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| PFWD > SEC Filings for PFWD > Form 10-Q on 6-Aug-2009 | All Recent SEC Filings |
6-Aug-2009
Quarterly Report
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto that appear elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2008, which has been filed with the Securities and Exchange Commission ("SEC").
Overview
Phase Forward Incorporated is a provider of integrated enterprise-level software products, services and hosted solutions for use in our customers' global clinical trial and drug safety monitoring activities. Our customers include pharmaceutical, biotechnology and medical device companies, as well as academic institutions, governmental regulatory agencies, contract research organizations, or CROs, and other entities engaged in clinical trial and drug safety monitoring activities. By automating essential elements of the clinical trial and drug safety monitoring processes, we believe our products allow our customers to accelerate the market introduction of new medical therapies and corresponding revenues, reduce overall research and development expenditures, enhance existing data quality control efforts, increase drug safety compliance and reduce clinical and economic risk.
Acquisitions
From time to time we have expanded our product and service offerings through the acquisition of other businesses or technologies; transactions occurring within the last year are described below.
Maaguzi
On July 27, 2009, we acquired privately held Maaguzi LLC ("Maaguzi"), an innovative provider of Web-based, electronic patient reported outcomes (ePRO) and late phase solutions, for $11.0 million in cash. The acquisition of Maaguzi extends our integrated clinical research suite and marks the entry into the increasingly important ePRO and observational studies markets. The acquisition of Maaguzi will be accounted for as a purchase under SFAS No. 141 (R), Business Combinations. Accordingly, the results of Maaguzi will be included in our consolidated financial statements from the date of acquisition.
Covance
On July 15, 2009, we entered into an agreement to purchase the Interactive Voice & Web Response Services (IVRS/IWRS) business of Covance Inc. ("Covance") for $10.0 million in cash. As part of this transaction, Covance has also agreed to enter into a multi-year marketing agreement to provide our InForm electronic data capture (EDC) solution and Clarix interactive response technology solution to Covance clients. The acquisition is expected to be completed by the middle of August 2009. The acquisition will be accounted for as a purchase under SFAS No. 141 (R). Accordingly, the results of the acquired IVRS/IWRS business will be included in our consolidated financial statements from the date of acquisition.
Waban
On April 22, 2009, we acquired all of the outstanding common stock of Waban Software, Inc. ("Waban"), a provider of platform solutions for the automation and compliance of clinical data analysis. Waban's Statistical Computing Environment and Clinical Data Repository (SCE/CDR) solutions provide automation, traceability and control of the key activities involved in the integration, analysis and reporting on clinical trial data. The aggregate purchase price was $13.8 million in cash, as adjusted by any working capital adjustments as of 90 days after the acquisition date, and minus any transaction fees or indebtedness of Waban. We acquired the technology of Waban to allow us to penetrate the market for statistical computing and clinical data repository solutions. The acquisition of Waban has been accounted for as a purchase under SFAS No. 141 (R). Accordingly, the results of Waban have been included in our consolidated financial statements since the date of acquisition.
Sources of Revenues
We derive our revenues from software licenses and services. Our product line is comprised of four general categories that include the following software products:
† Electronic Data Capture (EDC)
† InForm, our Internet-based electronic data capture solution for collection and transmission of patient information in clinical trials; and
† LabPas, our system for Phase I clinic automation.
† Clinical Data Management
† Clintrial, our clinical data management solution; and
† Empirica Study, our system for validating and reviewing clinical trial data represented in formats meeting industry standards, such as those established by the Clinical Data Interchange Standards Consortium, or CDISC.
† Drug Safety
† Empirica Trace, our adverse event management solution for monitoring drug safety and reporting adverse events that occur during and after conclusion of the clinical trial process;
† Empirica Signal, our data mining and signal detection solution for post-marketing data; and
† CTSD, our signal detection solution for data from clinical trials.
† Interactive Response Technology (IRT)
† Clarix, our Web-integrated interactive response technology.
† Clinical Data Analysis Systems
† Waban CDR, our controlled clinical data repository product for storing and managing clinical trials data (both data and metadata).
††† Waban SCE, our metadata-driven controlled clinical data repository product for automation and tracking of routine and repetitious statistical programming and analysis.
License revenues are derived principally from the sale of term licenses for our software products other than Clarix, which is presently available only on a hosted application basis. Service revenues are derived principally from our delivery of the hosted solution of our InForm, Clarix, Empirica Signal, CTSD and Empirica Study software products, and consulting services and customer support, including training, for all of our products. We generally recognize revenues ratably over the life of a license or service contract.
One customer, GlaxoSmithKline, accounted for approximately 12% of our total revenues in the three months ended June 30, 2008 and 13% of our total revenues in the six months ended June 30, 2008. The same customer accounted for $863 or 2% of
accounts receivable outstanding as of December 31, 2008. In the three and six months ended June 30, 2009, no customer accounted for 10% or more of our total revenues for the period. Our top 20 customers accounted for approximately 63% and 59% of our total revenues, net of reimbursable out-of-pocket expenses, in the three months ended June 30, 2008 and 2009, respectively, and 64% and 61% of our total revenues, net of reimbursable out-of-pocket expenses, in the six months ended June 30, 2008 and 2009, respectively.
License Revenues
We derive our license revenues principally from the sale of term licenses for the following software products: InForm, our Internet-based electronic data capture, or EDC, solution; Clintrialand Empirica Study, our clinical data management solutions; our drug safety solutions, including our Empirica Trace, Empirica Signal and CTSDproducts, our LabPas Phase I clinic automation solution, and our Waban CDR and Waban SCE products for clinical data analysis. Although each of our software solutions is available as a stand-alone enterprise application, we offer integrated enterprise solutions incorporating certain of our electronic data capture, data management and analysis, and drug safety products.
License revenues for our InForm electronic data capture software solution, either on a stand-alone or integrated basis, are determined primarily by the number, complexity and duration of the clinical trials and the number of participants in each clinical trial. License revenues for our Clintrial, Empirica Study, Empirica Trace, Empirica Signal, CTSD and LabPas software solutions are determined primarily by the number of users accessing the software solution. Except as discussed below, we enter into software license agreements for our InForm,Clintrial and Empirica Traceproducts with terms generally of three to five years with payment terms generally annually in advance. License agreements for our other licensed products are generally annual or multi-year with payment terms generally annually in advance. License revenues are recognized ratably over the duration of the software term license agreement, to the extent that amounts are fixed or determinable and collectable.
Following our acquisition of Clinsoft Corporation ("Clinsoft") in August 2001, we began converting holders of Clinsoft perpetual software licenses to our software term license arrangements. We continue to sell additional perpetual licenses of these products in certain situations to our existing customers with the option to purchase customer support, and may in the future do so for new customers based on customer requirements or market conditions. We recognize revenues on the perpetual licenses upon delivery of the software when all other revenue recognition criteria are met. We continue to provide and charge for maintenance and support on our products to those customers who do not convert to our software term license arrangements. We will continue our efforts to convert the remaining former Clinsoft customer base to software term license arrangements. However, we anticipate that some customers will not convert and instead will continue to make annual customer support payments.
Service Revenues
Application Hosting Services. In addition to making our software products other than Clarix available to customers through licenses, we offer our InForm, Empirica Signal, CTSD and Empirica Study software as hosted application solutions delivered through a standard Web-browser, with customer support and training services. OurClarix solution is presently available only on a hosted application basis. Service revenues from application hosting services are derived principally from our InForm hosted solution.
Revenues resulting from the InForm hosting service consist of three stages for each clinical trial:
† First stage-trial and application set up, including design of electronic case report forms and edit checks, installation and server configuration of the system;
† Second stage-application hosting and related support services; and
† Third stage-services required to close out, or lock, the database for the clinical trial.
Revenues resulting from the Clarix hosting service also consist of three stages for each clinical trial:
† First stage-trial and application set up, including design and set up of the subject randomization and medication inventory management, installation and server configuration of the system;
† Second stage-application hosting and related support services; and
† Third stage-services required to close out the clinical trial.
Services provided for the first and third stages of both InForm and Clarix are provided on a fixed fee basis depending upon the complexity of the trial and system requirements. Services for the second stage are charged separately as a fixed monthly fee. We recognize revenues from all stages of the hosting service ratably over the hosting period. Fees charged and costs incurred for the trial
system design, set up and implementation are deferred until the start of the hosting period and are amortized and recognized ratably over the estimated hosting period. The deferred 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 upon milestones. Fees for application hosting and related services in the second stage are generally billed quarterly in advance. Bundled into this revenue element are the revenues attributable to the software license used by the customer.
In the event that an application hosting customer cancels a clinical trial and its related statement of work, all deferred revenues are recognized and all deferred set up costs are expensed. In addition, certain termination-related fees may be charged and if so, such fees are recognized in the period of termination.
Revenues resulting from hosting services for our Empirica Signal, CTSD andEmpirica Study products consist of installation and server configuration, application hosting and related support services. Services for these offerings are charged monthly as a fixed fee. Revenues are recognized ratably over the period of the service.
In addition, application hosting service revenues include hosting services associated with term license customers and reimbursable out-of-pocket expenses.
Consulting Services. Consulting services include the design and documentation of the processes related to our customers' use of our products and services in their clinical trials and safety monitoring activities. Consulting services also include project planning and management services, guidance on best practices in using our software products, data management and configuration services for data mining and reporting, as well as implementation services consisting of application architecture design, systems integration, installation and validation. Consulting services can be sold on a stand-alone basis or as part of a bundled arrangement. In some circumstances, we sell additional follow on consulting services to a customer at a later date even if the customer purchased consulting services at the time of the initial license purchase under a bundled arrangement. Revenues from consulting services included in either a multiple element software license agreement or in an application hosting agreement are recognized ratably over the term of the arrangement. The value of our consulting services sold within a bundled arrangement is equal to the value of consulting services sold on a stand-alone basis, as the activities performed under both types of arrangements are similar in nature. The associated costs are expensed as incurred. We may also enter into arrangements to provide consulting services separate from a license arrangement. In these situations, revenue is recognized in accordance with the American Institute of Certified Public Accountants, or AICPA, Statement of Position, or SOP, No. 81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts, on either a time and materials basis or using the proportional performance method. If we are not able to produce reasonably dependable estimates, revenue is recognized upon completion of the project and final acceptance from the customer. If significant uncertainties exist about project completion or receipt of payment, the revenue is deferred until the uncertainty is resolved. Provisions for estimated losses on contracts are recorded during the period in which they are resolved. Provisions for estimated losses on contracts are recorded during the period in which they are identified.
Customer Support. We have a multinational services organization to support our software products and hosted solutions worldwide. Customer support includes multilingual training services, telephone support and software maintenance. We bundle customer support in our software term licenses and allocate 10% of the value of the license to customer support revenues. The customer support services rate of 10% for multi-year term-based licenses reflects a significant discount from the rate for customer support services associated with perpetual licenses due to the reduction in the time period during which the customer can utilize the upgrades and enhancements. We believe this rate is substantive and represents an amount we believe reasonable to be allocated. Our customer support revenues also consist of customer support fees paid by perpetual license customers. Customer support revenues are recognized ratably over the period of the customer support or term license agreement, with payment terms generally annually in advance.
Cost of Revenues and Operating Expenses
We allocate overhead expenses such as rent and occupancy charges and employee benefit costs to all departments based on headcount. As such, general overhead expenses are reflected in costs of service revenues and in the sales and marketing, research and development, and general and administrative expense categories.
Costs of Revenues. Costs of license revenues consist primarily of the amortization of royalties paid for certain modules within our Clintrialsoftware product as well as our InForm software product. In addition, costs of revenues include expense for the amortization of acquired technologies associated with the acquisitions of Lincoln Technology, Inc. ("Lincoln") in 2005 and Green Mountain Logic, Inc. in 2007. The costs of license revenues vary based upon the mix of revenues from software licenses for our products. We operate our service organization on a global basis as one distinct unit, and do not segment costs for our various service revenue elements. These services include performing application hosting, consulting and customer support services. Costs for these services consist primarily of employee-related costs associated with these services, amortization of the deferred clinical trial set up costs, allocated overhead, outside contractors, royalties associated with providing customer support for use with the Clintrial and
InForm software products and reimbursable out-of-pocket expenses. Costs of services also include hosting costs that primarily consist of hosting facility fees and server depreciation and amortization of acquired technologies associated with the acquisition of Clarix.
The costs of service revenues vary based upon the number of employees in the service organization, the type of work performed, and royalties associated with revenues derived from providing customer support, as well as costs associated with the flexible use of outside contractors to support internal resources. We supplement the trial design and set up activity for our InForm application hosting services through the use of outside contractors. This allows us to utilize outside contractors in those periods where trial design and set up activity is highest while reducing the use of outside contractors in those periods where trial activity lessens, allowing for a more flexible delivery model. The percentage of the services workforce represented by outside contractors varies from period to period depending on the volume of specific support required. The costs of service revenues is significantly higher as a percentage of revenues as compared to our costs of license revenues primarily due to the employee-related and outside contractor expenses associated with providing services.
Gross Margin. Our gross margin on license revenues varies based on the mix of royalty- and non-royalty-bearing license revenues and the amount of amortization of acquired technologies. Our gross margin on service revenues varies primarily due to variations in the utilization levels of the professional service team and the timing of expense and revenue recognition under our service arrangements. In situations where the service revenues are recognized ratably over the software license term, our costs associated with delivery of the services are recognized as the services are performed, which is typically during the first 6 to 12 months of the contract period. Accordingly, our gross margin on service revenues will vary significantly over the life of a contract due to the timing, amount and type of service required in delivering certain projects. In addition, consolidated gross margin will vary depending upon the mix of license and service revenues.
Sales and Marketing. Sales and marketing expenses consist primarily of employee-related expenses, including travel, marketing programs which include product marketing expenses such as trade shows, workshops and seminars, corporate communications, other brand building and advertising, allocated overhead and the amortization of commissions. In addition, sales and marketing include expense for the amortization of acquired technologies associated with the acquisition of Lincoln. We expect that sales and marketing expenses will continue to increase in absolute dollars as commission expense increases with our revenues and as we continue to expand sales coverage and to build brand awareness through what we believe are the most cost effective channels available, but may fluctuate quarter over quarter due to the timing of marketing programs.
Research and Development. Research and development expenses consist primarily of employee-related expenses, allocated overhead and outside contractors. We focus our research and development efforts on increasing the functionality, performance and integration of our software products. We expect that in the future, research and development expenses will increase in absolute dollars as we continue to add features and functionality to our products, introduce additional integrated software solutions to our product suite and expand our product and service offering.
General and Administrative. General and administrative expenses consist primarily of employee-related expenses, professional fees, primarily consisting of expenses for accounting, compliance with the Sarbanes-Oxley Act of 2002, and legal services, including litigation, information technology and other corporate expenses and allocated overhead. We expect that in the future our general and administrative expenses will increase in absolute dollars as we add personnel and incur additional costs related to the growth of our business and operations.
Stock-Based Compensation Expenses. Our cost of service revenues, sales and marketing, research and development, and general and administrative expenses include stock-based compensation expense. Stock-based compensation expense is the fair value of outstanding stock options and restricted stock awards and units, which are recognized over the respective stock option and award or unit service periods. During the three months ended June 30, 2008 and 2009, we recorded $2.0 million and $3.6 million of stock-based compensation expense, respectively. During the six months ended June 30, 2008 and 2009, we recorded $3.7 million and $6.2 million of stock-based compensation expense, respectively.
Foreign Currency Translation
With regard to our international operations, we frequently enter into transactions in currencies other than the U.S. dollar. As a result, our revenues, expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the euro, British pound, Australian dollar, Indian rupee, Japanese yen and Romanian leu. In the three months ended June 30, 2008 and 2009, approximately 45% and 39%, respectively, of our revenues were generated in locations outside the United States. In the six months ended June 30, 2008 and 2009, approximately 46% and 39%, respectively, of our revenues were generated in locations outside the United States. The majority of these revenues are in currencies other than the U.S. dollar, as are
many of the associated expenses. In periods when the U.S. dollar declines in value as compared to the foreign currencies in which we conduct business, our foreign currency-based revenues and expenses generally increase in value when translated into U.S. dollars.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and assumptions with our audit committee, including those related to revenue recognition, deferred set up costs, commissions and royalties, accounts receivable reserves, stock-based compensation expenses, long-lived assets, intangibles assets and goodwill, income taxes, restructuring, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There have been no material changes to these estimates for the periods presented in this Quarterly Report on Form 10-Q. Our actual results may differ from these estimates under different assumptions or conditions.
We believe that of our significant accounting policies, which are described in Note 1 and Note 2 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2008, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition and Deferred Set Up Costs. We recognize software license revenues in accordance with SOP No. 97-2,Software Revenue Recognition, as amended, issued by the AICPA, while revenues resulting from application services are recognized in accordance with Emerging Issues Task Force, or EITF, Issue No. 00-3, Application of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software Stored on Another Entity's Hardware, the Securities and Exchange Commission, or SEC, Staff Accounting Bulletin, or SAB, No. 104,Revenue Recognition, and EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.
Customers generally have the ability to terminate application hosting, consulting and training service agreements upon 30 days notice. License agreements, multiple element arrangements, including license and services agreements and certain application hosting services can generally be terminated by either party for material breach of obligations not corrected within 30 days after notice of the breach.
We recognize revenues when all of the following conditions are satisfied:
(1) there is persuasive evidence of an arrangement; (2) the product or service
has been provided to the customer; (3) the collection of our fees is probable;
and (4) the amount of fees to be paid by the customer is fixed or determinable.
We generally enter into software term licenses for our InForm, Clintrial, Empirica Trace Waban CDR and Waban SCEproducts with our customers for 3- to 5-year periods. License agreements for our Empirica Signal, CTSD and Empirica Study products are generally annual or multi-year terms. We do not license our Clarix product, which is presently offered only on a hosted application basis. These arrangements typically include multiple elements: software license, consulting services and customer support. We bill our customers in accordance with the terms of the underlying contract. Generally, we bill license fees annually in advance for each year of the license term. Our payment terms are generally net 30 days.
Our software license revenues are earned from the sale of off-the-shelf software requiring no significant modification or customization subsequent to delivery to . . .
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