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MDSO > SEC Filings for MDSO > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for MEDIDATA SOLUTIONS, INC.

Form 10-Q for MEDIDATA SOLUTIONS, INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. Forward-looking statements reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results of operations, business and growth strategies, financing plans, expectations that regulatory developments or other matters will not have a material adverse effect on our business or financial condition, our competitive position and the effects of competition, the projected growth of the industry in which we operate, the benefits and synergies to be obtained from our completed and any future acquisitions, and statements of management's goals and objectives, and other similar expressions concerning matters that are not historical facts. Words such as "may," "should," "could," "would," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," "appears," "projects" and similar expressions, as well as statements in the future tense, identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or management's good faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Important factors that could cause such differences include, but are not limited to the factors discussed under the "Risk Factors" section included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission, or SEC, on March 13, 2012.
The following is a discussion and analysis of our financial condition and results of operations and should be read together with our condensed consolidated financial statements and related notes to condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Overview
We are a leading global provider of cloud-based drug development solutions that optimize the efficiency of our customers' clinical development processes from concept to conclusion, optimizing their research and development investments. Our customers are pharmaceutical, biotechnology and medical device companies, academic institutions, contract research organizations, or CROs, and other organizations engaged in clinical trials to bring medical products and treatments to market and explore new indications for existing medical products. Our solutions allow our customers to increase the value of their development programs by more efficiently and effectively designing, planning, and managing key aspects of the clinical trial process, including study and protocol design, trial planning and budgeting, site negotiation, clinical portal, trial management, randomization and trial supply management, clinical data capture and management, safety events capture, medical coding, clinical business analytics, and data flow and interoperability among multiple trial applications. Our customers rely on our solutions to safely accelerate the clinical development process, driving decision-making and saving resources in the development lifecycle.
The demand for electronic clinical solutions, such as those provided by us, has been driven by the increasing complexity and cost associated with paper-based trials and inefficiencies with early generation electronic data capture, or EDC, solutions. Paper-based trials may delay the clinical development process, impair data quality and prevent real-time decision making, while traditional EDC solutions have faced challenges with integration, site requirements, customization and scalability.
We have grown our revenues significantly since inception by expanding our customer base, increasing penetration with existing customers, selling multiple products under our clinical cloud-based platform, enhancing our products and services and growing our indirect channel. In order to achieve and sustain our growth objectives, we have invested and will continue to invest in key areas, including: new personnel, particularly in direct domestic and international sales activities; resources to support our product development, including new and expanded product capabilities; marketing programs to build brand awareness; and infrastructure to support growth.
We derive a majority of our application services revenues through multi-study arrangements for a pre-determined number of studies. We also offer our application services on a single-study basis that allows customers to use our solution for a limited number of studies or to evaluate it prior to committing to multi-study arrangements. We invest heavily in training our customers, their investigators and other third parties to configure clinical trials independently. We believe this knowledge transfer accelerates customer adoption of our solutions.
We use a number of metrics to evaluate and manage our business. These metrics include revenue growth, customer growth, customer retention rate, revenues from lost customers, geographic contribution, and application services backlog.

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Our customer base has grown from 148 at January 1, 2009 to 333 at September 30, 2012. Our relationships with some of these customers include multiple divisions and business units at various domestic and international locations. We generate revenues from sales to new customers as well as sales and renewals from our existing customers. Our global direct sales organization represents our primary source of sales, with an increasing volume of sales generated through our CRO relationships. Our customer retention rate was 94.2% and 94.1% for the nine months ended September 30, 2012 and 2011, respectively. We calculate customer retention based upon the number of customers that existed both at the beginning and end of the relevant period. Revenues from lost customers for the nine months ended September 30, 2012 and 2011 accounted for 0.8% and 4.2%, respectively, of total prior year revenues. To calculate the impact of customers lost during the period, we consider the revenues recognized from lost customers during the most recent prior fiscal year as a percentage of total company revenues from the same period. Traditionally, we maintain a high percentage of customer retention and hence the revenue impact from lost customers is insignificant to our total revenues. We believe revenues from lost customers coupled with customer retention rate give the best sense of volume and scale of customer loss and retention. Our presentation of customer retention and revenues from lost customers may differ from other companies in our industry.
We manage our business as one reportable segment. Historically, we have generated most of our revenues from sales to customers located in the United States. However, revenues generated from customers located in Europe and Asia (including Australia) represent a significant portion of overall revenues. Revenues generated from customers located in Europe represented approximately 19% and 20% of total revenues for the three months ended September 30, 2012 and 2011, respectively, and approximately 19% and 21% of total revenues for the nine months ended September 30, 2012 and 2011, respectively. Revenues generated from customers in Asia represented approximately 14% of total revenues for each of the three months ended September 30, 2012 and 2011, and approximately 15% and 14% of total revenues for the nine months ended September 30, 2012 and 2011, respectively. We expect sales from customers in Europe and Asia to continue to represent a significant portion of total sales as we continue to serve existing and new customers in these markets.
With our adoption of Accounting Standards Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements, on January 1, 2011, we recognize revenue from professional services as services are delivered for all arrangements entered into or materially modified subsequent to the date of adoption, while revenue recognition for professional services arrangements entered into prior to 2011 continues to be ratable over the term of the corresponding application services arrangement until such arrangements expire. Thus, over time we expect professional services to no longer contribute to total backlog or deferred revenue in a significant manner. Consequently, we now monitor application services backlog as an indicator of the underlying health of our business. Application services backlog solely relates to our cloud-based offerings, representing the total future contract value of outstanding multi-study and single-study arrangements, billed and unbilled, at a point in time. Application services revenues generated in any given period is a function of revenue recognized from the beginning of period application services backlog, contract renewals, and new customer contracts. For this reason, application services backlog at the beginning of any period is not necessarily indicative of long-term future performance. We monitor the amount of revenues expected to be recognized from application services backlog over the current fiscal year while updating application services backlog each quarter to indicate how much remains to be recognized within the year. As of January 1, 2012, we had full year application services backlog of approximately $135 million. The remaining amount of revenue to be recognized from application services backlog in the current year, or remaining application services backlog, as of September 30, 2012 is approximately $44 million.
We consider the global adoption of clinical development technologies to be essential to our future growth. Our future growth will also depend on our ability to sustain the high levels of customer satisfaction and our ability to increase sales to existing customers. In addition, the market for our products is often characterized by rapid technological change and evolving regulatory standards. Our future growth is dependent on the successful development and introduction of new products and enhancements. To address these challenges, we will continue to expand our direct and indirect sales channels in domestic and international markets, pursue research and development as well as acquisition opportunities to expand and enhance our product offerings, expand our marketing efforts, and drive customer adoption through our knowledge transfer professional services offerings. Our success in these areas will depend upon our abilities to execute on our operational plans, interpret and respond to customer and regulatory requirements, and retain key staff. Acquisition of Clinical Force
On July 1, 2011, we completed an acquisition of Clinical Force, a provider of clinical trial management systems, or CTMS. With this acquisition, we expanded our service offerings to include a clinical trial management solution, which enables our customers to reduce the financial and operational management burden of clinical trials, streamline clinical processes and increase visibility to timely information that enhances governance and decision making. The total consideration is expected to be $7.0 million consisting of a cash payment of $5.2 million paid at the closing date, plus additional performance-based earn-out payments of up to $2.6 million, which had an estimated fair value of $1.8 million as of the acquisition date. Clinical Force's

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operations have been included in our consolidated financial statements since the date of acquisition on July 1, 2011. We have combined Clinical Force into our single operating segment.

Sources of Revenues
We derive revenues from application services and professional services. Application services consist of multi-study or single-study arrangements, which give our customers the right to use our software solutions, hosting and site support, as well as clinical trial planning software solutions, which enable our customers to effectively manage their trial planning. Professional services consist of assisting our customers and partners with the design, workflow, implementation and management of their clinical trials.
Our application services are principally provided through multi-study arrangements, which grant customers the right to manage up to a predetermined number of clinical trials for a term generally ranging from three to five years, as well as single-study arrangements that allow customers to use application services for an individual study and/or to evaluate our application services prior to committing to multi-study arrangements. Many of our customers have migrated from single-study arrangements to multi-study arrangements and multi-study arrangements represent the majority of our application services revenues. We also offer other applications under our cloud-based platform that improve efficiencies for clinical trials from concept to conclusion. Our professional services provide our customers with reliable, repeatable and cost-effective implementation and training in the use of our application services. We also offer consulting services to advise customers on ways to optimize their clinical development process from trial concept to conclusion. Professional services revenues have represented a smaller portion of overall revenues in recent years. Over the long term, we expect professional services revenues to decline slightly as a percentage of total revenues as our customers and partners become more adept at the management and configuration of our technology for their clinical trials as part of our knowledge transfer efforts.

Cost of Revenues
Cost of revenues consists primarily of costs related to hosting, maintaining and supporting our application suite and delivering our professional services and support. These costs include salaries, benefits, bonuses and stock-based compensation for our data center and professional services staff. Cost of revenues also includes costs associated with our data center, including networking and related depreciation expense; as well as outside service provider costs, amortization expense and general overhead. We allocate general overhead, such as applicable shared rent and utilities, to cost of revenues based on relative headcount. The costs associated with providing professional services are recognized as such costs are incurred. Over the long term, we believe that cost of revenues as a percentage of total revenues will decrease.

Operating Costs and Expenses
Research and Development. Research and development expenses consist primarily of personnel and related expenses for our research and development staff, including salaries, benefits, bonuses and stock-based compensation, the cost of certain third-party service providers and allocated overhead. We have focused our research and development efforts on expanding the functionality and ease of use of our applications. We expect research and development costs to increase in absolute dollars in the future as we intend to release new features and functionality designed to maximize the efficiency and effectiveness of the clinical development process for our customers. Over the long term, we believe that research and development expenses as a percentage of total revenues will decline slightly.
Sales and Marketing. Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including salaries, benefits, bonuses and stock-based compensation, commissions, travel costs, and marketing and promotional events, corporate communications, advertising, other brand building and product marketing expenses and allocated overhead. Our sales and marketing expenses have increased in absolute dollars primarily due to our ongoing substantial investments in customer acquisition. We expect sales and marketing expenses to continue to increase in absolute dollars. Over the long term, we believe that sales and marketing expenses as a percentage of total revenues will decline slightly.
General and Administrative. General and administrative expenses consist primarily of personnel and related expenses for executive, legal, quality assurance, finance and human resource departments, including salaries, benefits, bonuses and stock-based compensation, professional fees, insurance premiums, allocated overhead and other corporate expenses. On an ongoing basis, we expect general and administrative expenses to increase modestly in absolute dollars as we continue to add administrative personnel and incur additional professional fees and other expenses resulting from continued growth and the compliance requirements of operating as a public company. Over the long term, we believe that general and administrative expenses as a percentage of total revenues will decrease.

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Income Tax Expense
Prior to the fourth quarter of 2011, we did not realize an income tax benefit for the majority of our net operating loss carryforwards and other net deferred tax assets as we had yet to determine that it was more likely than not that our future taxable income would be sufficient to utilize these tax benefits. As a result, we had provided a valuation allowance against the majority of our net deferred tax assets.
In the fourth quarter of 2011, we determined that, as a result of our evaluation of deferred tax asset recoverability against our estimated future taxable income, it was more likely than not that we will realize the benefit from the majority of our deferred tax assets. Consequently, we recorded a one-time benefit of approximately $19.0 million resulting from the reversal of the valuation allowance on the majority of our deferred tax assets.
We have U.S. Federal and state net operating loss carryforwards available to offset future taxable income, which do not fully expire until 2028 and are subject to limitations under Section 382 of the Internal Revenue Code, or
Section 382. With the reversal of the valuation allowance that occurred in the fourth quarter of 2011, we expect that our effective income tax rate will range from 38 to 42 percent in 2012. In addition, we expect our overall income tax expense to increase in absolute dollars.

Critical Accounting Policies
Our condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Our critical accounting policies, including the assumptions and judgments underlying them, require the application of significant judgment in the preparation of our financial statements, and as a result they are subject to a greater degree of uncertainty. In applying these policies, we use our judgment to determine the appropriate assumptions to be used in calculating estimates that affect the reported amounts of assets, liabilities, revenues and expenses. Estimates and assumptions are based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Accordingly, actual results could differ from those estimates. Our critical accounting policies consist of revenue recognition, stock-based compensation, goodwill and intangibles and income taxes, descriptions of which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. There have been no material changes to our critical accounting policies since December 31, 2011.

Results of Operations
We recognize revenues from application services arrangements ratably over the terms of these arrangements. As a result, a substantial majority of our application services revenues in each quarter are generated from arrangements entered into in prior periods. Consequently, an increase or a decrease in application services arrangements in a particular quarter may not significantly affect results of operations in that quarter.
Our typical practice is to sell application services and professional services in a multiple-element arrangement. In connection with our adoption of ASU No. 2009-13 on January 1, 2011, we began to recognize revenues from professional services as delivered for any multiple-element arrangements entered into or materially modified subsequent to 2011. Concurrently, as required by ASU No. 2009-13, we continue to recognize revenues from professional services ratably over the term of the multiple-element arrangements entered into prior to 2011 under the pre-amended Accounting Standards Codification, or ASC, 605-25, Revenue Recognition - Multiple-Element Arrangements, until such arrangements expire. As a result, professional services revenues for the three and nine months ended September 30, 2012 and 2011 consisted of revenues recognized under different revenue recognition policies as stated. Regardless of revenue recognition, we recognize expenses related to our professional services in the period in which the expenses are incurred.
As of the current year, we now expect professional services revenues and gross margins to be more reflective of the services delivered during each reporting period. The revenue impact of multiple-element arrangements entered into prior to 2011 continues to decline significantly as those arrangements expire and more professional services revenues are recognized on an as delivered basis.

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The following table sets forth our consolidated results of operations as a percentage of total revenues for the periods shown:

                                     Three Months Ended         Nine Months Ended
                                        September 30,             September 30,
                                      2012           2011         2012         2011
Revenues:
Application services                   78.7 %         77.6 %       77.6 %      79.0 %
Professional services                  21.3 %         22.4 %       22.4 %      21.0 %
Total revenues                        100.0 %        100.0 %      100.0 %     100.0 %
Cost of revenues:
Application services                   15.0 %         15.7 %       15.1 %      15.6 %
Professional services                  13.4 %         13.4 %       13.9 %      13.5 %
Total cost of revenues                 28.4 %         29.1 %       29.0 %      29.1 %
Gross profit                           71.6 %         70.9 %       71.0 %      70.9 %
Operating costs and expenses:
Research and development               20.1 %         15.8 %       19.9 %      15.7 %
Sales and marketing                    21.8 %         19.0 %       21.8 %      19.3 %
General and administrative             17.4 %         19.7 %       17.6 %      20.1 %
Total operating costs and expenses     59.3 %         54.5 %       59.3 %      55.1 %
Operating income                       12.3 %         16.4 %       11.7 %      15.8 %

Three Months Ended September 30, 2012 Compared with Three Months Ended

September 30, 2011
Revenues

                                      Three Months Ended September 30,
                              2012                    2011                 Change
                                    % of                    % of
                       Amount     Revenues     Amount     Revenues     Amount      %
                                            (Amount in thousands)
Revenues:
Application services  $ 43,973       78.7 %   $ 35,940       77.6 %   $ 8,033    22.4 %
Professional services   11,872       21.3 %     10,365       22.4 %     1,507    14.5 %
Total revenues        $ 55,845      100.0 %   $ 46,305      100.0 %   $ 9,540    20.6 %

Total revenues. Total revenues increased $9.5 million, or 20.6%, to $55.8 million for the three months ended September 30, 2012 from $46.3 million for the same period in 2011. The increase in revenues was primarily due to an $8.0 million increase in revenues from application services and a $1.5 million increase in revenues from professional services. During the third quarter of 2012, we added 24 new customers to reach a total of 333 customers as of September 30, 2012. At the start of the third quarter of 2012, we had approximately $80 million of 2012 remaining application services backlog. As of September 30, 2012, the total 2012 remaining application services backlog was approximately $44 million.
Application services revenues. Revenues from application services increased $8.0 million, or 22.4%, to $44.0 million for the three months ended September 30, 2012 from $36.0 million for the same period in 2011. The majority of the increase in application services revenues was derived from increased activity among our existing large customers and midmarket customers, primarily resulting from new studies and renewals. We also benefited from strong demand from both new and existing customers for multiple products. The revenues from products other than our principal offering, Medidata Rave, or non-Rave revenues, grew 142% compared with prior period. Revenues from new customers accounted for 43% of the total increase in application services revenues. Application services revenues also increased significantly from both international and domestic customers compared with the prior period. Revenues from customers based in North America and Asia grew 25% and 21%, respectively, whereas revenues from customers based in Europe grew 16%.

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Professional services revenues. Revenues from professional services increased $1.5 million, or 14.5%, to $11.9 million for the three months ended September 30, 2012 from $10.4 million for the same period in 2011. The increase in professional services revenues was due to high demand for servicing of new products as well as demand from our new customers. The majority of our professional services were recognized as delivered in current year as compared with the same period in prior year, following our adoption of ASU No. 2009-13 on January 1, 2011.

Cost of Revenues
                                       Three Months Ended September 30,
                               2012                    2011                 Change
                                     % of                    % of
                        Amount     Revenues     Amount     Revenues     Amount      %
                                             (Amount in thousands)
Cost of revenues:
Application services   $  8,402       15.0 %   $  7,279       15.7 %   $ 1,123    15.4 %
Professional services     7,497       13.4 %      6,224       13.4 %     1,273    20.5 %
Total cost of revenues $ 15,899       28.4 %   $ 13,503       29.1 %   $ 2,396    17.7 %

Total cost of revenues. Total cost of revenues increased $2.4 million, or 17.7%, to $15.9 million for the three months ended September 30, 2012 from $13.5 million for the same period in 2011.
Cost of application services revenues. Cost of application services revenues increased $1.1 million, or 15.4%, to $8.4 million for the three months ended September 30, 2012 from $7.3 million for the same period in 2011. The increase . . .

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