forma net income andearnings per share in Note 8 to our unaudited condensed consolidatedfinancial statements.

**18.   ForwardForeign Exchange Contracts**

The Company enters into transactions in currenciesother than the U.S. dollar and holds cash in foreign currencies which exposethe Company to transactions gains and losses as foreign currency exchange ratesfluctuate against the U.S. dollar. In October 2004, the Company began toenter into forward foreign exchange contracts to hedge the foreign currencyexposure of non-U.S. dollar denominated third-party and intercompanyreceivables and cash balances. The contracts, which relate to the Britishpound, Euro, and the Japanese yen, generally have terms of one month. Thesehedges are deemed fair value hedges and have not been designated for hedgeaccounting. The gains or losses on the forward foreign exchange contracts alongwith the associated losses and gains on the revaluation and settlement of theintercompany balances, accounts receivable and cash balances are recorded incurrent operations.

Thefollowing table summarizes the outstanding forward foreign exchange contractheld by the Company at March 31, 2005:
| ** **    | ** ** | **As of March 31, 2005** | ** ** |
|---------------|------------|----------------------------------------------|------------|
| ** **    | ** ** | **Local  Currency  Amount**                  | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       |                                         | 1,000      |   |   |   | $ | 1,889 |   |   |

 

The forward foreign exchange contract is short-termand matures within 40 days of origination.

As of March 31, 2005 the fair value of theforward foreign exchange contract was insignificant.

Realized and unrealized gains (losses), net of hedgingare accounted for in other income (expense). Losses, net of hedging, were $16and $112 for the three months ended March 31, 2004 and 2005, respectively.The Company settles foreign exchange contracts in cash.

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

**ForwardLooking Statements May Prove Inaccurate**

*The following discussion and analysis of our financialcondition and results of operations should be read in conjunction with ourunaudited condensed consolidated financial statements and related notes thatappear elsewhere in this Quarterly Report on Form 10-Q. In additionto historical consolidated financial information, the following discussioncontains forward-looking statements that reflect our plans, estimates andbeliefs. Our actual results could differ materially from those discussed in theforward-looking statements. Factors that could cause or contribute to thesedifferences include those discussed below and elsewhere in this QuarterlyReport on Form 10-Q.*

**Overview**

We are a provider ofintegrated enterprise-level electronic data capture, management and adverseevent reporting software solutions for use in the clinical trial component ofour customers’ global research and development initiatives. We offer softwareproducts, services and hosted solutions to pharmaceutical, biotechnology andmedical device companies, as well as academic institutions, clinical researchorganizations and other entities engaged in clinical trials. By automatingessential elements of the clinical trial process, we believe our products allowour customers to accelerate the market introduction of new medical therapiesand corresponding revenue, reduce overall research and development expenditures,enhance existing data quality control efforts and reduce clinical and economicrisk.

**Sources of Revenues**

We derive our revenuesfrom software licenses and services. License revenue is derived principallyfrom the sale of multi-year software term licenses for our *InForm, Clintrial* and *Clintrace* software products. Servicerevenue is derived from our delivery of the hosted solution of our *InForm *software product, consultingservices and customer support, including training. We generally recognize revenueratably over the life of a license or service contract. This allows us tomaintain a backlog that provides multi-year visibility in revenue. As ourbacklog grows, we believe that the predictability of our future revenues willincrease. Two customers including Eli Lilly and Company, the holder of recordof approximately 1% of our common stock, accounted for approximately 21% and23% of our total revenues for the quarters ending March 31, 2004 and 2005,respectively. Our top 20 customers accounted for approximately 69% and 71% ofour total revenues in the quarters ending March 31, 2004 and 2005,respectively, net of reimbursable out-of-pocket expenses.

*License Revenue*

We derive our license revenue from our three majorsoftware products: *InForm*, ourInternet based electronic data capture solution; *Clintrial*, our clinical data management solution; and *Clintrace*, our adverse event reportingsolution. Although each of our *InForm,Clintrial* and *Clintrace*software solutions are available as stand-alone enterprise applications, wealso offer integrated enterprise solutions incorporating certain of ourelectronic data capture, data management and adverse event reporting products.

License revenue for our *InForm *electronic data capture software solution,either on a stand-alone or integrated basis, are determined primarily by thenumber, complexity and duration of the clinical trials and the number ofparticipants in each clinical trial. License revenue for our *Clintrial* and *Clintrace* software solutions are determined primarily by thenumber of users accessing the software solution. Except as discussed below, weenter into software license agreements with terms generally of three to fiveyears with payment terms generally annually in advance. License revenue is recognizedratably over the duration of the software term license agreement, to the extentthat amounts are fixed or determinable and collectable.

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Following our acquisitionof Clinsoft in August of 2001, we began converting holders of Clinsoftperpetual software licenses to our software term license agreements. In certainsituations we continue to sell perpetual licenses of our *Clintrial*and*Clintrace*software products to our existing customers. Werecognize revenue on the perpetual licenses upon delivery of the software.Perpetual license revenue represented less than 1% of total revenue for thethree months ended March 31, 2004 and 2005. We continue to provide andcharge for maintenance and support on our products to those customers who donot convert to our software term license arrangements. We generally charge 18%of the perpetual license fee for customer support. We intend to continue ourefforts to convert the remaining former Clinsoft customer base to software termlicense arrangements.

*Service Revenue*

*ApplicationHosting Services.  *In addition to making our softwareproducts available to customers through licenses, we offer our *InForm *electronic data capturesoftware as a hosted application solution delivered through a standardweb-browser, with customer support and training services. Revenue resultingfrom this hosting service consists of three stages for each clinical trial:

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

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

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

Services provided for the first and third stages 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 revenue 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 thesecond stage and then amortized ratably over the estimated hosting period. Thedeferred costs include direct costs related to the trial and application set up.Fees for the first and third stages of the services are billed based uponmilestones. Fees for application hosting and related services in the secondstage are billed quarterly in advance. Bundled into this revenue element is therevenue attributable to the software license used by the customer. In addition,application hosting services revenue includes reimbursable out-of-pocketexpenses.

In the event that an application hosting customercancels a clinical trial and its related statement of work, all deferredrevenue is recognized and all deferred set up costs are expensed and certaintermination-related fees may be charged. In addition, application hostingservices revenue includes hosting services associated with term licensearrangements and reimbursable out-of-pocket expenses.

*Consulting Services.  *Consultingservices include the design and documentation of the processes related to ourcustomers’ use of our products and services in their clinical trials. Consultingservices also include project planning and management services, guidance onbest practices in using our software products, as well as implementationservices consisting of application architecture design, systems integration,installation and validation. Revenue from consulting services included in amultiple element software license agreement or in a hosted solution arerecognized ratably over the term of the arrangement. The associated costs areexpensed as incurred. Revenue from consulting services that are not included ina multiple element software license arrangement are recognized as services areperformed. Fixed priced arrangements are billed based upon contractualmilestones, and time-and-materials arrangements are billed monthly.

*CustomerSupport.  *We have a multinational services organizationto support our software products and hosted solutions worldwide. Customersupport includes telephone support, software maintenance and training. Webundle customer support in our software term licenses and allocate 10% of thevalue of the 

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license to customersupport revenue. Our customer support revenue also consists of customer supportfees paid by the*Clintrial* and *Clintrace* perpetual license customers.Customer support revenue is recognized ratably over the period of the customersupport or term license agreement, with payment terms generally annually inadvance.

**Costof Revenues and Operating Expenses**

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

*Cost of Revenues.  *Costof license revenue consists primarily of the amortization of royalties paid forcertain modules within our *Clintrial*software product and the Japanese version of our *InForm *software product. The cost of license revenuevaries based upon the mix of revenue from software licenses for our products.We operate our service organization on a global basis as one distinct unit, anddo not segment costs for our various service revenue elements. These servicesinclude performing application hosting, consulting and customer supportservices, and costs consist primarily of employee-related costs associated withthese services, amortization of the deferred clinical trial set up costs,allocated overhead, outside contractors, royalties associated with providing customersupport for third-party modules licensed to our customers for use with the *Clintrial* software product andreimbursable out-of-pocket expenses. Cost of services also includes hostingcosts that primarily consist of hosting facility fees and server depreciation.The cost of service revenue varies based upon employee utilization levels inthe service organization and royalties associated with revenue derived fromproviding customer support, as well as costs associated with the flexible useof outside contractors to support internal resources. We supplement the trialdesign and set up activity for application hosting services through the use ofoutside contractors. This allows us to utilize outside contractors in thoseperiods where trial design and set up activity is highest while reducing theuse of outside contractors in those periods where trial activity lessens,allowing for a more flexible delivery model. The percentage of the servicesworkforce represented by outside contractors varies from period to perioddepending on the volume of specific support required. The cost of services issignificantly higher as a percentage of revenue as compared to our cost oflicense revenue primarily due to the employee-related and outside contractorexpenses associated with providing services.

*Gross Margin.  *Ourgross margin on license revenue varies based on the mix of royalty- andnonroyalty-bearing license revenue. Our gross margin on service revenue variesprimarily due to variations in the utilization levels of the professionalservice team and the timing of expense and revenue recognition under ourservice arrangements. In situations where the service revenue is recognizedratably over the software license term, typically three to five years, ourcosts associated with delivery of the services are recognized as the servicesare performed, which is typically during the first 9 to 12 months of thecontract period. Accordingly, our gross margin on service revenue will varysignificantly over the life of a contract due to the timing, amount and type ofservice required in delivering certain projects. In addition, consolidatedgross margin will vary depending upon the mix of license and service revenue.

*Sales and Marketing.  *Salesand marketing expenses consist primarily of employee-related expenses,including travel, marketing programs (which include product marketing expensessuch as trade shows, workshops and seminars, corporate communications, otherbrand building and advertising), allocated overhead and the amortization ofcommissions. We expect that sales and marketing expenses will increase inabsolute dollars, as we expand and further penetrate our customer base, expandour domestic and international selling and marketing activities associated withexisting and new product and service offerings, build brand awareness andsponsor additional marketing events.

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*Research and Development.  *Researchand development expenses consist primarily of employee-related expenses,allocated overhead and outside contractors. We have historically focused ourresearch and development efforts on increasing the functionality, performanceand integration of our software products. We expect that in the future,research and development expenses will increase in absolute dollars as weintroduce additional integrated software solutions to our product suite.

*General and Administrative.  *Generaland administrative expenses consist primarily of employee-relatedexpenses, professional fees, primarily consisting of expenses for accounting,compliance and legal services and other corporate expenses and allocatedoverhead. We expect that in the future, general and administrative expenseswill increase as we add personnel, incur additional professional fees relatedto the growth of our business and operations, and incur additional costsassociated with being a public company.

*Restructuring.  *Werecorded a $4.5 million restructuring charge in 2003 which related to therelocation of our corporate headquarters. This charge includes approximately$2.5 million relating to the estimated future obligation under thenon-cancelable lease and an approximate $2.0 million write-off of therelated abandoned leasehold improvements and fixed assets. As of March 31,2005, the payment of all charge related expenses had occurred and, as a result,we recorded a restructuring benefit of $92,000 representing the elimination ofaccrued expenses associated with the restructuring charge.

*Stock-BasedExpenses.  *Our cost of service revenue and operatingexpenses, excluding our restructuring charges, include stock-based expensesrelated to the fair value of options issued to non-employees and optiongrants to employees in situations where the exercise price is determined to beless than the deemed fair value of our common stock at the date of grant.

**Foreign Currency Translation**

With regard to ourinternational operations, we frequently enter into transactions in currenciesother than the U.S. dollar. As a result, our revenues, expenses and cash flowsare subject to fluctuations due to changes in foreign currency exchange rates,particularly changes in the Euro, British pound sterling, Australian dollar andJapanese yen. In the three months ended March 31, 2004 and 2005,approximately 38% and 48%, respectively, of our revenues were generated inlocations outside the United States. The majority of these revenues were incurrencies other than the U.S. dollar. In periods when the U.S. dollar declinesor increases in value as compared to the foreign currencies in which we conductbusiness, our foreign currency-based revenues and expenses increase ordecrease, as the case may be, in value when translated into U.S. dollars.

**CriticalAccounting Policies and Estimates**

Our unaudited condensed consolidated financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues, costs and expenses and related disclosures.On an ongoing basis, we evaluate our estimates and assumptions with our auditcommittee. There have been no material changes to these estimates for theperiods presented in this Quarterly Report on Form 10-Q. Our actualresults may differ from these estimates.

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

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*Revenue Recognition and Deferred SetUp Costs.  *We recognize software license revenue inaccordance with Statement of Position (“SOP”) No. 97-2, *Software Revenue Recognition,* as amended,issued by the American Institute of Certified Public Accountants, while revenueresulting from application services are recognized in accordance with EmergingIssues Task Force (“EITF”) Issue No. 00-03, *Application of AICPA Statement of Position 97-2to Arrangements that Include the Right to Use Software Stored on Another Entity’sHardware* and SEC Staff Accounting Bulletin (SAB) Nos. 101 and 104, *Revenue Recognition*. On August 1,2003, we adopted EITF Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables.* Theadoption of EITF Issue No. 00-21 did not have a material impact onour financial position or results of operations.

Customers generally have the ability to terminateapplication hosting, consulting and training service agreements upon30 days notice to the Company. License agreements, multiple elementarrangements, including license and services agreements, and certainapplication hosting services can generally be terminated by either party formaterial breach of obligations not corrected within 30 days after noticeof the breach.

We recognize revenue when all of the followingconditions are satisfied: (1) there is persuasive evidence of anarrangement; (2) the service has been provided to the customer; (3) thecollection of our fees is probable; and (4) the amount of fees to be paidby the customer is fixed or determinable.

We generally enter into software term licenses withour customers for three to five year periods. These arrangements typicallyinclude multiple elements: software license, consulting services and customersupport. We bill our customers in accordance with the terms of the underlyingcontract. Generally, we bill the annual license fee for the first year of the multi-yearcontract in advance and bill license fees for subsequent years on theanniversary date. Our payment terms are generally net 30 days.

Our software license revenue is earned from the saleof off-the-shelf software requiring no significant modification orcustomization subsequent to delivery to the customer. Consulting services,which can also be performed by third-party consultants, are deemed to benon-essential to the functionality of the software and typically are for trialconfiguration, implementation planning, loading of software, building simpleinterfaces and running test data and documentation of procedures.

We generally bundle customer support with the softwarelicense for the entire term of the arrangement. As a result, we generallyrecognize revenue for all elements ratably over the term of the multipleelement arrangement. We allocate the revenue for these arrangements to thedifferent elements based on management’s estimate of the relative fair value ofeach element. For our contracts accounted for ratably under SOP No. 97-2,we allocate to consulting services the anticipated service level throughout theterm of the arrangement at an amount equal to what it would have been had thoseservices been sold separately to the customer. The remaining value is allocatedto license and support services, with a 10% value allocated to supportservices. The costs associated with the consulting and customer supportservices are expensed as incurred. There are instances in which we sellsoftware licenses based on usage levels. These software licenses can be basedon estimated usage, in which case the license fee charged to the customer isfixed based on this estimate. When the fee is fixed, the revenue is recognizedover the contractual term of the arrangement. If the fee is based on actualusage, and therefore variable, the revenue is recognized in the period of use.Revenue from certain follow-on consulting services, which are sold separatelyto customers with existing software licenses and are not considered part of amultiple element arrangement, is generally recognized as the services areperformed.

Revenue from perpetual software licenses representedless than one percent of total revenues for the quarters ending March 31,2004 and 2005. We continue to sell perpetual licenses for the *Clintrial* and *Clintrace* software products in certain situations to ourexisting customers with the option to purchase customer support. We haveestablished vendor specific objective evidence of fair value for the customer support.Accordingly the perpetual license revenue is recognized upon delivery of thesoftware and when 

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all other revenuerecognition criteria are met. Customer support revenue is recognized ratablyover the term of the underlying support arrangement.

In addition to making our software products availableto customers through licenses, we offer our *InForm *electronicdata capture software solution through a hosted application solution deliveredthrough a standard web-browser. Revenue resulting from application hostingservices consist of three stages for each clinical trial: the first stageinvolves application set up, including design of electronic case report formsand edit checks, implementation of the system and server configuration; thesecond stage involves application hosting and related support services; and thethird stage involves services required to close out, or lock, the database forthe clinical trial. Services provided for the first and third stages areprovided on a fixed fee basis based upon the complexity of the trial and systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. We recognize revenue from all stages of the hosting service overthe hosting period. Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred and capitalized as applicable,until the start of the second stage and then amortized and recognized, asapplicable, ratably over the estimated hosting period. The capitalized costsinclude incremental direct costs with third parties and certain internal directcosts related to the trial and application set up, as defined under Statementof Financial Accounting Standards (“SFAS”) No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognized overthe remaining term of the hosting period. Fees for the first and third stagesof the services are billed based upon milestones. Fees for application hostingand related services in the second stage are billed quarterly in advance.Bundled into this revenue element is the revenue attributable to the softwarelicense used by the customer.

We capitalized $527,000 and $666,000 of deferred setup costs and amortized $496,000 and $449,000 during the three months ended March 31,2004 and 2005, respectively. The amortization of deferred set up costs is acomponent of cost of services.

Deferred revenue represents amounts billed or cashreceived in advance of revenue recognition.

*Accounting for Commission Paymentsand Royalties.  *For arrangements where we recognizerevenue over the relevant contract period, we defer related commission paymentsto our direct sales force and software license royalties paid to third partiesand amortize these amounts over the same period that the related revenue arerecognized. This is done to better match commission and royalty expenses withthe related revenue. During the three months ended March 31, 2004 and2005, we deferred $760,000 and $677,000, respectively, of commissions andamortized $568,000 and $830,000, respectively, to sales and marketing expense.

Royalties are paid on a percentage of billings basisfor certain of our products. During the three months ended March 31, 2004and 2005, we deferred $1.2 million and $822,000, respectively, of royaltyexpenditures and amortized $585,000 and $571,000, respectively, to cost oflicense and service revenue.

*Accounts Receivable Reserves.  *Wemaintain allowances for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. We regularly evaluatethe collectibility of our trade receivables based on a combination of factors,which may include dialogue with the customer to determine the cause ofnon-payment, the use of collection agencies, and/or the use of litigation. Inthe event it is determined that the customer may not be able to meet its fullobligation to us, we record a specific allowance to reduce the relatedreceivable to the amount that we expect to recover given all informationavailable to us. We monitor collections from our customers and maintain aprovision for estimated credit losses based upon our historical experience andany specific customer collection issues that we have identified. While suchcredit losses have historically been within our expectations and the 

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provisions established, wecannot guarantee that credit loss rates will not increase in the future. If thefinancial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. Our accounts receivable reserves were $391,000 and $289,000 as of December 31,2004 and March 31, 2005, respectively.

*Accounting for Stock-Based Awards.  *Werecord deferred stock-based compensation charges in the amount by which theexercise price of an option is less than the deemed fair value of our commonstock at the date of grant. Because there had been no public market for ourstock prior to the July 2004 initial public offering of our common stock(the “IPO”), our board of directors had determined the fair value of our commonstock based upon several factors, including, but not limited to, our operatingand financial performance, sales of convertible preferred stock to thirdparties, the rights and preferences of securities senior to common stock andthe anticipated offering price of our common stock in connection with the IPO.

We have not historically engaged unrelated thirdparties to prepare valuations of our common stock. In connection with the IPO,management and the board of directors retroactively assessed the fair value ofour common stock during 2003 and through the date of the IPO.

During 2003, all stock options were granted with anexercise price of $3.00 per share, while the estimated per share fair value ofour common stock was subsequently determined to range from $3.00 to $4.00 inthe first quarter of 2003, $4.00 to $5.00 in the second quarter of 2003, $5.00to $7.50 in the third quarter of 2003 and $7.50 to $9.00 in the fourth quarterof 2003.

At the beginning of 2003, we determined the value ofour common stock based principally on the per share amounts that would havebeen distributed to the common stockholders, after all required distributionsto the preferred stockholders, in the event of a sale of the Company at thevalue established in our January 2002 preferred stock financing. We chosethis valuation methodology based on our operating performance during 2002 andthe limited, if any, access we had to the public equity markets at the time.

The increase in our estimated per share fair value ofcommon stock since the beginning of 2003 reflects a number of significantfactors, including an improvement in our operating results, especially in thesecond half of the year, changes to our management team throughout 2003,additions to our board of directors in the second half of 2003 and an overallimprovement in stock market indices and increasing volume of initial publicofferings of common stock throughout 2003.

We improved our operating results during each of thefour quarters of 2003. In the first, second and third quarters, we incurredoperating losses of $1.4 million, $1.1 million and $31,000,respectively. In the fourth quarter, we had an operating profit of $432,000,excluding a restructuring charge in the fourth quarter. Our increasing pershare fair value of common stock throughout 2003 reflects this positive trendin operating results. In addition, in the second half of 2003, because of ourimproved operating performance and the improving equity markets, we began tocontemplate an initial public offering of our common stock.

During the six months ended June 30, 2004,options were granted at exercise prices ranging from $4.50 to $6.00 per sharewhile the estimated fair value of our common stock was $10.00 per share. Thefair value of our common stock in the six months ended June 30, 2004 wasbased on the high end of the range of estimated offering prices of common stockas contemplated in the preliminary prospectus for our initial public offeringthat was filed with the Securities and Exchange Commission. All options grantedsince the IPO were priced at the fair market value of the common stock at thedate of grant.

As of March 31, 2005, there was an aggregate of$1.5 million of deferred stock-based compensation remaining to beamortized. Historically, we have elected not to record employee stock-basedawards at fair value. The impact of recording employee stock-based awards atfair value, using the Black-Scholes 

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option-pricingmodel, is further described in Note 8 of the notes to our unauditedcondensed consolidated financial statements contained in this Quarterly Report.Effective January 1, 2006, we will be required to adopt a fair valueapproach to valuing stock-based awards. See Note 17 in the notes to ourunaudited condensed consolidated financial statements.

In the past, we haveawarded a limited number of stock options to non-employees. For these options,we recognize the stock-based compensation over the vesting periods of theunderlying awards, based on an estimate of their fair value on the vestingdates using the Black-Scholes option-pricing model.

*Other SignificantEstimates*

*Goodwill Impairment.  *Wereview the carrying value of goodwill periodically based upon the expectedfuture discounted operating cash flows of our business. Our cash flow estimatesare based on historical results adjusted to reflect our best estimate of futuremarkets and operating conditions. 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.

*Accounting for Income Taxes.  *Inconnection with preparing our financial statements, we are required to estimateour income taxes in each of the jurisdictions in which we operate. This processinvolves the assessment of our net operating loss carryforwards and credits, aswell as estimating the actual current tax liability together with assessingtemporary differences resulting from differing treatment of items, such asreserves and accrued liabilities, for tax and accounting purposes. We thenassess the likelihood that deferred tax assets will be recovered from futuretaxable income, and to the extent we believe that recovery is not likely, wemust establish a valuation allowance. As of March 31, 2005, we haveincurred a three year cumulative loss from operations. Once we are no longer ina three year cumulative loss position, we would expect to recognize some or allof our deferred tax assets based principally on our ability to forecast futureoperating income. Currently we believe that it is more likely than not that wewill not realize the value of our deferred tax assets and therefore haveprovided a full valuation allowance against our net deferred tax assets.

The American Jobs Creation Act of 2004 (the “Act”),which was enacted on October 22, 2004, introduced a special one-time dividendsreceived deduction on the repatriation of certain foreign earnings to a U.S.taxpayer (repatriation provision), provided certain criteria are met. Even inlight of the Act, our current intention is to reinvest the total amount of ourunremitted earnings in the local jurisdiction or to repatriate the earningsonly when tax-effective. As such, we have not provided U.S. tax expense on theunremitted earnings of our foreign subsidiaries.

*RestructuringCharge.  *We recorded a $4.5 million restructuringcharge in 2003 relating to the relocation of our corporate headquarters. Thischarge includes approximately $2.5 million relating to the estimatedfuture obligation under the non-cancelable lease and an approximate$2.0 million write-off of the related abandoned leasehold improvements andfixed assets. As of March 31, 2005, payment of all charge related expenseshad occurred and, as a result, we recorded a restructuring benefit of $92,000representing the elimination of accrued expenses associated with therestructuring charge.

**Overviewof Results of Operations for the Three Months Ended March 31, 2004 and2005**

License revenue increased 43% in the three monthsended March 31, 2005 as compared to the three months ended March 31,2004. Service revenue increased 9% in the three months ended March 31,2005 as compared to the three months ended March 31, 2004.

Our gross margin increased 32%, or $3.1 million,in the quarter ended March 31, 2005 to $12.9 million, compared to$9.8 million for the same period in 2004, primarily due to the increase inlicense and application hosting services revenue.

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Operating income increasedby $1.0 million from $875,000 in the three months ended March 31,2004 to an operating income of $1.9 million for the three months ended March 31,2005. The operating income in the three months ended March 31, 2004 and2005 included $446,000 and $224,000 of stock-based compensation, respectively. Asof March 31, 2005, we had $65.3 million of cash, cash equivalents andshort-term investments securities, an increase of $7.1 million from$58.2 million at December 31, 2004.

*Revenues*
| ** **                    | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **     | ** ** |
|-------------------------------|------------|------------------------------------------------------------------------|------------|----------------|------------|
| ** **                    | ** ** | **2004**                                                               | ** ** | **2005**       | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** **                                                             | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Revenues**                  | ** ** | ** **                                                             | ** ** | **Amount**     | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                                | ** ** | ** **     | ** ** | ** ** | ** ** |
| License                       |       | $                                                                      | 6,166      |           |       | 36 | % |   | $ | 8,819 |   |   | 43 | % |   | $ | 2,653 |   | 43 | % |
| Application hosting  services |       | 5,913                                                                  |       |           | 35         |   |   | 6,832 |   |   | 33 |   |   | 919 |   | 16 | % |
| Professional  services        |       | 1,564                                                                  |       |           | 9          |   |   | 1,394 |   |   | 7 |   |   | (170 | ) | (11 | )% |
| Customer support              |       | 3,319                                                                  |       |           | 20         |   |   | 3,517 |   |   | 17 |   |   | 198 |   | 6 | % |
| Total                         |       | $                                                                      | 16,962     |           |       | 100 | % |   | $ | 20,562 |   |   | 100 | % |   | $ | 3,600 |   | 21 | % |
|                               |            |                                                                        |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Totalrevenues increased in the three months ended March 31, 2005 as compared tothe same period in 2004 due to an increase in license revenue across allproducts, as well as an increase in *InForm*applicationhosting services. The increase in license revenue in the three months ended March 31,2005 was primarily due to an increase in sales of *InForm *into our existing *Clintrial* customer base and, to a lesser extent, an increasein sales of both *Clintrial* and *Clintrace* products. This increase was aresult of our continued strategy to expand the usage of our software productsby cross selling the *InForm*, *Clintrial* and *Clintrace* products to our existing customer base, additionalutilization of our products within our customer base and sales to newcustomers. The increase in revenue associated with the hosted-applicationversion of our *InForm *productin the three months ended March 31, 2005 was due to an increase inclinical trials under management. Consulting services revenue for the threemonths ended March 31, 2005 decreased compared to the same period in 2004.The relatively small increase in customer support revenue for the three monthsended March 31, 2005 was due primarily to an increase in *InForm *support revenue associatedwith an increase in *InForm *licenserevenue, offset partially by a reduction in the *Clintrial* and *Clintrace*maintenance renewal base as a result of the conversion of the former Clinsoftcustomers to term-based licenses that have a lower customer support fee.
| ** **                          | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** **          | ** ** |
|-------------------------------------|------------|------------------------------------------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                          | ** ** | **2004**                                                               | ** ** | **2005**       | ** ** | ** **          | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** **                                                             | ** ** | **Percentage** | ** ** | ** **          | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | ** **                                                             | ** ** | **Amount**     | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                                | ** ** | ** **     | ** ** | ** **          | ** ** |
| United States                       |       | $                                                                      | 10,525     |           |       | 62                  | %          |   | $ | 10,745 |   |   | 52 | % |   | $ | 220 |   | 2 | % |
| United Kingdom                      |       | 3,405                                                                  |       |           | 20         |                |       | 6,146 |   |   | 30 |   |   | 2,741 |   | 80 | % |
| France                              |       | 2,146                                                                  |       |           | 13         |                |       | 2,282 |   |   | 11 |   |   | 136 |   | 6 | % |
| Asia-Pacific                        |       | 886                                                                    |       |           | 5          |                |       | 1,389 |   |   | 7 |   |   | 503 |   | 57 | % |
| International subtotal              |       | 6,437                                                                  |       |           | 38         |                |       | 9,817 |   |   | 48 |   |   | 3,380 |   | 53 | % |
| Total                               |       | $                                                                      | 16,962     |           |       | 100                 | %          |   | $ | 20,562 |   |   | 100 | % |   | $ | 3,600 |   | 21 | % |
|                                     |            |                                                                        |            |                |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in revenuesworldwide was due primarily to the increase in *InForm *revenuein the United Kingdom, resulting from additional enterprise-wide license andservice agreements, with one customer accounting for one-half of the increase*.*Inaddition, the Asia-Pacific license and services revenue increased across allproducts.

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*Cost of Revenues*
| ** **                     | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **             | ** ** | ** **  | ** ** |
|--------------------------------|------------|------------------------------------------------------------------------|------------|------------------------|------------|-------------|------------|
| ** **                     | ** ** | **2004**                                                               | ** ** | **2005**               | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **                                                             | ** ** | **Percentage of** | ** ** | ** **  | ** ** | **Percentage of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **                                                             | ** ** | **Related**            | ** ** | ** **  | ** ** | **Related** | ** ** | **Change** | ** ** |
| **Cost of Revenues** | ** ** | ** **                                                             | ** ** | **Amount**             | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                     | ** ** | **(in thousands)**                                                | ** ** | ** **             | ** ** | ** **  | ** ** |
| License                        |       | $                                                                      | 422        |                   |       | 7           | %          |   | $ | 448 |   |   | 5 | % |   |   | $ | 26 |   |   | 6 | % |
| Services                       |       | 6,781                                                                  |       |                   | 63         |        |       | 7,212 |   |   | 61 |   |   |   | 431 |   |   | 6 | % |
| Total                          |       | $                                                                      | 7,203      |                   |       | 42          | %          |   | $ | 7,660 |   |   | 37 | % |   |   | $ | 457 |   |   | 6 | % |
|                                |            |                                                                        |            |                        |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cost of licenserevenue increased in the three months ended March 31, 2005 primarily dueto a $44,000 increase in royalty expense as revenue increased on certainmodules of the *Clintrial* softwareproduct, and to a lesser extent, the Japanese version of our *InForm *software product. Cost ofservices for the three months ended March 31, 2005 increased by $431,000as we incurred $261,000 of additional employee related expenses and $146,000incremental outside contractor expense to deliver increased services. Inaddition there were also expense increases in computer and related andrecruiting of $96,000 and $76,000, respectively. These expense increases werepartially offset by a decrease in the amortization of capitalized labor of$185,000.

*Gross Margin*
| ** **            | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **             | ** ** | ** **  | ** ** |
|-----------------------|------------|------------------------------------------------------------------------|------------|------------------------|------------|-------------|------------|
| ** **            | ** ** | **2004**                                                               | ** ** | **2005**               | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                             | ** ** | **Percentage of** | ** ** | ** **  | ** ** | **Percentage of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                             | ** ** | **Related**            | ** ** | ** **  | ** ** | **Related** | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | ** **                                                             | ** ** | **Amount**             | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                                                | ** ** | ** **             | ** ** | ** **  | ** ** |
| License               |       | $                                                                      | 5,744      |                   |       | 93          | %          |   | $ | 8,371 |   |   | 95 | % |   | $ | 2,627 |   | 46 | % |
| Services              |       | 4,015                                                                  |       |                   | 37         |        |       | 4,531 |   |   | 39 |   |   | 516 |   | 13 | % |
| Total                 |       | $                                                                      | 9,759      |                   |       | 58          | %          |   | $ | 12,902 |   |   | 63 | % |   | $ | 3,143 |   | 32 | % |
|                       |            |                                                                        |            |                        |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The license gross marginpercentage increased in the three months ended March 31, 2005 primarilydue to an increase in sales of *InForm*, whichincurs a lower royalty than *Clintrial*. Theservices gross margin percentage increased for the three months ended March 31,2005 due to a reduction in labor and contractor expenses as a percentage ofrevenue. It is likely that gross margin, as a percentage of revenues, willfluctuate, quarter by quarter, due to the timing and mix of license and servicerevenues, and the amount and type of service required in delivering certainprojects.

*Operating Expenses*
| ** **                  | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** **          | ** ** |
|-----------------------------|------------|------------------------------------------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                  | ** ** | **2004**                                                               | ** ** | **2005**       | ** ** | ** **          | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                                             | ** ** | **Percentage** | ** ** | ** **          | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | ** **                                                             | ** ** | **Amount**     | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                | ** ** | ** **     | ** ** | ** **          | ** ** |
| Sales and  marketing        |       | $                                                                      | 3,305      |           |       | 19                  | %          |   | $ | 3,951 |   |   | 19 | % |   | $ | 646 |   | 19 | % |
| Research and  development   |       | 2,936                                                                  |       |           | 17         |                |       | 3,281 |   |   | 16 |   |   | 345 |   | 12 | % |
| General and  administrative |       | 2,643                                                                  |       |           | 16         |                |       | 3,804 |   |   | 18 |   |   | 1,161 |   | 44 | % |
| Restructuring               |       | —                                                                 |       |           | —     |                |       | (92 | ) |   | (0 | ) |   | (92 | ) | NM |   |
| Total                       |       | $                                                                      | 8,884      |           |       | 52                  | %          |   | $ | 10,944 |   |   | 53 | % |   | $ | 2,060 |   | 23 | % |
|                             |            |                                                                        |            |                |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*Sales and Marketing.  *Salesand marketing expenses increased for the three months ended March 31, 2005primarily due to a $303,000 increase in employee-related expenses, which mainlyconsisted of one-time charges associated with changes in management, and a$262,000 increase in commission expense resulting from an increase in revenuesand an increase in the effective commission rate. We expect that our sales andmarketing expenses will continue to increase in absolute dollars as commissionexpense increases with our revenues and we continue to build our brandawareness through what we believe are the most cost-effective channelsavailable. However, sales and marketing expenses may fluctuate, quarter byquarter, due to the timing of marketing programs.

*Research and Development.  *Researchand development expenses increased in the three months ended March 31,2005 primarily due to an increase in employee related expenses of $563,000 aswe hired 18 additional people to improve our quality assurance and productdevelopment team. This was partially offset by a $263,000 decrease in outsideconsultant expense as we brought certain research and development activitiesin-house. We expect that our research and development costs will continue toincrease in absolute dollars as we continue to add features and functionalityto our products and expand our product and service offerings.

*Generaland Administrative.  *General and administrative expensesincreased in the three months ended March 31, 2005 primarily due to a$716,000 increase in professional fees primarily associated with actionsdefending our intellectual properties and $194,000 of increased employee-relatedexpenses. In addition, outside contractor expenses increased $150,000 primarilyrelated to the implementation of Section 404 of the Sarbanes-Oxley Act andadditional insurance expense of $112,000 due to requirements related to being apublic company.

*Operating Income, Other Income (Expense)*
| ** **                 | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|----------------------------|------------|------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                 | ** ** | **2004**                                                               | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                                                             | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                                             | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                                | ** ** | ** **          | ** ** | ** ** | ** ** |
| **Operating  income**      |       |                                                                   | $          | 875                 |       |       |       | 5 | % |   | $ | 1,958 |   |   | 10 | % |   | $ | 1,083 |   | 124 | % |
| **Other income (expense)** | ** ** |                                                                   |       |                |       |       |       |   | ** ** | ** ** | ** ** |   |   |   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income            |       |                                                                   | $          | 105                 |       |       |       | 1 | % |   | $ | 348 |   |   | 2 | % |   | $ | 243 |   | 231 | % |
| Interest expense           |       |                                                                   | (82        | )                   |       |       | (0         | ) |   | (144 | ) |   | (1 | ) |   | (62 | ) | (76 | )% |
| Other, net                 |       |                                                                   | (16        | )                   |       |       | (0         | ) |   | (130 | ) |   | (1 | ) |   | (114 | ) | (713 | )% |
| Total                      |       |                                                                   | $          | 7                   |       |       |       | 1 | % |   | $ | 74 |   |   | 0 | % |   | $ | 67 |   | 957 | % |

 

*Operating Income.  *Theincrease in operating income in the three months ended March 31, 2005 wasprimarily due to an increase in gross margins from both license and services,partially offset by increased operating expenses resulting from increases inemployee related expenses, commission expense and professional fees. It islikely that operating income, as a percentage of revenues, will fluctuate,quarter by quarter, due to the timing and mix of license and services revenues,and the amount and type of service required in delivering certain projects, aswell as the timing of operating expense activities.

*OtherIncome (Expense).  *The increase in interest income inthe three months ended March 31, 2005 was primarily due to an increase incash and cash equivalents available for investment and short-term investments.The increase in interest expense in the three months ended March 31, 2005was primarily due to the timing of borrowings and fees associated with the paydown of our equipment lines of credit. Other, net expense primarily increaseddue to an increase in the foreign exchange losses related to unfavorableexchange rate movements on non-U.S. dollar denominated accounts receivable andintercompany balances.

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*Provision for Income Taxes*
| ** **                  | ** ** | **For the Three Months Ended March 31,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                  | ** ** | **2004**                                                               | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                                             | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                                                             | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                | ** ** | ** **          | ** ** | ** ** | ** ** |
| Provision for  income taxes |       |                                                                   | $          | 499                 |       |       |       | 3 | % |   |   | $ | 564 |   |   |   | 3 | % |   |   | $ | 65 |   |   | 13 | % |
|                             |            |                                                                        |            |                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The provision for incometaxes for 2004 represents foreign withholding taxes and income taxes payablethat cannot be offset through loss carryforwards. The provision for incometaxes for 2005 represents income taxes payable that cannot be offset throughloss carryforwards. The effective tax rate for 2005 decreased to 28% comparedto an effective tax rate of 56% for 2004. The decrease in our effective taxrate is primarily due to a reduction in foreign withholding taxes and foreignand U.S. income taxes payable. The decrease in the foreign withholding taxesrelated to the elimination of withholding tax due to changes in legislationbetween the U.S. and Japan effective in the second quarter of 2004. Thedecrease in foreign income taxes payable was due to the decrease inprofitability of certain of our foreign operations. The decrease in U.S. incometaxes payable related to the change in the mix and timing of the use of netoperating loss carryforwards to offset taxable income. In utilizing our netoperating loss carryforwards, we are required to use our oldest net operatinglosses first. As a result, the Company has first used the net operating lossesacquired in the Clinsoft acquisition. The utilization of the acquired netoperating losses reduces the amount of income taxes payable to local taxauthorities. This benefit has been reflected as a reduction of goodwill. Thebenefit of utilization of the net operating loss carryforwards that were notacquired has been reflected as a reduction to the income tax provision.

**Liquidity and Capital Resources**

At December 31, 2004 and March 31, 2005 ourprincipal sources of liquidity were cash, cash equivalents and short-terminvestments totaling $58.2 million and $65.3 million, respectively,and accounts receivable of $19.7 million and $14.9 million,respectively.

From our inception, we funded our operations primarilythrough issuances of convertible preferred stock for aggregate net cashproceeds of $79.7 million, including net cash acquired in the Clinsoftacquisition, the proceeds from the initial public offering and exercise of theover-allotment option resulting in net proceeds of $36.6 million, and the issuanceof notes payable for an aggregate of $17.3 million.

Cash provided by (used in) operating activities hashistorically been affected by changes in working capital accounts, primarilydeferred revenue, accounts receivable and accrued expenses, and add-backs of non-cashexpense items such as depreciation and amortization, non-cash income taxexpense and stock-based compensation. Fluctuations within accounts receivableand deferred revenue are primarily related to the timing of billings of ourterm license customers and the associated revenue recognition. Movements indeferred costs are related to the volume and stages of hosted clinical trialsand movements in accrued expenses and accounts payable are due to the timing ofcertain transactions.

Net cash provided by operating activities was$11.2 million for the three months ended March 31, 2005, which wasgreater than net income of $1.5 million. The difference is primarily dueto $1.6 million of non-cash depreciation, stock-based compensation, foreigncurrency exchange loss and non-cash income tax expense and changes in workingcapital, which consisted primarily of a $4.6 million decrease in accountsreceivable and an increase in deferred revenue of $6.7 million, partiallyoffset by decreases in accrued expenses of $2.4 million and accountspayable of $438,000.

Net cash used in investing activities was $194,000 forthe three months ended March 31, 2005, consisting primarily of thepurchase of short-term investments of $842,000 and capital expenditures of$611,000, partially offset by $1.3 million of proceeds from the maturitiesof short-term investments.

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Net cash used in financingactivities was $3.2 million for the three months ended March 31,2005, consisting primarily of $4.4 million of debt repayments as we paid all ofour outstanding bank debt, partially offset by $1.1 million from proceeds fromthe exercise of stock options.

At December 31, 2004and March 31, 2005, respectively, we had $1.6 million and $1.3million of outstanding letters of credit related to our facilities. The lettersof credit are reflected as a reduction in the amount available under the lineof credit.

Substantially all of ourlong-lived assets as of December 31, 2004 and March 31, 2005 arelocated in the United States.

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

Wegenerally do not enter into binding purchase commitments. Our principalcommitments consist of leases for office space. At March 31, 2005, thefuture minimum payments under these leases were as follows:
| **Year ended December 31,** | ** ** | ** **              | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                                 | ** ** | **(in thousands)** | ** ** |
| 2005                                       |       |                    | $          | 1,885     |       |   |
| 2006                                       |       |                    | 2,622      |      |       |
| 2007                                       |       |                    | 2,252      |      |       |
| 2008                                       |       |                    | 2,047      |      |       |
| 2009                                       |       |                    | 346        |      |       |
| Total minimum payments                     |       |                    | $          | 9,152     |       |   |

 

Between April 2000and September 2004, we had entered into several equipment lines of creditwith a bank. All advances under these equipment lines of credit were payable in30 to 36 equal monthly installments of principal, plus accrued interest. Theinterest that accrued under these notes ranges from prime rate (5.25% and 5.75%at December 31, 2004 and March 31, 2005, respectively) to prime rateplus 1.0%. As of December 31, 2004 there was a total of $4.4 millionoutstanding and $3.2 million available under all of our equipment lines ofcredit. In March 2005, we paid in full all outstanding debt related to ourequipment lines of credit. The equipment line of credit expired on March 31,2005 and was not renewed.

Effective March 31,2004, we renewed our working capital line of credit with a bank and increasedthe amount under which we can borrow to $5.0 million. Interest accrues at primerate. All advances made under the working capital line shall be immediately dueand payable on March 31, 2006. As of December 31, 2004 and March 31,2005, $0 was outstanding under the working capital line of credit. At March 31,2005, there was $3.7 million available under the line of credit, and $1.3million reserved under a letter of credit associated with our leasedfacilities.

Borrowings under ourworking capital line of credit are secured by substantially all of our assetsother than our intellectual property. We have also entered into a negativepledge agreement that, subject to certain exceptions, generally prohibits usfrom pledging our intellectual property to others. Under the terms of thiscredit line, we are required to comply with certain financial covenants. At March 31,2005, we were in compliance with all financial covenants. To the extent we areunable to satisfy those covenants in the future, we would be in default of the termsof these credit lines and could be required to repay all amounts thenoutstanding. We currently expect that we will have sufficient resources to fundany amounts which may become due under these credit lines as a result of adefault by us or otherwise.

At December 31, 2004,we had net operating loss carryforwards of approximately $88.4 million,which may be used to offset future U.S. federal taxable income, if any, and$4.8 million of federal research and development tax credit carryforwards.In addition, we have $5.6 million of net operating losses relating to ournon-U.S. jurisdictions. Of these amounts, approximately $26.9 million and$3.0 million of net operating 

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losscarryforwards and tax credit carryforwards, respectively, relate to amountsacquired as part of the Clinsoft acquisition. These tax carryforwards mayreduce our future cash payments to the taxing authorities. The cash benefits ofthe acquired carryforwards will be reflected as an adjustment through goodwilland not a reduction in the effective tax rate. The carryforwards expirebeginning in 2008 through 2023 and are subject to review and possibleadjustment by the taxing authorities. The Internal Revenue Code containsprovisions that may limit the net operating loss and tax credit carryforwardsavailable to be used in any given year in the event of certain changes in theownership interests of significant stockholders.

We believe our existingcash, cash equivalents, short-term investments and cash provided by operatingactivities and our various debt facilities will be sufficient to meet ourworking capital and capital expenditure needs over the next 12 months. Ourfuture capital requirements will depend on many factors, including our rate ofrevenue growth, the expansion of our marketing and sales activities, the timingand extent of spending to support product development efforts, the timing ofintroductions of new services and enhancements to existing services, and thecontinuing market acceptance of our services. To the extent that existing cashand securities and cash from operations are insufficient to fund our futureactivities, we may need to raise additional funds through public or privateequity or debt financing. From time to time, we may also enter into agreementswith respect to potential investments in, or acquisitions of, businesses,services or technologies, which could also require us to seek additional equityor debt financing. Additional funds for those purposes may not be available onterms favorable to us or at all.

**CertainFactors Which May Affect Future Results**

*Our operating results and financial condition havevaried in the past and may in the future vary significantly depending on anumber of factors. Except for the historical information in this report, thematters contained in this report include forward-looking statements thatinvolve risks and uncertainties. The following factors, among others, couldcause actual results to differ materially from those contained inforward-looking statements made in this report and presented elsewhere bymanagement from time to time. Such factors, among others, may have a materialadverse effect upon our business, results of operations and financialcondition.*

**Risks Related to Our Industry**

***We depend primarilyon the pharmaceutical, biotechnology and medical device industries and aretherefore subject to risks relating to changes in these industries.***

Our businessdepends on the clinical trials conducted or sponsored by pharmaceutical,biotechnology and medical device companies and other entities conductingclinical research. General economic downturns, increased consolidation ordecreased competition in the industries in which these companies operate couldresult in fewer products under development or decreased pressure to accelerateproduct approval which, in turn, could materially adversely impact ourrevenues. Our operating results may also be adversely impacted by otherdevelopments that affect these industries generally, including:

·       the introduction oradoption of new technologies or products;

·*      *thediscovery of safety issues with approved products or products in clinicaldevelopment;

·       theassertion of product liability claims;

·       changes in third-partyreimbursement practices;

·       changes in governmentregulation or governmental price controls;

·       changes in medicalpractices;

·       changes in the purchasingpatterns of entities conducting clinical research; and

·       changes in general businessconditions.

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Any decrease in researchand development expenditures or in the size, scope or frequency of clinicaltrials conducted or sponsored by pharmaceutical, biotechnology or medicaldevice companies or other entities as a result of the foregoing or other factorscould materially adversely affect our operations or financial condition.

***If entities engagedin clinical trials do not shift from traditional paper-based methods ofcollecting clinical trial data to electronic systems, we may not achieve themarket penetration necessary to obtain or maintain profitability.***

If entities engaged inclinical trials are unwilling to use our electronic data capture solutions orto change the way of collecting clinical trial data, our future growth andmarket share may be limited. Most clinical trials today rely on pre-printed,three-part paper case report forms for data collection. Our efforts toestablish an electronic process to capture clinical trial data are asignificant departure from the traditional paper-based methods of collectingclinical trial data. As is typical for new and rapidly evolving industries,customer demand for recently introduced technology is highly uncertain. We maynot be successful in persuading entities engaged in clinical trials to changethe manner in which they have traditionally collected clinical trial data andto accept our software products, services and hosted solutions. If we fail toconvince entities engaged in clinical trials to use our methods of capturingclinical trial data, our revenues may be limited and we may fail to continue tobe profitable.

***We operate in ahighly competitive industry and if we are not able to compete effectively, ourbusiness and operating results will be harmed.***

The market for our software products, services andhosted solutions is characterized by rapidly changing technologies, evolvingindustry standards and frequent new product and service introductions andenhancements that may render existing products and services obsolete.Accordingly, we are susceptible to rapid and significant declines in marketshare due to unforeseen changes in the features, functions or pricing ofcompeting products. Barriers to entry are relatively low and, with theintroduction of new technologies and new market entrants, we expect that competitionwill increase. Increased competition is likely to result in pricing pressures,which could negatively impact our sales, gross margins or market share. Ourfailure to compete effectively could materially adversely affect our business,financial condition or results of operations.

Some of our currentcompetitors, as well as many of our potential competitors, have greater namerecognition, longer operating histories and significantly greater resources. Asa result, our competitors may be able to respond more quickly and effectivelythan we can to new or changing opportunities, technologies, standards orcustomer requirements. In addition, current and potential competitors haveestablished, and may in the future establish, cooperative relationships withvendors of complementary products, technologies or services to increase theavailability of their products to the marketplace. Accordingly, new competitorsor alliances may emerge that have greater market share, larger customer bases,more widely adopted proprietary technologies, greater marketing expertise andlarger sales forces than we have, which could put us at a competitivedisadvantage. Further, in light of these advantages, even if our products andservices are more effective than the product or service offerings of ourcompetitors, current or potential customers might accept competitive productsand services in lieu of purchasing our software products, services and hostedsolutions. We cannot assure you that we can maintain or enhance our competitiveposition against current and future competitors.

***Changing customeror prospective customer requirements could decrease the demand for our productsand services, which would adversely affect our revenues and operating results.***

Our future success will dependin large part on our ability to enhance and broaden our software products,services and hosted solutions to meet the evolving needs of our customers andprospective 

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customers.To achieve our goals, we need to effectively respond to our customers’ and prospectivecustomers’ needs, technological changes and new industry standards anddevelopments in a timely manner. If we are unable to enhance our existingproduct and service offerings or develop new products and services to meetchanging requirements, demand for our software products, services and hostedsolutions could suffer and our revenues and operating results could bematerially adversely affected. We could also incur substantial costs if we needto modify our products or services, or information technology infrastructure,to adapt to technological changes or new industry standards or developments.

***Changes inregulations and regulatory guidance applicable to our customers or potentialcustomers and the approval process for their products may result in ourinability to continue to do business.***

Demand for our software products, services and hostedsolutions is largely a function of regulation and regulatory guidanceassociated with the approval of new drugs, biological products and medicaldevices imposed upon the clinical trial process by the U.S. federal governmentand related regulatory authorities such as the U.S. Food and DrugAdministration, or FDA, and by foreign governments. In recent years, effortshave been made to streamline the FDA approval process and coordinate U.S.standards with those of other developed countries. Any change in the scope ofapplicable regulations and regulatory guidance could alter the type or amountof clinical trial spending or negatively impact interest in our softwareproducts, services and hosted solutions. Any regulatory reform that limits orreduces the research and development spending of entities conducting clinicalresearch upon which our business depends could have a material adverse effecton our revenues or gross margins.

In addition, any failureto conform our software products, services and hosted solutions to domestic orinternational changes in regulations and regulatory guidance applicable to ourcustomers or potential customers and the approval process for their productsmay result in our inability to continue to do business. Changing our softwareproducts, services and hosted solutions to allow our customers to comply withfuture changes in regulation or regulatory guidance, either domestically orinternationally, could cause us to incur substantial costs. We cannot assureyou that our product and service offerings will allow our customers andpotential customers to stay in compliance with regulations and regulatoryguidance as they develop. If our product and service offerings fail to allowour customers and potential customers to operate in a manner that is compliantwith applicable regulations and regulatory guidance, clinical trial sponsorsand other entities conducting clinical research may be unwilling to use oursoftware products, services and hosted solutions.

**Risks Related to Our Company**

***We operate in an emerging market, which makes itdifficult to evaluate our business and future prospects.***

We wereincorporated in June 1997 and operate in an emerging market. Accordingly,our business and future prospects are difficult to evaluate. You shouldconsider the challenges, risks and uncertainties frequently encountered bycompanies using new and unproven business models in rapidly evolving markets.These challenges include our ability to:

·       generate sufficientrevenues to maintain profitability;

·       manage growth in ouroperations;

·       attract and retaincustomers;

·       attract and retain keypersonnel;

·       develop and renew strategicrelationships; and

·       access additional capitalwhen required and on reasonable terms.

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We cannot be certain thatwe will successfully address these and other challenges, risks anduncertainties or that our business model will be successful. Failure to do socould adversely affect our business, results of operations or financialcondition.

***Our softwareproducts and hosted solutions are at varying stages of market acceptance andthe failure of any of our products to achieve wide acceptance would harm ouroperating results.***

We began offeringour *InForm *electronic datacapture software solution for clinical trials in December 1998. Althoughthe *Clintrial* and *Clintrace* products were introduced over10 years ago, we did not begin offering these products until after ouracquisition of Clinsoft Corporation in 2001. Continued use of our *Clintrial* and *Clintrace* software products, and broad and timely acceptanceof our *InForm *product, aswell as integrated solutions combining one or more of our software products, iscritical to our future success and is subject to a number of significant risks,some of which are outside our control. These risks include:

·       our customers’ andprospective customers’ desire for and acceptance of our electronic datacapture, management and adverse event reporting software solutions;

·       our software products andhosted solutions’ ability to support large numbers of users and manage vastamounts of data;

·       our customers’ ability touse our software products and hosted solutions, train their employees andsuccessfully deploy our technology in their clinical trials;

·       our ability to meet productdevelopment and release schedules; and

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

Our failure to address,mitigate or manage these risks would seriously harm our business, particularlyif the failure of any or all of our software products or hosted solutions toachieve market acceptance negatively affects our sales of our other productsand services.

***Claims that we orour technologies infringe upon the intellectual property or other proprietaryrights of a third party may require us to incur significant costs, to enterinto royalty or licensing agreements or to develop or license substitutetechnology.***

We are, and may in thefuture be, subject to claims that our technologies infringe upon theintellectual property or other proprietary rights of a third party. Forinstance, Dr. Mark L. Kozam, doing business under the name MLK Software,has filed a complaint against us and one of our customers alleging that weinfringe a patent claimed to be owned by Dr. Kozam. We have incurredsubstantial professional fees in connection with the Kozam claim. In addition,the vendors who provide us with technology that we use in our technology couldbecome subject to similar infringement claims. Although we believe that oursoftware solutions do not infringe the patents of any third party, we cannotassure you that our technology does not infringe patents held by others or thatthey will not in the future. The Kozam claim and any future claims ofinfringement could cause us to incur substantial costs defending against theclaim, even if the claim is without merit, and could distract our managementfrom our business. Moreover, any settlement or adverse judgment resulting fromthe claim could require us to pay substantial amounts or obtain a license tocontinue to use the technology that is the subject of the claim, or otherwiserestrict or prohibit our use of the technology. There can be no assurance thatwe would be able to obtain a license from the third party asserting the claimon commercially reasonable terms, if at all, that we would be able to successfullydevelop alternative technology on a timely basis, if at all, or that we wouldbe able to obtain a license from another provider of suitable alternativetechnology to permit us to continue offering, and our customers to 

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continueusing, the applicable technology. In addition, we generally provide in ourcustomer agreements, including our agreement with the customer that is thesubject of the Kozam claim referenced above, that we will indemnify ourcustomers, against third-party infringement claims relating to our technologyprovided to the customer, which could obligate us to fund significant amounts.Infringement claims asserted against us or our vendors may have a materialadverse effect on our business, results of operations or financial condition.

***We may be unable toadequately protect, and we may incur significant costs in defending, ourintellectual property and other proprietary rights.***

Our success depends on ourability to protect our intellectual property and other proprietary rights. Werely upon a combination of trademark, trade secret, copyright, patent andunfair competition laws, as well as license agreements and other contractualprovisions, to protect our intellectual property and other proprietary rights.In addition, we attempt to protect our intellectual property and proprietaryinformation by requiring our employees and consultants to enter intoconfidentiality, noncompetition and assignment of inventions agreements. To theextent that our intellectual property and other proprietary rights are notadequately protected, third parties might gain access to our proprietaryinformation, develop and market products or services similar to ours, or usetrademarks similar to ours, each of which could materially harm our business.Existing U.S. federal and state intellectual property laws offer only limitedprotection. Moreover, the laws of other countries in which we market oursoftware products, services and hosted solutions may afford little or noeffective protection of our intellectual property. If we resort to legalproceedings to enforce our intellectual property rights or to determine thevalidity and scope of the intellectual property or other proprietary rights ofothers, the proceedings could be burdensome and expensive, even if we were toprevail. The failure to adequately protect our intellectual property and otherproprietary rights may have a material adverse effect on our business, resultsof operations or financial condition.

***We may acquire ormake investments in companies or technologies that could cause disruption ofour business and loss of value or dilution to our stockholders.***

From time to time,we evaluate potential investments in, and acquisitions of, complimentarytechnologies, services and businesses. We have made in the past, and may makein the future, acquisitions or significant investments in other businesses.Entering into an acquisition entails many risks, any of which could harm ourbusiness, including:

·       difficulties in integratingthe operations, technologies, products, existing contracts and personnel of thetarget company and realizing the anticipated synergies of the combinedbusinesses;

·       the price we pay or otherresources that we devote may exceed the value we eventually realize or thevalue we could have realized if we had allocated the purchase price or otherresources to another opportunity;

·       potential loss of keyemployees, customers and strategic alliances from either our current businessor the target company’s business;

·       managing the risks ofentering markets or types of businesses in which we have limited or no directexperience;

·       the diversion of management’sattention from other business concerns; and

·       assumption of unanticipatedproblems or latent liabilities, such as problems with the quality of the targetcompany’s products.

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In addition, if we financeany future acquisitions by issuing equity securities or convertible debt, ourexisting stockholders may be diluted or the market price of our stock may beadversely affected. The failure to successfully evaluate and executeacquisitions or investments or otherwise adequately address these risks couldmaterially harm our business and financial results.

***As a result of longsales cycles and our business model, we may be required to spend substantialtime and expense before we recognize a significant portion of the revenues, ifany, attributable to our customer contracts.***

The sales cycle for someof our software solutions frequently takes in excess of nine months frominitial customer contact to contract execution. During this time, we may expendsubstantial time, effort and financial resources without realizing any revenuewith respect to the potential sale In addition, while we begin recognizingrevenue upon the execution of our agreements for software term licenses andrelated services, it may be difficult for us to rapidly increase our revenuethrough additional sales in any period, as license revenue and, whenapplicable, related services revenue, from new customers is recognized over theapplicable license term, typically three to five years. As a result, we may notrecognize significant revenues, if any, from some customers despite incurringconsiderable expense related to our sales, implementation, and service deliveryprocesses. Even if we do realize revenues from a contract, our term licensepricing model may keep us from recognizing a significant portion of theserevenues (including revenues for related services) during the same period inwhich sales, implementation, and service delivery expenses were incurred. Forexample, pursuant to our contract with GlaxoSmithKline, we have incurredsignificant up-front implementation and other service expenses associated withdelivery of services under the contract, whereas the revenue under the contractwill be recognized ratably over an approximately 5-year period from July 2004.Timing differences of this nature could cause our service gross margins andprofitability to fluctuate significantly from quarter to quarter. Similarly, adecline in new or renewed software term licenses in any one quarter will notnecessarily be fully reflected in the revenue in that quarter and maynegatively affect our revenue in future quarters. This could also cause ouroperating results to fluctuate from quarter to quarter.

***We have incurred substantial losses in the past andmay not continue to be profitable in the future.***

We incurred significantlosses in each fiscal year from our inception in June 1997 through 2003,and we may incur significant operating losses in the future. As a result of ouroperating losses and accretion of preferred dividends, we had an accumulateddeficit of $102.9 million at March 31, 2005. You should not considerrecent revenue growth as indicative of our future performance as our operatingresults may fluctuate significantly from quarter to quarter. In addition, weexpect our development, sales and other operating expenses to increase in thefuture. If our revenue does not grow to offset these expected increasedexpenses, we may not continue to be profitable. In fact, in future quarters wemay not have any revenue growth and our revenue could decline. Furthermore, ifour operating expenses exceed our expectations, our financial performance willbe adversely affected.

***Interruptions ordelays in service from our third-party providers could impair the delivery ofour hosted InForm electronic data capture solution and harm our business.***

We host our *InForm *electronic data capturesoftware solution at third-party facilities. Consequently, the occurrence of anatural disaster or other unanticipated problems at the facilities of ourthird-party provider could result in unanticipated interruptions in ourcustomers’ access to our *InForm *electronicdata capture software solution. Our hosted services may also be subject tosabotage, intentional acts of malfeasance and similar misconduct due to thenature of the Internet. In the past, Internet users have occasionallyexperienced difficulties with Internet and online services due to system orsecurity failures. We cannot assure you that our business interruptioninsurance will adequately compensate our customers or us for losses that mayoccur. Even if covered by insurance, any failure or breach of security of oursystems could damage our reputation and cause us to lose customers. Further,certain of our hosted 

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*InForm *electronic data capturesolutions, are subject to service level agreements that guarantee 95% to 99%server availability. In the event that we fail to meet those levels, whetherresulting from an interruption in service caused by our technology or that of athird-party provider, we could be subject to customer credits or termination ofthese customer contracts.

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

The technology underlyingour software products and hosted solutions processes vast amounts of clinicaltrial data. Customers relying on our products to collect, manage and reportclinical trial information may have a greater sensitivity to product errors andsecurity vulnerabilities than customers of software products in general. In thepast, failures of our technology and human error have negatively impacted thedata capture, management or reporting capabilities of our products, and newerrors may be detected in the future. Any delay or failure of our technologymay result in the disruption of the clinical trial process and could harm ourbusiness and operating results. Product or service errors could materially andadversely affect our reputation, result in significant costs to us and impairour ability to sell our products and services in the future. The costs incurredin correcting any defects or errors may be substantial and could adverselyaffect our operating margins. In addition, security breaches, whetherintentional or accidental, could expose us to a risk of loss of data,litigation and possible liability.

***The global nature of our business exposes us tomultiple risks.***

For the quarterended March 31, 2005, approximately 48% of our revenues were derived frominternational operations. We expect that our international operations willcontinue to account for a significant portion of our revenues. As a result ofour international operations, we are exposed to many risks and uncertainties,including:

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

·       tariff and internationaltrade barriers;

·       fewer legal protections forintellectual property and contract rights abroad;

·       different and changinglegal and regulatory requirements in the jurisdictions in which we currentlyoperate or may operate in the future;

·       government currency controland restrictions on repatriation of earnings;

·       fluctuations in foreigncurrency exchange and interest rates; and

·       political and economicchanges, hostilities and other disruptions in regions where we currentlyoperate or may operate in the future.

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

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***We may lose ordelay revenues related to our hosted solutions if our customers terminate ordelay their contracts with us.***

Certain of our hosted electronicdata capture and other service and consulting contracts are subject tocancellation by our customers at any time with limited notice. Entities engagedin clinical trials may terminate or delay a clinical trial for various reasonsincluding the failure of the tested product to satisfy safety or efficacyrequirements, unexpected or undesired clinical results, decisions tode-emphasize a particular product or forego a particular clinical trial,decisions to downsize clinical development programs, insufficient patientenrollment or investigator recruitment and production problems resulting inshortages of required clinical supplies. In the case of our hosted solutions,any termination or delay in the clinical trials would likely result in aconsequential delay or termination in those customers’ service contracts. Wehave experienced terminations and delays of our customer service contracts inthe past and expect to experience additional terminations and delays in thefuture. Because we do not recognize any portion of a hosted service contract’srevenue until the implementation cycle is complete, the termination or delay ofour customers’ clinical trials could result in decreased or delayed revenuesunder these contracts which could materially harm our business.

***The loss of one ormore major customers could materially and adversely affect our results ofoperations and financial condition.***

Our top five customersaccounted for approximately 37% and 38% of our revenues during the quartersended March 31, 2004 and 2005, respectively. Two customers, Eli Lilly andCompany and GlaxoSmithKline, accounted for approximately 21% and 23% of ourtotal revenues for the quarters ending March 31, 2004 and 2005,respectively. The loss of any of our major customers could have a materialadverse effect on our results of operations or financial condition. We may notbe able to maintain our customer relationships, and our customers may not renewtheir agreements with us, which could adversely affect our results ofoperations or financial condition. A significant change in the liquidity orfinancial position of any of these customers could also have a material adverseeffect on the collectibility of our accounts receivables, our liquidity and ourfuture operating results.

***Our business could be seriously harmed by ourdependence on a limited number of suppliers.***

We depend upon a limitednumber of suppliers for specific components of our software products and hostedsolutions. We may increase our dependence on certain suppliers as we continueto develop and enhance our software and service solutions. Our dependence on alimited number of suppliers leaves us vulnerable to having an inadequate supplyof required components, price increases, delayed supplier performance and poorcomponent quality. For instance, we rely on Oracle Corporation to supply thedatabase component of our software solutions and on Equinix, Inc. toprovide the server facilities for our hosting services. Oracle Corporation alsooffers a software package that is competitive with our products and services.If we are unable to obtain components for our software solutions fromthird-party suppliers in the quantities and of the quality that we need, on atimely basis or at acceptable prices, we may not be able to deliver oursoftware products, services and hosted solutions on a timely or cost-effectivebasis to our customers, and our business, results of operations and financialcondition could be seriously harmed. Moreover, delays or interruptions in ourservice may reduce our revenue, cause customers to terminate their contractsand adversely affect our customer renewals.

***If we are unable toretain our personnel and hire additional skilled personnel, we may be unable toachieve our goals.***

Our future success dependsupon our ability to attract, train and retain highly skilled employees andcontract workers, particularly our management team, sales and marketingpersonnel, professional services personnel and software engineers. Each of ourexecutive officers and other employees could terminate his 

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or herrelationship with us at any time. The loss of any member of our management teammight significantly delay or prevent the achievement of our business ordevelopment objectives and could materially harm our business. In addition,because of the technical nature of our software products, services and hostedsolutions and the dynamic market in which we compete, any failure to attractand retain qualified direct sales, professional services and productdevelopment personnel, as well as our contract workers, could have a materialadverse affect on our ability to generate sales or successfully develop newsoftware products, services and hosted solutions or software enhancements.

***We could incursubstantial costs resulting from product liability claims relating to ourproducts or services or our customers’ use of our products or services.***

Any failure or errors in acustomer’s clinical trial or adverse event reporting obligations caused orallegedly caused by our products or services could result in a claim forsubstantial damages against us by our customers or the clinical trialparticipants, regardless of our responsibility for the failure. Although we areentitled to indemnification under our customer contracts against claims broughtagainst us by third parties arising out of our customers’ use of our products,we might find ourselves entangled in lawsuits against us that, even ifunsuccessful, divert our resources and energy and adversely affect ourbusiness. Further, in the event we seek indemnification from a customer, wecannot assure you that a court will enforce our indemnification right ifchallenged by the customer obligated to indemnify us or that the customer willbe able to fund any amounts for indemnification owed to us. We also cannotassure you that our existing general liability insurance coverage will continueto be available on reasonable terms or will be available in amounts sufficientto cover one or more large claims, or that the insurer will not disclaimcoverage as to any future claim.

***We and our productsand services could be subjected to governmental regulation, requiring us toincur significant compliance costs or to cease offering our products andservices.***

The clinical trial processis subject to extensive and strict regulation by the FDA, as well as otherregulatory authorities worldwide. Our electronic data capture, management andadverse event reporting products and services could be subjected to state,federal and foreign regulations. We cannot assure you that our products andservice offerings will comply with applicable regulations and regulatoryguidelines as they develop. If our products or services fail to comply with anyapplicable government regulations or guidelines, we could incur significantliability or be forced to cease offering our applicable products or services.Also, conforming our products and services to any applicable regulations andguidelines could substantially increase our operating expenses.

***Failure to manage our rapid growth effectively couldharm our business.***

We recently experienced aperiod of rapid growth that placed a significant strain on our operational andfinancial resources and our personnel. From January 1, 1999 to March 31,2005, the number of our employees increased from 35 to approximately 361. Tomanage our anticipated future growth effectively, we must continue to maintainand may need to enhance our information technology infrastructure, financialand accounting systems and controls and manage expanded operations in geographicallydistributed locations. We will also be required to attract, integrate, trainand retain a significant number of qualified sales and marketing personnel,professional services personnel, software engineers and other managementpersonnel. Our failure to manage our rapid growth effectively could have amaterial adverse effect on our business, operating results or financialcondition.

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***We may not be ableto obtain capital when desired on favorable terms, if at all, or withoutdilution to our stockholders.***

We anticipate thatour current cash and cash equivalents will be sufficient to meet our currentneeds for general corporate purposes. However, we may need additional financingto execute on our current or future business strategies, including to:

·       hire additional personnel;

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

·       enhance our operatinginfrastructure;

·       acquire businesses ortechnologies; or

·       otherwise respond tocompetitive pressures.

If we raise additional fundsthrough the issuance of equity or convertible debt securities, the percentageownership of our stockholders could be significantly diluted, and these newlyissued securities may have rights, preferences or privileges senior to those ofexisting stockholders. We cannot assure you that additional financing will beavailable on terms favorable to us, or at all. If adequate funds are notavailable or are not available on acceptable terms, when we desire them, ourability to fund our operations, take advantage of unanticipated opportunities,develop or enhance our software products, services and hosted solutions, orotherwise respond to competitive pressures would be significantly limited.

***In the course ofconducting our business, we possess or could be deemed to possess personalmedical information in connection with the conduct of clinical trials, which ifwe fail to keep properly protected, could subject us to significant liability.***

Our software solutions areused to collect, manage and report information in connection with the conductof clinical trails. This information is or could be considered to be personalmedical information of the clinical trial participants. Regulation of the useand disclosure of personal medical information is complex and growing.Increased focus on individuals’ rights to confidentiality of their personalinformation, including personal medical information, could lead to an increaseof existing and future legislative or regulatory initiatives giving directlegal remedies to individuals, including rights to damages, against entitiesdeemed responsible for not adequately securing such personal information. Inaddition, courts may look to regulatory standards in identifying or applying acommon law theory of liability, whether or not that law affords a private rightof action. Since we receive and process personal information of clinical trialparticipants from our customers, there is a risk that we could be liable ifthere were a breach of any obligation to a protected person under contract,standard of practice or regulatory requirement. If we fail to properly protectthis personal information that is in our possession or deemed to be in ourpossession, we could be subjected to significant liability.

***Our loan agreementscontain operating and financial covenants that may restrict our business andfinancing activities.***

We have loanagreements with a bank that provide for a $5.0 million working capitalcredit line. Our loan agreements restrict our ability to:

·       redeem subordinated indebtedness;

·       incur additionalindebtedness;

·       create liens;

·       enter into transactionswith affiliates;

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·       make investments;

·       sell assets;

·       pay dividends or makedistributions on, or repurchase, our stock; or

·       consolidate or merge withother entities.

In addition, our credit facility requires us to meetspecified revenue thresholds and maintain specified financial ratios and tests.The operating and financial restrictions and covenants in this credit facility,as well as any future financing agreements that we may enter into, may restrictour ability to finance our operations, engage in business activities or expandor fully pursue our business strategies. Our ability to comply with thesecovenants may be affected by events beyond our control, and we may not be ableto meet those covenants. A breach of any of these covenants could result in adefault under the loan agreement, which could cause all of the outstandingindebtedness under both credit facilities to become immediately due and payableand terminate all commitments to extend further credit.

While we believe that wewill have sufficient resources to fund any amounts which may become due underthese credit facilities, we cannot assure you that we will have sufficientassets to repay our credit facilities upon any default or that the bank willnot seek to enforce its remedies against us. If we were unable to repay thoseamounts, the bank could proceed against the collateral granted to them tosecure that indebtedness. We have pledged substantially all of our assets,other than our intellectual property, as collateral under the loan agreement.We have also entered into a negative pledge agreement that, subject to certainexceptions, generally prohibits us from pledging our intellectual property toothers.

***Our operatingresults may fluctuate and could cause the market price of our common stock tofall rapidly and without notice.***

Our revenues andoperating results are difficult to predict and may fluctuate from quarter toquarter, particularly because of the rapidly evolving market in which weoperate and our term license model. Our results of operations in any givenquarter will be based on a number of factors, including:

·       the extent to which oursoftware products, services and hosted solutions achieve or maintain marketacceptance;

·       our ability to introducenew products and services and enhancements to our existing products andservices on a timely basis;

·       the competitive environmentin which we operate;

·       the timing of our productsales and the length of our sales and implementation cycles;

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

·       changes in our operatingexpenses;

·       our ability to hire andretain qualified personnel;

·       changes in the regulatoryenvironment related to the clinical trial market;

·       changes in our customers’purchasing patterns;

·       the financial condition ofour current and potential customers; and

·       the timing, size andintegration success of potential future acquisitions.

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A significant portion ofour operating expense is relatively fixed in nature and planned expendituresare based in part on expectations regarding future revenues. Accordingly,unexpected revenue shortfalls or operating expenses may decrease our grossmargins and could cause significant changes in our operating results fromquarter to quarter. Results of operations in any quarterly period should not beconsidered indicative of the results to be expected for any future period. Inaddition, our future quarterly operating results may fluctuate and may not meetthe expectations of securities analysts or investors. If this occurs, thetrading price of our common stock could fall substantially either suddenly orover time.

**Risks Related to our Common Stock**

***The market price ofour common stock may be volatile, which could result in substantial losses forinvestors purchasing shares in the public markets and subject us to securitiesclass action litigation. The current market price of our common stock may notbe indicative of future market prices and we may be unable to sustain orincrease the value of an investment in our common stock.***

We only recentlycompleted our initial public offering. An active public market for our commonstock may not continue to develop or be sustained. Market prices for securitiesof software, technology and health care companies have been particularlyvolatile. The trading price of our common stock may fluctuate significantlyand, accordingly, may not be indicative of future trading prices and we may beunable to sustain or increase the value of an investment in our common stock.Some of the factors that may cause the market price of our common stock tofluctuate include:

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

·       changes in marketvaluations of similar companies;

·       changes in estimates of ourfinancial results or recommendations by securities analysts;

·       announcements by us or ourcompetitors of significant products, contracts, acquisitions or strategicalliances;

·       sales or transfers of largeblocks of stock by existing investors;

·       the failure of any of oursoftware products, services and hosted solutions to achieve or maintaincommercial success;

·       success of competitiveproducts and technologies;

·       litigation involving ourcompany or our general industry or both;

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

·       regulatory developments inthe United States and foreign countries;

·       additions or departures ofkey personnel;

·       investors’ generalperception of us; and

·       changes in generaleconomic, industry and market conditions.

In addition, if the marketfor software, technology or health care stocks or the stock market in generalexperiences a loss of investor confidence, the trading price of our commonstock could decline for reasons unrelated to our business, operating results orfinancial condition. If any of the foregoing occurs, it could cause our stockprice to fall and may expose us to class action lawsuits that, even ifunsuccessful, could be costly to defend and a distraction to management.

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***A significantnumber of our total outstanding shares may be sold into the market at any time.This could cause the market price of our common stock to drop significantly,even if our business is doing well.***

Approximately 30% of ouroutstanding shares of common stock are “restricted securities” within themeaning of Rule 144 promulgated under the Securities Act of 1933. Thismeans that they may not be sold without first being registered under theSecurities Act unless an exemption from registration is available, includingthe exemptions contained in Rule 144. These shares are eligible for salepursuant to Rule 144, subject in certain instances to the volume andmanner of sale limitations under Rule 144. In addition, as of March 31,2005, we had approximately 4.6 million shares subject to outstandingoptions and approximately 1.3 million shares reserved for future issuanceunder our stock option and stock purchase plans. Moreover, a relatively smallnumber of our shareholders own large blocks of shares. We cannot predict theeffect, if any, that public sales of these shares or the availability of theseshares for sale will have on the market price of our common stock. If ourstockholders, and particularly our directors and officers, sell substantialamounts of our common stock in the public market, or if the public perceivesthat such sales could occur, this could have an adverse impact on the marketprice of our common stock, even if there is no relationship between such salesand the performance of our business.

***Our directors and management exercise significantcontrol over our company.***

At March 31, 2005,our directors and executive officers and their affiliates beneficially controlapproximately 34% of our outstanding common stock. As a result, thesestockholders, if they act together, are able to influence our management andaffairs and all matters requiring stockholder approval, including the electionof directors and approval of significant corporate transactions. Thisconcentration of ownership may have the effect of delaying or preventing achange in control of our company and might affect the market price of ourcommon stock.

***Delaware law andour corporate documents may prevent or frustrate a change in control or achange in management that stockholders believe is desirable.***

Provisions of ourcertificate of incorporation and bylaws and Delaware law may discourage, delayor prevent a merger, acquisition or other change in control that stockholdersmay consider favorable, including transactions in which you might otherwisereceive a premium for your shares. These provisions may also prevent or frustrateattempts by our stockholders to replace or remove our management. Theseprovisions include:

·       limitations on the removalof directors;

·       advance notice requirementsfor stockholder proposals and nominations;

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

·       the ability of our board ofdirectors to designate the terms of and issue new series of preferred stockwithout stockholder approval, which could be used to institute a rights plan,or a poison pill, that would work to dilute the stock ownership of a potentialhostile acquirer, likely preventing acquisitions that have not been approved byour board of directors.

The affirmative vote of the holders of at least 75% ofour shares of capital stock entitled to vote is necessary to amend or repealthe above provisions of our certificate of incorporation. In addition, absentapproval of our board of directors, our bylaws may only be amended or repealedby the affirmative vote of the holders of at least 75% of our shares of capitalstock entitled to vote.

In addition, Section 203 of the Delaware GeneralCorporation Law prohibits a publicly held Delaware corporation from engaging ina business combination with an interested stockholder, generally a person whichtogether with its affiliates owns, or within the last three years has owned,15% of our voting stock, 

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for a period of threeyears after the date of the transaction in which the person became aninterested stockholder, unless the business combination is approved in aprescribed manner.

The existence of theforegoing provisions could limit the price that investors might be willing topay in the future for shares of our common stock.

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

*Foreign Currency ExchangeRisk*

Our results of operations and cash flows are subjectto fluctuations due to changes in foreign currency exchange rates, particularlychanges in the Euro, British pound sterling, Australian dollar and Japaneseyen. In the quarters ended March 31, 2004 and 2005, 38% and 48%,respectively, of our revenues were generated in locations outside the UnitedStates. The majority of these revenues are denominated in currencies other thanthe U.S. dollar, as are many of the associated expenses. Except for revenuetransactions in Japan, we enter into transactions directly with substantiallyall of our foreign customers. This creates a foreign currency exchange risk forus.

As of March 31, 2005,we had $5.3 million of receivables denominated in currencies other than theU.S. dollar. If the foreign exchange rates fluctuated by 10% as of March 31,2005, our foreign exchange exposure would have fluctuated by approximately$530,000. In addition, our subsidiaries have intercompany accounts thateliminate upon consolidation; however, such accounts expose us to foreigncurrency rate movements. Exchange rate fluctuations on short-term intercompanyaccounts are recorded in our consolidated statements of operations under “otherincome (expense)”, while exchange rate fluctuations on long-term intercompanyaccounts are recorded in our consolidated balance sheets under “accumulatedother comprehensive loss” in stockholders’ equity. We also maintain cashaccounts denominated in currencies other than the local currency which exposeus to foreign exchange rate movements. We have implemented a risk managementprogram under which we measure foreign currency exchange risk monthly andmanage those exposures through the use of various internal controls and the useof forward foreign exchange contracts. This process is designed to minimizeforeign currency translation exposures that could otherwise affect consolidatedresults of operations. As of March 31, 2005 we hedged approximately$1.9 million of receivables, intercompany accounts and cash balancesdenominated in currencies other than the U.S. dollar.

*Interest RateSensitivity*

We had unrestricted cash, cash equivalents and shortterm investments totaling $65.3 million at March 31, 2005. Investments insecurities are invested primarily in high quality securities of a shortduration and are not materially affected by fluctuations in interest rates. Thecash and cash equivalents are held for working capital purposes. We do notenter into investments for trading or speculative purposes. Due to theshort-term nature of these investments, we believe that we do not have anymaterial exposure to changes in the fair value of our investment portfolio as aresult of changes in interest rates. Declines in interest rates, however, wouldreduce future investment income.

We have a working capitalline of credit which bears interest based upon the prime rate. At December 31,2004 and March 31, 2005 there were no amounts outstanding under ourworking capital line of credit.

**Item 4.**                        Controlsand Procedures

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourSecurities Exchange Act reports is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and thatsuch information is accumulated 

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and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, as ours are designed to do, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.

As of March 31, 2005, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in enabling us to record, process,summarize and report information required to be included in our periodic SECfilings within the required time period.

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

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**Part II—Other Information**

**Item 1.**                        LegalProceedings

From time to time and inthe ordinary course of business, we are subject to various claims, charges andlitigation, including the litigation described in Note 13 of the unauditedcondensed consolidated financial statements included in this Quarterly Reporton Form 10-Q. The outcome of litigation cannot be predicted with certaintyand some lawsuits, claims or proceedings may be disposed of unfavorably to us,which could materially and adversely affect our financial condition or resultsof operations.

**Item 5.**                        OtherInformation

Our policy governingtransactions in our securities by directors, officers and employees permits ourofficers, directors and certain other persons to enter into trading planscomplying with Rule 10b5-1 under the Securities Exchange Act of 1934, asamended. We have been advised that our Vice President, General Counsel andSecretary, D. Ari Buchler, Vice President of Worldwide Sales, Stephen J.Powell, Vice President of Development, Steven J. Rosenberg, and our Chairmanand Chief Strategy Officer, Paul A. Bleicher have each entered into a tradingplan in accordance with Rule 10b5-1 and our policy governing transactionsin our securities. We anticipate that, as permitted by Rule 10b5-1 and ourpolicy governing transactions in our securities, some or all of our officers,directors and employees may establish trading plans in the future. We intend todisclose the names of executive officers and directors who establish a tradingplan in compliance with Rule 10b5-1 and the requirements of our policygoverning transactions in our securities in our future quarterly and annualreports on Form 10-Q and 10-K filed with the Securities and ExchangeCommission. However, we undertake no obligation to update or revise theinformation provided herein, including for revision or termination of anestablished trading plan, other than in such quarterly and annual reports.

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**Item 6.**                        Exhibits.

**EXHIBIT INDEX**
| Exhibit | ** ** | ** **                                                                                                                   |
|---------|------------|------------------------------------------------------------------------------------------------------------------------------|
| **No.** | ** ** | **Description**                                                                                                              |
| 10.1(1) |       | Agreement between the Registrant, Phase Forward  Europe Limited and Martin Young.                                            |
| 10.2(2) |       | Form of Executive Agreement between the  Registrant and its officers, as amended March 7, 2005.               |
| 10.3(3) |       | 2005 Global Sales Executive Incentive Compensation  Plan.                                                                    |
| 10.4(4) |       | 2005 Management Incentive Plan.                                                                                              |
| 10.5(5) |       | Summary of cash compensation practices for  non-employee directors.                                                          |
| 31.1    |       | Certification of CEO pursuant to  Rule 13a-14(a) and 15d-14(s) under the Securities Exchange Act  of 1934.    |
| 31.2    |       | Certification of CFO pursuant to  rules 13a-14(a) and 15d-14(s) under the Securities Exchange  Act of 1934.   |
| 32.1    |       | Certification of CEO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2    |       | Certification of CFO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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(1)          Incorporatedby reference herein to Exhibit 10.12 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(2)          Incorporated byreference herein to Exhibit 10.22 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(3)          Incorporated byreference herein to Exhibit 10.19 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(4)          Incorporated byreference herein to Exhibit 10.21 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(5)          Incorporated byreference herein to Exhibit 10.20 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

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**Signatures**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                         | **PHASE  FORWARD INCORPORATED** |
|-------------------------|---------------------------------|
|                    | By:                             | /s/ ROBERT K. WEILER |
|                    |                            | Robert K. Weiler |
|                    | * *                        | *Chief Executive Officer* |
|                    | * *                        | *(Duly authorized officer)* |
|                    | By:                             | /s/ RODGER WEISMANN |
|                    |                            | Rodger Weismann |
|                    | * *                        | *Chief Financial Officer* |
|                    | * *                        | *(Duly authorized officer and  principal financial officer)* |
| Date: May 11, 2005 |                            |   |

 

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**EXHIBIT INDEX**
| Exhibit  No. | ** ** | ** **                                                                                                                   | ** ** | **Description** |
|--------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.1(1)      |       | Agreement between the Registrant, Phase Forward  Europe Limited and Martin Young.                                            |
| 10.2(2)      |       | Form of Executive Agreement between the  Registrant and its officers, as amended March 7, 2005.               |
| 10.3(3)      |       | 2005 Global Sales Executive Incentive Compensation  Plan.                                                                    |
| 10.4(4)      |       | 2005 Management Incentive Plan.                                                                                              |
| 10.5(5)      |       | Summary of cash compensation practices for  non-employee directors.                                                          |
| 31.1         |       | Certification of CEO pursuant to  Rule 13a-14(a) and 15d-14(s) under the Securities Exchange Act  of 1934.    |
| 31.2         |       | Certification of CFO pursuant to  rules 13a-14(a) and 15d-14(s) under the Securities Exchange  Act of 1934.   |
| 32.1         |       | Certification of CEO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2         |       | Certification of CFO pursuant to 18 U.S.C. 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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(1)          Incorporated byreference herein to Exhibit 10.12 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(2)          Incorporated byreference herein to Exhibit 10.22 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(3)          Incorporated byreference herein to Exhibit 10.19 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(4)          Incorporated byreference herein to Exhibit 10.21 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

(5)          Incorporated by referenceherein to Exhibit 10.20 of the Company’s Annual Report on Form 10-Kfor the period ended December 31, 2004.

48

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