Cautionary Statement for Forward-Looking Information The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes to the consolidated financial statements appearing elsewhere in this Form 10-Q. The following discussion and analysis includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflect our current views as to future events and financial performance with respect to our operations. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They use words such as "aim," "anticipate," "are confident," "estimate," "expect," "will be," "will continue," "will likely result," "project," "intend," "plan," "believe," "look to" and other words and terms of similar meaning in conjunction with a discussion of future operating or financial performance.
These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause such a difference include:
unfavorable economic conditions; our ability to obtain new contracts and accurately estimate net revenues due to variability in size, scope and duration of projects and internal issues at the sponsoring client; integration of future acquisitions; competitive factors; technological development; and market demand. There is no guarantee that the amounts in our backlog will ever convert to revenue. Should the current economic conditions continue or deteriorate further, the cancellation rates that we have historically experienced could increase. Further information on potential factors that could affect the Company's financial results can be found in the reports we file with the Securities and Exchange Commission.
Forward-looking statements speak only as of the date made. We undertake no obligation to update any forward-looking statements, including prior forward-looking statements, to reflect the events or circumstances arising after the date as of which they were made. As a result of these risks and uncertainties, readers are cautioned not to place undue reliance on any forward-looking statements included in this discussion or that may be made in our filings with the Securities and Exchange Commission or elsewhere from time to time by, or on behalf of, us.
Overview
We were founded in 1977 to provide Cardiac Safety solutions to evaluate the safety of new drugs. We provide technology and service solutions that enable the pharmaceutical, biotechnology and medical device industries to collect, interpret and distribute cardiac safety data more efficiently. We are a market leader in providing centralized electrocardiographic solutions (Cardiac Safety solutions) and a provider of technology solutions that streamline the clinical trials process by enabling our clients to evolve from traditional, paper-based methods to electronic processing using our ePRO products and solutions. On June 23, 2009, we completed the sale of certain assets relating to our EDC operations. Under the terms of the transaction, OmniComm Systems, Inc. issued 8.1 million shares of common stock and assumed certain liabilities including deferred revenue relating to our EDC operations in exchange for our EDC assets which primarily included our EDC software, applications and fixed assets and $1.15 million in cash we paid. During the three months ended June 30, 2009, we recorded a gain on the sale of these assets of $0.5 million within general and administrative expenses in the consolidated statement of operations. Our services revenues consist primarily of our services offered under our Cardiac Safety and, to a lesser extent, ePRO™ solutions. Our site support revenue consists of cardiac safety equipment rentals and sales along with related supplies and logistics management.
We offer Cardiac Safety solutions, which are utilized by pharmaceutical companies, biotechnology companies, medical device companies, clinical trial sponsors and clinical research organizations (CROs) during the conduct of clinical trials. Our Cardiac Safety solutions include the collection, interpretation and distribution of electrocardiographic (ECG) data and images and are performed during clinical trials in all phases of the clinical research process. The ECG provides an electronic map of the heart's rhythm and structure, and is performed in most clinical trials. Our Cardiac Safety solutions permit assessments of the safety of therapies by documenting the occurrence of cardiac electrical change. Specific trials, such as a Thorough QTc study, focus on the cardiac safety profile of a compound. Thorough QTc studies are comprehensive studies that typically are of large volume and short duration and are generally required by the United States Food and Drug Administration (FDA) under guidance issued in 2005 by the International Committee on Harmonization (ICH E14). We also offer site support, which includes the rental and sale of cardiac safety equipment along with related supplies and logistics management. We also offer ePRO solutions along with proprietary clinical assessments. We offer the following products and services on a global basis:
Cardiac Safety. Cardiac Safety solutions, including our EXPERT® technology platform, provide for workflow-enabled cardiac safety data collection, interpretation and distribution of electrocardiographic (ECG) data and images as well as for analysis and cardiologist interpretation of ECGs performed on research subjects in connection with our clients' clinical trials. EXPERT® is designed specifically to address global regulatory guidance and technical standards for digital ECG processing to include digital collection, waveform measurements and annotations, review and output to the regulatory standard file format. Also included in Cardiac Safety solutions is FDA XML delivery, which provides for the delivery of ECGs in a format compliant with the United States Food and Drug Administration's XML standard for digital ECGs. We also provide ECG equipment through rental and sales to clients to perform the ECG recordings and give them means to send such recordings to us. A new portal product, MyStudy Portal, is now providing sponsors and investigator sites with the ability to order supplies, gain real time reports and respond to queries via a secure web portal in lieu of less efficient means such as faxing and telephone calls.

Cardiac Safety Consulting. The centralization of electrocardiograms in clinical research has become increasingly important to organizations involved in the development of new drugs. Global regulators each apply their own slightly different interpretation of the International Conference on Harmonization E14 guidelines and, as a result, sponsors look to their vendors to provide key scientific input into the overall process. Our cardiac safety consulting service aids sponsors in the development of protocol synopses, the creation and analysis of statistical plans as well as the provision of an expert medical report with regard to the cardiac findings. We are involved in all phases of clinical development from a consultancy point of view. We offer this service both as a stand-alone service and integrated with our full suite of Cardiac Safety solutions.
ePRO. Our electronic patient reported outcome (ePRO) solution is an Interactive Voice Response (IVR) system that allows subjects to easily and quickly report data for a clinical trial. Because it can be accessed from a standard phone, our ePRO system is cost effective while being extremely scalable and suitable from Phase I through Phase IV. Diaries, screening, recruitment and all clinical assessments can be completed directly by the subject without requiring clinician involvement.
Project Assurance. We provide a full spectrum of consulting services for all of our products that augment the study management and implementation efforts of clients in support of their clinical research requirements.
Services revenues consist of Cardiac Safety and ePRO services that we provide on a fee for services basis and are recognized as the services are performed. We also provide Cardiac Safety consulting services on a time and materials basis and recognize revenues as we perform the services. Site support revenues are recognized at the time of sale or over the rental period.
For arrangements with multiple deliverables where the fair value of each element is known, the revenue is allocated to each component based on the relative fair values of each element in accordance with Emerging Issues Task Force (EITF) Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." For arrangements with multiple deliverables where the fair value of one or more delivered elements is not known, revenue is allocated to each component of the arrangement using the residual method provided that the fair value of all undelivered elements is known. Fair values for undelivered elements are based primarily upon stated renewal rates for future products or services. We have recorded reimbursements received for out-of-pocket expenses incurred as revenue in the accompanying consolidated financial statements in accordance with EITF Issue No. 01-14, "Income Statement Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses."
Revenue is recognized on unbilled services and relates to amounts that are currently not billable to the customer pursuant to contractual terms. In general, such amounts become billable in accordance with predetermined payment schedules, but recognized as revenue as services are performed. Amounts included in unbilled revenue are expected to be collected within one year and are included within current assets.
Our former electronic data capture (EDC) business is included in EDC licenses and services and included license revenue, technology consulting and training services and software maintenance services. We recognized software revenues in accordance with the Accounting Standards Executive Committee Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2, 'Software Revenue Recognition', With Respect to Certain Transactions." Accordingly, we recognized up-front license fee revenues under the residual method when a formal agreement existed, delivery of the software and related documentation occurred, collectability was probable and the license fee was fixed or determinable. We recognized monthly and annual term license fee revenues over the term of the arrangement. Hosting service fees were recognized evenly over the term of the service. We recognized revenues from software maintenance contracts on a straight-line basis over the term of the maintenance contract, which was typically twelve months. We provided consulting and training services on a time and materials basis and recognized revenues as we performed the services.
Cost of services includes the cost of Cardiac Safety and ePRO services. Cost of services consists primarily of direct costs related to our centralized Cardiac Safety services and includes wages, depreciation, amortization, fees paid to consultants and other direct operating costs. Cost of site support consists primarily of wages, cardiac safety equipment rent and depreciation, related supplies, cost of equipment sold, shipping expenses and other direct operating costs. Selling and marketing expenses consist primarily of wages and incentive compensation paid to sales personnel, travel expenses and advertising and promotional expenditures. General and administrative expenses consist primarily of wages and direct costs for our finance, administrative, corporate information technology, legal and executive management functions, in addition to professional service fees and corporate insurance. Research and development expenses consist primarily of wages paid to our product development staff, costs paid to outside consultants and other direct costs associated with the development of our technology.

Costs of our former EDC operations included primarily wages, fees paid to outside consultants and other direct operating costs related to our software licensing, consulting and client support functions.
We conduct our operations through offices in the United States (U.S.) and the United Kingdom (UK). Our international net revenues represented approximately 21% and 18% of total net revenues for the six months ended June 30, 2008 and 2009, respectively. The majority of our revenues are allocated among our geographic segments based upon the profit split transfer pricing methodology, and revenues are generally attributed to the geographic segment where the work is performed. The profit split methodology equalizes gross margins for each legal entity based upon its respective direct costs. Reclassifications
The consolidated financial statements for prior periods have been reclassified to conform to the current period's presentation. In particular, the revenue and cost of revenue of our former EDC operations have been reclassified from the licenses and services categories to the EDC category on the consolidated statements of operations for all periods presented. Additionally, the remaining revenues and costs of sales in licenses, related to Cardiac safety reporting and ePRO subscriptions, were reclassified to the services category on the consolidated statements of operations for all periods presented as these items are relatively insignificant.

Results of Operations
Executive Overview
Net revenues were $24.2 million for the second quarter of 2009, a decrease of $11.3 million or 31.8% from $35.5 million in the second quarter of 2008. The year over year revenue decline is due to a decline in transaction volumes primarily in Thorough QTc and to a lesser extent routine studies, lower revenue from acquired backlog of Covance Cardiac Safety Services, Inc. (CCSS) as this backlog nears completion and lower equipment sales in the second quarter of 2009 than in the second quarter of 2008 as more customers chose to rent cardiac safety equipment.
Gross margin percentage in the second quarter of 2009 was 52.3% compared to 57.0% in the second quarter of 2008. Gross margin percentage is significantly impacted by volume. The negative impacts of volume on the gross margin percentage compared to the prior year's quarter was partially offset by the elimination of legacy costs associated with processing the CCSS backlog during the period we integrated the CCSS operations and lower depreciation and amortization.
Operating income for the second quarter of 2009 was $4.8 million or 20.0% of total net revenues compared to $10.8 million or 30.3% of total net revenues in the second quarter of 2008. Total expenses were $19.3 million in the second quarter of 2009, a decrease of $5.4 million from $24.7 million in the second quarter of 2008. Our effective income tax rate for the second quarter of 2009 was 42.5% compared to 39.5% in the second quarter of 2008.
Net income for the second quarter of 2009 was $2.5 million, or $0.05 per share, compared to $6.7 million, or $0.13 per share in the second quarter of 2008. Commencing in the fourth quarter of 2008, general business and economic conditions have deteriorated globally. Starting in the fourth quarter of 2008, we experienced an increased focus in Phase III opportunities, a decline in the number of Thorough QTc bookings, and a delay in starts for certain Thorough QTc trials, and we believe these trends will continue through fiscal 2009. We believe the increase in Phase III opportunities will provide us with a base of business into the future; however, this business will take longer to turn into revenue. We believe that the delays in Thorough QTc trials are related to timing as the result of the uncertain economic environment, especially in small to midsize customers. Thorough QTc trials are generally required to be performed due to regulatory guidance; however, the timing of when these trials are done is discretionary.
We also experienced an increase in awards of new and expanded exclusive or near-exclusive long-term enterprise relationships with large pharmaceutical companies during the latter portion of fiscal 2008 and also continuing into 2009, including several with whom we had very little business in the past. In exchange for these long-term enterprise relationships with large pharmaceutical companies, which are targeted to generate larger volumes of business, we have made selective pricing concessions which we believe will have the effect of lowering overall average transaction pricing in the future as studies performed under these agreements become active and generate revenue. However, we have also recently implemented certain cost reductions to realign our cost structure, which may offset the impact on our gross margin percentage of any pricing reduction. Overall, we believe the fundamental drivers of our core business remain positive. However, a continued weakened global economy could have a negative impact on future results of operations.

The following table presents certain financial data as a percentage of total net revenues:

                                          Three Months Ended June 30,            Six Months Ended June 30,
                                           2008                2009               2008               2009

Net revenues:
EDC licenses and services                        4.2 %               4.5 %             4.0 %              5.2 %
Services                                        75.4 %              67.1 %            74.3 %             67.4 %
Site support                                    20.4 %              28.4 %            21.7 %             27.4 %

Total net revenues                             100.0 %             100.0 %           100.0 %            100.0 %

Costs of revenues:
Cost of EDC licenses and services                1.3 %               1.6 %             1.3 %              1.8 %
Cost of services                                28.7 %              31.7 %            29.6 %             32.0 %
Cost of site support                            13.0 %              14.4 %            14.3 %             14.8 %

Total costs of revenues                         43.0 %              47.7 %            45.2 %             48.6 %

Gross margin                                    57.0 %              52.3 %            54.8 %             51.4 %

Operating expenses:
Selling and marketing                           10.7 %              13.6 %            10.3 %             14.0 %
General and administrative                      13.0 %              14.6 %            13.7 %             15.8 %
Research and development                         3.0 %               4.1 %             3.0 %              4.5 %

Total operating expenses                        26.7 %              32.3 %            27.0 %             34.3 %

Operating income                                30.3 %              20.0 %            27.8 %             17.1 %
Other income (expense), net                      0.7 %              -1.7 %             1.0 %             -0.7 %

Income before income taxes                      31.0 %              18.3 %            28.8 %             16.4 %
Income tax provision                            12.2 %               7.8 %            10.9 %              6.8 %

Net income                                      18.8 %              10.5 %            17.9 %              9.6 %

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2009. The following table presents our consolidated statements of operations with product line detail (dollars in thousands):

                                           Three Months Ended June 30,
                                            2008                 2009              Increase (Decrease)
EDC licenses and services:
Net revenues                           $        1,487       $        1,083      $      (404 )        (27.2 %)
Costs of revenues                                 468                  397              (71 )        (15.2 %)

Gross margin                           $        1,019       $          686      $      (333 )        (32.7 %)

Services:
Net revenues                           $       26,763       $       16,215      $   (10,548 )        (39.4 %)
Costs of revenues                              10,185                7,671           (2,514 )        (24.7 %)

Gross margin                           $       16,578       $        8,544      $    (8,034 )        (48.5 %)

Site support:
Net revenues                           $        7,222       $        6,878      $      (344 )         (4.8 %)
Costs of revenues                               4,599                3,470           (1,129 )        (24.5 %)

Gross margin                           $        2,623       $        3,408      $       785           29.9 %

Total
Net revenues                           $       35,472       $       24,176      $   (11,296 )        (31.8 %)
Costs of revenues                              15,252               11,538           (3,714 )        (24.4 %)

Gross margin                                   20,220               12,638           (7,582 )        (37.5 %)


Operating expenses:
Selling and marketing                           3,810                3,274             (536 )        (14.1 %)
General and administrative                      4,601                3,527           (1,074 )        (23.3 %)
Research and development                        1,051                  993              (58 )         (5.5 %)

Total operating expenses                        9,462                7,794           (1,668 )        (17.6 %)

Operating income                               10,758                4,844           (5,914 )        (55.0 %)
Other income (expense), net                       244                 (409 )           (653 )       (267.6 %)

Income before income taxes                     11,002                4,435           (6,567 )        (59.7 %)
Income tax provision                            4,342                1,887           (2,455 )        (56.5 %)

Net income                             $        6,660       $        2,548      $    (4,112 )        (61.7 %)

The following table presents costs of revenues as a percentage of related net revenues and operating expenses as a percentage of total net revenues:

                                         Three Months Ended June 30,          Increase
                                         2008                  2009          (Decrease)
 Cost of EDC licenses and services            31.5 %                36.7 %           5.2 %
 Cost of services                             38.1 %                47.3 %           9.2 %
 Cost of site support                         63.7 %                50.5 %         (13.2 %)
 Total costs of revenues                      43.0 %                47.7 %           4.7 %

 Operating expenses:
 Selling and marketing                        10.7 %                13.6 %           2.9 %
 General and administrative                   13.0 %                14.6 %           1.6 %
 Research and development                      3.0 %                 4.1 %           1.1 %

EDC
On June 23, 2009, we completed the sale of certain assets relating to our EDC operations. Under the terms of the transaction, OmniComm Systems, Inc. issued 8.1 million shares of common stock and assumed certain liabilities including deferred revenue relating to our EDC operations in exchange for our EDC assets which primarily included our EDC software, applications and fixed assets and $1.15 million in cash we paid. During the three months ended June 30, 2009, we recorded a gain on the sale of these assets of $0.5 million within general and administrative expenses in the consolidated statement of operations. The decrease in revenues and corresponding expenses for the three and six months ended June 30, 2009 as compared to the same periods ended June 30, 2008 were due to fewer one-time license sales in 2009 and termination of maintenance agreements.
Revenues
The decrease in services revenues was primarily due to an $8.4 million reduction in transactions performed in the three months ended June 30, 2009 as compared to the three months ended June 30, 2008. There was also a decrease in average revenue per transaction that was largely due to a heavier weighting of semi-automatic studies which carry lower transaction prices which resulted in a decrease in revenue of approximately $0.8 million. Project management fees, excluding reporting configuration revenue, decreased $0.8 million, consistent with the decreased Cardiac Safety activity.
Site support revenues decreased primarily due to a reduction in freight revenue due to decreased shipping activity consistent with the decreased Cardiac Safety activity.
Costs of Revenues
The decrease in the cost of services was primarily due to $2.1 million of costs recognized in the second quarter of 2008 associated with the CCSS operations. We completed the integration of the CCSS acquisition in the third quarter of 2008 with the complete transfer of all operating activities from the CCSS Reno facility into our operations in Philadelphia and Peterborough. Additionally, amortization of intangible assets decreased $0.3 million as result of certain assets becoming fully amortized and variable incentive compensation expense decreased $0.4 million due to reduced accruals based on operating results. Partially offsetting the decrease were increases in several areas including labor costs related to additional staff added in the second half of 2008 and market adjustments to salaries made in 2009, increased depreciation due to systems placed in service in 2009 and other expense increases. The increase in the cost of services as a percentage of service revenues reflects the fact that some of the costs do not necessarily change in direct relation with changes in revenue.
The decrease in the cost of site support, both in absolute terms and as a percentage of site support revenues, was primarily due to a $0.8 million decrease in depreciation expense as older, more expensive ECG equipment has become fully depreciated and a $0.2 million decrease in freight. Additional small decreases occurred in costs associated with the CCSS operations in 2008, labor and other expenses.
Operating Expenses
The decrease in selling and marketing expenses was due primarily to a $0.5 million decrease in incentive compensation consistent with lower levels of revenue. The increase in selling and marketing expenses as a percentage of total net revenues reflects the fact that the costs do not necessarily change in direct relation with changes in revenue.
The decrease in general and administrative expenses was due primarily to $0.9 million of costs recognized in the second quarter of 2008 resulting from including the administrative costs of CCSS in 2008 for which there were no corresponding costs in the second quarter of 2009. Additionally, variable incentive compensation expense decreased $0.4 million due to reduced accruals based on operating results and stock option compensation expense decreased $0.2 million. Partially offsetting these decreases were severance of $0.3 million in the second quarter of 2009 related to the relocation of our . . .