Phase Forward Incorporated Q3 2009 Earnings Call Transcript

| About: Phase Forward (PFWD)

Phase Forward Incorporated (PFWD) Q3 2009 Earnings Call October 29, 2009 5:00 PM ET

Executives

Timothy Dolan – ICR

Robert K. Weiler – Chairman of the Board, President & Chief Executive Officer

Christopher Menard – Chief Financial Officer, Senior Vice President, Chief Accounting Officer & Treasurer

Analysts

Steven F. Crowley – Craig-Hallum Capital

Bret Jones – Brean Murray, Carret & Co, LLC.

[John Krigger] – William Blair & Company

Richard Close – Jefferies & Company

Nabil Elshshai – Pacific Crest

Sean W. Wieland – Piper Jaffray

Richard Davis – Needham & Company

Raymond A. Myers – Emerging Growth Equities, Ltd

[Charles Berati] – Citigroup

Operator

Welcome to the Phase Forward Incorporated third quarter 2009 earnings conference call. At this time all participants are in listen only mode. Later, we will conduct a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Mr. Tim Dolan with ICR.

Timothy Dolan

Please note that various marks today consist of forward-looking statements for the purpose of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. These statements including management’s forecast of financial performance and management’s plans, objectives and strategies are subject to a variety of risks and uncertainties which could cause actual results to differ materially from those discussed today. These risks and uncertainties are contained in the company’s public filings with the Securities & Exchange Commission.

With that, let me turn it over to the CEO of Phase Forward Robert Weiler.

Robert K. Weiler

Thank you for joining us on the call to review our third quarter results. We are pleased that the combination of solid revenue growth and expense management led to non-GAAP operating income and EPS that were above our guidance for the quarter. We also made progress against our strategic growth objectives. We signed large commitment deals, a leading provider of information technology, consulting and business process outsourcing services selected InForm to manage large scale trials as part of their outsourcing services to a top 10 pharma and we continue to reinforce our leadership position with CROs in the EDC segment of our market.

We also expanded CRO relationships to include other components of our Integrated Clinical Research Suite or ICRS and we are encouraged by interest levels and early stage cross sale activity related to our end-to-end suite of solutions. Phase Forward has a unique combination of best of breed solutions and the industry’s broadest integrated clinical research suite. We are focused on capitalizing on our market leadership position to continue driving solid revenue growth, margin expansion and cash flow.

Now, let me talk you through a summary of our third quarter results and then I’ll take you through a few of the business highlights of the quarter. Total non-GAAP revenue came in at $53.9 million representing 25% year-over-year growth. From a profitability perspective, non-GAAP operating income of $7.1 million was well above the high end of our guidance leading to non-GAAP EPS of $0.11.

I am very pleased with the company’s level of execution during the quarter. In addition to bringing the most significant new release of our EDC solution InForm GTM to market our teams are working hard to quickly and effectively integrate our recent acquisition. As we pointed out on last quarters’ call we feel very good about the current makeup of our integrated clinical research suite after filling in a major missing pieces with disruptive technology in the ePRO and late stage areas.

The focus now is integrating and educating customers on Phase Forward’s expanded value proposition and the ability to lower total cost of ownership through a single supplier relationship. We believe this will enable Phase Forward to capitalize on a market opportunity that we have effectively doubled over the past year. EDC continues to be the largest contributor among our ICRS components and our momentum in the market place continues to be strong. At the end of the third quarter we had over 1,000 live EDC clinical trials being managed within our datacenter representing a milestone for the company.

During the third quarter the market response related to our InForm GTM solution was extremely favorable. There has been a paradigm shift in userability requirements whereby longer and more complex trials are being managed by more sophistication and knowledgeable EDC users. InForm GTM is the result of over two years of comprehensive customer research and testing and we believe it’s redesigned user interface and enhanced global trail management capabilities are unique in its ability to meet end user requirements.

There are a number of noteworthy EDC wins during the third quarter where customers will take advantage of the enhanced capabilities of our InForm GTM offering. For example, we signed a multiyear commitment with Allergan. They are one of the top 40 pharmaceutical companies in the world and this multimillion dollar signing represents one of the largest transactions that Phase Forward has signed during 2009.

We also signed a commitment deal with Takeda Pharmaceuticals which builds on Phase Forward’s strong momentum in the Asia Pacific region and local market reception of InForm GTM. We are also very pleased to have signed sets of large trials with Cognizant Technology Solutions which is among the largest IT service providers in the world and a recognized industry leader with global service delivery model.

There are a couple of aspects of this relationship that are noteworthy. First, the trials that we were selected for are large, complex and global in nature. We believe that Cognizant chose to work with us over the competition because of our unique ability to support trials with such characteristics from both the technology and scalability of our architecture perspective as well as from an overall service delivery perspective. Secondly, our selection demonstrates our ability to work with pharmaceutical companies either on a direct basis or through one of the growing number of third party service providers that have selected Phase Forward as an important component of their overall value proposition.

We have spent considerable time, effort and resources in building close relationships with service providers the success of our efforts can be seen in the fact that during the third quarter our CRO related non-GAAP revenue of $12.3 million grew 44% on a year-over-year basis. During the third quarter a number of CRO partners made sizeable commitments with Phase Forward including PAREXEL, INC Research, PharmaNet, Covance who is standardized on Phase Forward as a preferred EDC and IRT solutions provider and SGS who recently signed an agreement related to Phase Forward’s EDC, IRT and ePRO solutions. In addition, PRA recently selected Phase Forward’s OutcomeLogix solution as a preferred late stage solution provider.

We believe the trend towards more outsourcing by life science companies will increase and our robust relationships with CROs and IT service providers strengthens our position in the market. From an overall perspective, we continue to be very encouraged by the interest level associated with the solutions that we have recently acquired. Our IRT offerings are enjoying particularly strong momentum driven primarily by our Clarix offering.

In addition to closing strong order flow on a standalone basis and benefitting from the continuing support of Covance, our largest IRT channel partner, we also had combined InForm Clarix orders from companies such as OncoGenex and [Long RX] during the quarter. In addition, we see many InForm customers on either commitment or enterprise contracts moving forward with or evaluating Clarix for ASP.

We are already realizing the benefits of our expanded product portfolio even though we are at the early stages of integrating these solutions and bringing them to market. In fact, it was just last week that we announced for immediately availability Phase Forward IRT 5.0 which provides seamless data and workflow integration between our IRT and EDC solutions including the ability for users to see both solutions in their local language.

IRT 5.0 provides major functional userabilty enhance such as smart system intelligence for proactive trial supply management and response to fluctuations in trial subjects. A new integrated drug forecasting module and a new enhanced user interface to streamline navigation and consolidate work flow. We’ll be demonstrating this integrated solution at our upcoming international user conference next week.

As it relates to other components of our integrated clinical research suite, we signed business with Clinical Data, Theravance and Cardio DX related to our Waban statistical computing environment and data repository. In the area of safety analysis, we signed a multimillion dollar agreement with the Department of Defense related to the Army’s pharmacovigilance center project. In addition to multiple sizeable agreements with the FDA related to our Empirica Signal and WebSDM solutions.

This is a significant win that further validates the strength of Phase Forward’s technology as the most important inaudible] in the United States for pharmaceutical companies continue to relay on Phase Forward to receive, validate and review data submitted in CDISC STDM standard. In addition, we recently announced the release of a free download CDIS adopters, our defined validator tool which was developed under the corporate R&D agreement for the FDA. This is part of our effort to help drive widespread adoption of standards in order to make the submission process smoother for life science companies as well as the FDA.

Moreover, the FDA also signed on for Phase Forward’s Empirica Study solution during the third quarter in order to proactively analyze safety data as part of the development and submission process. We believe this could lead to further pressure on pharmaceutical companies to increase their level of safety analysis throughout the clinical trial lifecycle which would be a positive for vendors such as Phase Forward. In addition, this win is another example of the value of providing a full suite of safety applications to support safety management throughout the product life cycle which supports our suite strategy and increases our opportunity for cross selling solutions.

From a summary perspective, we are pleased with the company’s performance in the third quarter. We made solid progress executing on the integration of our recent acquisitions, we were selected for important wins in the EDC segment of the market, we made progress selling combined ICRS offerings in the quarter and customer and partner feedback relative to our ICS research suite strategy continues to be very positive. We believe we can win on a point solution basis in any individual category and our continued investment in R&D and recent major releases are extending our advantages.

That said, we believe that customers will ultimately look for a single vendor to solve their ICRS needs in order to lower their total cost of ownership and minimize the portion of their IT budget that must be dedicated to maintenance, integration of multiple systems provided by multiple vendors. We believe Phase Forward is in the strongest position to take advantage of this movement based on our unique product capabilities, leadership position with CROs and current market share leadership position.

With that, let me turn the call over to Chris to review our financials in more details.

Christopher Menard

Now let me provide some further detail on the third quarter financial statements and then I will close with our fourth quarter and full year 2009 guidance. We will then open the call to Q&A. we will review our numbers on both a GAAP and non-GAAP basis. A reconciliation between GAAP and non-GAAP results is contained in our earnings release which is posted on our website at www.PhaseForward.com under the investors link. Our non-GAAP results exclude non-GAAP expenses associated with FAS123R, the amortization of intangibles associated with acquisitions, the write down of deferred revenue and backlog associated with certain acquisitions and restructuring expenses.

Beginning with the P&L; GAAP revenues for the third quarter of 2009 were $53.1 million an increase of 24% year-over-year. Non-GAAP revenues were $53.9 million excluding the $802,000 purchase accounting adjustment to the fair value of the deferred revenues and backlog of Clarix and Waban. This was consistent with our guidance and represented a year-over-year increase of 25%. Within total revenue, electronic data capture, license, application hosting and other related revenues were $38.5 million representing 71% of the total non-GAAP revenue an increasing 18% on a year-over-year basis.

In addition ,on a year-to-date basis, our EDC related revenue has grown 22% against the comparable year ago period. The combined non-GAAP revenue contribution related to the Maaguzi and Covance IRT business unit acquisitions was in line with our expectations entering the quarter while non-GAAP revenue related to our IRT solutions came in at $4.1 million. This compares to $2.9 million in the previous quarter with a sequential improvement driven by a combination of continued growth from our Clarix IRT product offering as well as the partial quarter contribution related to Covance’s IRT offering which we acquired in August.

Non-GAAP gross margin was 57.7% in the third quarter of 2009 compared to 58.9% in the same period a year ago and 60.6% in Q2 of 2009. Our services margin was 42% in the third quarter compared to 43% a year ago and 47% last quarter. The decline in both the overall and services gross margin is the result of dilutive impacts from the recent acquisitions as discussed last quarter. We expect gross margins to expand back to the approximate range of recent quarters over the course of 2010.

From an operating expense perspective total non-GAAP expenses in Q3 were $24 million leading to non-GAAP income from operations for the third quarter of $7.1 million. This was above our guidance of $5.5 to $6.2 million and represented a non-GAAP operating margin of 13.2%. Interest income of $331,000 was down from $1.5 million in the year ago quarter and $500,000 last quarter resulting from a decline in both interest rates and our cash balance. Our non-GAAP tax rate was 36% in the third quarter leading to a non-GAAP net income of $4.8 million or $0.11 diluted earnings per share which was above our guidance of $0.09 to $0.10. Looking at our third quarter results on a GAAP basis, GAAP net income was $1.8 million or $0.04 per diluted share compared to $0.08 diluted earnings per share in the same quarter of 2008.

Moving to the balance sheet, total cash, cash equivalents and investments were $147.2 million at the end of the third quarter, a decrease from $168.7 million at the end of the prior quarter. The decrease in cash was due primarily to the use of $21 million for the acquisitions of Maaguzi and the Covance IRT business unit.

At the end of the quarter our accounts receivable balance was $60.4 million, an increase from $40.5 million at the end of the prior quarter. This resulted in DSOs of 103 days compared to 69 days last quarter. A number of factors resulted in the increase in DSOs. First, our quarter end AR balance included approximately $3 million or five days of our DSOs from receivables related to the Covance business unit and Maaguzi acquisitions. Second, we received a significant amount of cash collections on the first day of the fourth quarter which represented approximately 11 days of our DSO. Finally, we upgraded our financial systems to ORACLE financial in the third quarter which impacted the timing of invoicing and collections. We anticipate DSOs will return to normal levels in the fourth quarter which have historically been between 70 and 80 days.

Total deferred revenue was $103.6 million at the end of the quarter, a sizeable increase compared to $91.1 million at the end of the prior quarter. Deferred revenue would have experienced a solid sequential increase on an organic basis during the third quarter and it was aided by $3.4 million related to balances from the recent acquisitions. With that, let me turn to guidance.

The following statements are based on our expectations as of today and we assume no further obligation to update or confirm them. As a reminder, our non-GAAP references exclude the amortization of intangibles associated with acquisitions, deferred revenue and backlog write downs associated with certain acquisitions, FAS 123R stock-based compensation expense and restructuring expenses.

Turning to our expectations for the fourth quarter, we expect non-GAAP revenues of between $58 and $59.5 million. We anticipate gross margins will be between 56.5% and 57.5% and services margins to be between 42% and 43%. We expect non-GAAP operating income to be between $8.2 and $8.9 million or a non-GAAP operating margin of between 14% and 15% for the quarter. Non-GAAP EPS is expected to be between $0.12 and $0.13. We expect GAAP revenues to be between $57.5 and $59 million. GAAP EPS is expected to be between $0.05 and $0.06 which includes stock-based compensation expense of approximately $3.7 million and amortization expense of approximately $1.1 million.

As a result of our third quarter actual performance and fourth quarter guidance, our updated annual guidance is as follows. We are narrowing our total non-GAAP revenue guidance to be between $215 and $216.5 million. On a GAAP basis 2009 revenues including the write down of deferred revenues and backlog from our acquisitions are expected to be between $212 and $213.5 million. We expect non-GAAP operating income to be between $33 and $33.7 million. Finally, on a non-GAAP basis we are increasing full year EPS guidance to be between $0.50 and $0.51. We expect full year GAAP EPS to be between $0.23 and $0.24.

In summary, the third quarter was a strong financial performance and we are pleased with the better than expected profitability the company generated in the quarter. Even more important are the strides we are making to further differentiate the company and establish Phase Forward as the clear leader of the ICRS market which we believe is multibillion market opportunity. With that, we will begin the Q&A portion of the call. So we can try to get to each analyst before time expires, we ask that you please limit yourself to one question and a brief follow up if desired. We appreciate your efforts in this regard.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven F. Crowley – Craig-Hallum Capital.

Steven F. Crowley – Craig-Hallum Capital

I may have been a little crossed up or there may have been a timing difference that added or that altered the deferred revenue add back in the quarter. I’m looking at your performance in the quarter relative to my estimates and you were actually stronger than our top line estimate by a bit in GAAP revenues but a little bit under in non-GAAP revenues and the variance was obviously that add back. Was there any timing differences with the closing of the Covance deal or any other factors that affected that add back?

Christopher Menard

It’s not so much the timing. As you know when you go to do the reduction between GAAP and non-GAAP you do things like go out and get an appraisal and you verify the backlog and make sure things are being set at appropriate margins and we had probably misestimated a little bit the amount of haircut from Maaguzi and Covance.

Steven F. Crowley – Craig-Hallum Capital

So it was really a bookkeeping adjustment there that caused that variance?

Christopher Menard

Yes, as you go through the appraisal process but our GAAP revenues were pretty much in line in Q3 to what we had guided at the start of the quarter.

Steven F. Crowley – Craig-Hallum Capital

Now, a question for you Bob, you highlighted the success you had with a leading provider of information technology consulting and business processing outsourcing. You implied in the press release that their efforts with you were targeted at a particular top 10 pharmaceutical customer, I believe a particular customer. Do you envision getting a substantial portion of their business with that customer or that customer group, a majority of the business? Help us understand what you have in motion with those guys please?

Robert K. Weiler

Essentially we find a number of trials with them and they were all of a very large scalable nature and we signed them, we’re building them, we’re implementing them and I think as our performance against those trials get stronger, I would hope, but, I have no indication so I’m not going to mislead, I have no indication of them getting all the trials or staying with multiple trials. The factor is they looked at our GTM product, they liked it, they liked the architecture, they like the scale and wanted to go our direction. But, I cannot imply all trials or any percentage.

Steven F. Crowley – Craig-Hallum Capital

Was it geared towards one particular customer or is it a group of customers?

Robert K. Weiler

One particular customer.

Operator

Your next question comes from Bret Jones – Brean Murray, Carret & Co, LLC.

Bret Jones – Brean Murray, Carret & Co, LLC.

I was wondering on the margin compression side or I was expecting more margin compression I should say from Covance and Maaguzi and maybe this is related to the answer on the deferred revenue add back, was there anything going on in that number as far as service margins that were not impacted as much as you had expected from the Covance acquisition or was the profitability of the core business better than expected?

Christopher Menard

It was actually a combination of both. Some of the transition fees that we had anticipated for both Covance and Maaguzi, they came in less than we expected on the cost of goods sold line and the core business, the margins were actually slightly higher than I would have anticipated at the start of the quarter.

Bret Jones – Brean Murray, Carret & Co, LLC.

Was there anything unusual going on there as far as cancellation rates or anything like that?

Christopher Menard

No, we actually had less cancellation related revenue in Q3 than we did in Q2.

Bret Jones – Brean Murray, Carret & Co, LLC.

Then kind of a tagalong on that, the slowdown that we saw in pre-clinical and I’m talking mainly in the industry as a whole, pre-clinical in Phase I hasn’t really had much of an effect on your business but I would think eventually that has to flow through to lower Phase II trial starts and eventually Phase III. Is that a safe assumption and when would you expect that to really sort of impact you?

Robert K. Weiler

It’s a safe assumption but it is really out in the future. When you look at the process for pre-clinical, you’re talking anywhere between seven and nine years as these things go down the stream. So, we really don’t see any impact. We started hearing about pre-clinical dropping and Phase I’s dropping 18 months ago, we still haven’t seen that so my guess is the way our cycle works, by the time the pharmaceuticals get around to restoring Phase Is and pre-clinical business comes back on track that we will never even see the dip or the boost. It’s kind of even for us in IIs and IIIs and late phase.

Operator

Your next question comes from [John Krigger] – William Blair & Company.

[John Krigger] – William Blair & Company.

Can you just dissect the 5% non-GAAP revenue growth that you had? Give us a sense of how much of that was organic versus contributed by acquisitions in the past year?

Christopher Menard

First I’ll break it down in to different categories for you and take it from there. First we were 28% license revenue, 57% ASP, 9% consulting and 6% support. To further break that down IRT made up 8% of our revenues, [EBMS] was 11%, safety was 10% and EDC was 71%. Within the IRT line which was $4.1 million of total revenue for the quarter approximately $700,000 of that revenue came from Covance’s legacy product so Clarix still would have grown by about 15% or 17% quarter-over-quarter with just a traditional Clarix offering. Maaguzi made up a couple hundred thousand of revenue within the quarter, it’s approximately $300,000, that’s sitting in EDC. Then, Waban which is part of CDMS is consistent with what we saw last quarter, it’s a little over $600,000.

Robert K. Weiler

We just did a series of acquisitions and I don’t want to set the expectation that we’ll be going through that detailed product breakout in the future. As our customers are starting to buy and as we’re seeing the blend of products and start times that’s going to be getting to be a difficult breakout. We recognize the need to do it coming right off these acquisitions but obviously in the future we’ll only be reporting on the categories that we have.

[John Krigger] – William Blair & Company.

As you go back to your core clients with this broader product suite and functionality, are you finding their willingness to kind of put those new products in to the same preferred status that your EDC product has or not necessarily?

Robert K. Weiler

Not necessarily. What we’re seeing, you know I’d love to say that our customers embrace everything we do and just do it blindly but our customers are intelligent and they want to take the products in, they want to try a few trials with it or they want to work with the product. What is encouraging is that they immediately see the benefit of the ICRS. I cannot overstate how excited I am about how the customers are seeing what the solution can provide.

So now, what the process is, is that many of these customers are buying or doing one or two trials with IRT or looking at Maaguzi or trying to figure out how to pull it all together with Waban and that’s the process we’re in. We’re very, very excited about the opportunities for that.

[John Krigger] – William Blair & Company.

A quick follow up for Chris and I’ll shut up, Chris you mentioned that you hadn’t seen cancellations increase, in fact they went down sequentially, what about delays? Are you seeing the start up time change at all with some of your newer projects?

Christopher Menard

No. In terms of the ASP trials we’re running roughly the same duration between signing and go live that we’ve over the last couple of quarters.

Robert K. Weiler

Something I want to point out however, we did have a number of customers, particularly new customers that bought multiple products right out of the box. Maybe they were buying their first InForm trial and they bought multiple products with it coming out of the box because of the integration. I was answering the conversation about our existing enterprise and ASP customers trying products and putting them forward but a number of new customers bought them, bought multiple products at the same time and embraced the whole concept.

Operator

Your next question comes from Richard Close – Jefferies & Company.

Richard Close – Jefferies & Company

Bob, I was wondering if you could give us a little bit more information on Takeda, that transaction, how that came about and what exactly are you signed up to do there?

Robert K. Weiler

It is essentially a straightforward InForm commitment deal where they’ve signed up with a large commitment to perform a number of trails using InForm. As with all deals, they are competitive and the selection process has been going on for a while. I would believe that the turning point for us in the sales cycle was our InForm GTM release that had the new user interface and global capabilities that gave us a competitive advantage.

Richard Close – Jefferies & Company

Is this you’re the sole source of EDC for them on a go forward basis?

Robert K. Weiler

They have not made that statement.

Richard Close – Jefferies & Company

Is Cognizant the business processor outsourcer you’re talking about?

Robert K. Weiler

Yes.

Richard Close – Jefferies & Company

Then on the CROs and the 44% growth that you mentioned, you gave a couple of examples of additional business and you mentioned one I did not catch, I apologize, about IRT, EDC and ePRO and if you could go in to a little more detail on how that purchase was made? Was that one of those purchases everything made at once or maybe just a little bit more detail on those lines?

Robert K. Weiler

Well we had SGS in there, that might have been the one you missed which was a commitment for InForm, IRT and Maaguzi, our late phase outcomes product. So essentially what they did is they made a commitment for all of those products so they can start providing the integrated solution to their customers. PRA, that has been using us somewhat for InForm but has been spreading it around signed a preferred relationship with us for our outcome technologies. INC that had been pretty much be using some competitors has signed up now with a commitment for a relationship for InForm as well.

It’s pretty much across the board. Many of the CROs that we have are also looking at our other products so they can in turn offer an integrated solution because they see the benefits of it as well.

Richard Close – Jefferies & Company

Are the CROs more I guess apt to buy multiple products? Do they understand it better than the pharma companies now? What you’re doing, the value proposition that the integration has? I guess I’m trying to understand are they going to be the faster up take of your complete broad solution?

Robert K. Weiler

I think some of them, particularly the larger ones will be. If you remember what they are selling to their customers is more productivity, faster cycle times and lower cost of ownership. That is their pitch. What they are pitching, many of them, they are pitching a full service solution so essentially they are pitching the same integrated strategy around a full service solution. If you look at the leaders in this space, they are recognizing that that same criteria is necessary for the technology they provide and are embracing it so they can the same benefits themselves to pass that on to their customers so they can provide better service and be price competitive.

The CROs which I always say have to make the tougher decisions because it’s really, really their business, are really leading the curve I think on understanding the integrated solution. That’s not to say the other companies are seeing it but the CROs will move faster to bring it to market I think than the large sponsors.

Operator

Your next question comes from Nabil Elshshai – Pacific Crest.

Nabil Elshshai – Pacific Crest

Actually to step back, I think we hit around this a little bit earlier but what have you seen in terms of trends just in overall trial starts? There’s been a lot of noise over the last year and a half on declines in Phase II and III. Are you seeing an uptick in that side and just regular trial starts?

Robert K. Weiler

We’re not seeing an uptick yet. It’s been kind of still variable and volatile. As Chris mentioned, our revenues on cancellations were down, that’s good. We’re hearing more biotech companies even though it’s not a big part of our business because most of that comes through the CROs, we’re hearing more about the funding is freeing up so they’re showing plans for 2010 starting trials so maybe that’s an uptick there, that’s more of tailwind that we’re seeing in the future.

We’re getting feedback from the CRO market that while some are performing well in late phase and some are kind of getting big cancellations that there’s this bolus of a backlog that sometime in 2010 I think uniformly they all agree that is going to start hitting the market. They all have large, large backlogs, they all have commitments from these companies and they are looking at capacity and looking to us for what they see in 2010 as an acceleration. That’s kind of an anecdotal point for what we’re seeing in the market.

Nabil Elshshai – Pacific Crest

Real quick on Covance, since they selected you as the preferred partner, is that something that takes a while for them to kind of roll out to their organization and have an impact on new trial starts going to you guys or are you seeing an impact over this last quarter?

Robert K. Weiler

We didn’t last quarter so we expect to see the impact to take hold pretty much in the fourth quarter and going forward. It won’t be a six month process.

Operator

Your next question comes from Sean W. Wieland – Piper Jaffray.

Sean W. Wieland – Piper Jaffray

My question is on the SG&A leverage that you saw, exactly where did that come from and how sustainable is that?

Christopher Menard

Sean it didn’t move a whole lot we were $7.6 million of non-GAAP expense in Q2 and $7.6 million again in Q3 so it stayed around that 14.2% to 14.3%. Long term I think we do have leverage in G&A as we go in to next year, there’s not a lot of infrastructure we need to do as we continue to scale. The team is pretty much built out. I think if you take a look at last year we averaged out at about 13.2% for all 2008 and I would expect we can get back to those levels in the future.

Sean W. Wieland – Piper Jaffray

A follow up to something Bob that you said earlier, could you quantify the percentage of your revenues that are coming in that are for lack of a better word combo deals?

Christopher Menard

In terms of the attach rate which is what I think you’re going for, we’re working on ways to measure it for you. What I can tell you is we’re seeing especially in regards to Clarix because that’s the one we owned for the longest amount of time at this point we’re seeing people purchase Clarix who are InForm customers who are enterprise adoption customers and that’s important because it’s hard to measure the attaché rate for that because the enterprise adoption InForm customer already has InForm and they’ve taken it in house. That means you don’t see an incremental InForm purchase at that time because they’ve already made the InForm purchase. We think that is very significant that some of the existing InForm customers are starting to take Clarix in house.

In addition, some of our ASP customers who have existing commitments are also starting to purchase Clarix and it’s being put inside of those commitments. Again, you might not see an incremental order but people are using that technology within their commitments. Then finally we did see, and Bob mentioned a couple of the customers, people buying both InForm and Clarix at the same time when they buy the full turnkey ASP studies which are customers like [Long RX] and [inaudible].

To go back to your G&A question, one of the reasons why you saw G&A go up a little bit in the middle of the year, remember under the new accounting rules, all the M&A expenses now go through the P&L and we’re running them through G&A which is one of the reasons why you’ve seen it go up a little bit in recent quarters.

Operator

Your next question comes from Richard Davis – Needham & Company.

Richard Davis – Needham & Company

I may have missed it but did you guys say how much your kind of average deal size has increased compare to last year due to the fact that you have a broader collection of functions that you can now bring to bear when you’re pitching a new client and even kind of the order of magnitude would be helpful because presumably that’s why you had a nice broad suite to pitch people there. That would be the first question I’d have.

Christopher Menard

You didn’t miss it, we didn’t say it. Our typical EDC studies are still running approximately $450,000 when they’re sold standalone and a typical Clarix study is in the range of about $200,000.

Richard Davis – Needham & Company

Have you found that with a suite sale, does the purchase decision have they started to migrate higher up in the organization even to the C suite or have you been able and it can be positive or negative, but has it stayed at the same managerial level inside the customer organization? What’s kind of the motion with regard to if I were a salesman for you guys where would I be selling in to?

Robert K. Weiler

That’s our biggest challenge Richard because we’re pitching it and then we have get our sponsors and advocate to see the value of that and have them help us move up. You just can’t call in above and say, “Hey we’ve got this great new solution.” But, once we get an advocate at whatever point product whether it be the IRT side or the late stage side and we’re able to pitch our story then what is happening is they say, “Oh, we have to have a follow up meeting with the next level up,” and then we schedule that out.

We aren’t kind of just calling up and being able to tell the story at the C level but like in past categories you have to kind of get a sponsor to move you up from the point product. The key is we are getting a point product solution sale, we’re still in selling point products, still competing head-to-head. While we’re competing head-to-head we then introduce the other products and try and move up and then that’s cumulating now in many of the larger, and why I am optimistic is that those meetings of this high level strategy particularly now with Waban – Waban is really driving us up much higher in the organization maybe than all the other products are.

Operator

Your next question comes from Raymond A. Myers – Emerging Growth Equities, Ltd.

Raymond A. Myers – Emerging Growth Equities, Ltd

The first one is for Chris, what was the M&A expense in the third quarter?

Christopher Menard

I think it’s about $300,000.

Raymond A. Myers – Emerging Growth Equities, Ltd

Second question, why did accounts receivable increase $19 million? You mentioned that there was 11 days of DSO you received in the fourth quarter already but $19 million is a big increase in receivables.

Christopher Menard

It’s three factors, the first factor is the accounts receivable balance was $3 million higher just because of the acquisitions of Covance and Maaguzi so that’s the AR that we acquired from them. So, as the business gets a little bit bigger the accounts receivable balance is going to go up. We did collect about 11 days worth of DSOs on the very first day of October so we think we had some customers who were managing their balance sheets and those payments were wired through on the first day of the quarter.

Then the third reason is we switched the financial systems during the quarter so we’ve migrated on to ORACLE Financial is now our system of record and as we were doing that there were delays in terms of when invoices went out during the quarter and some of the time we had that we were making collection calls during the quarter. I anticipate we’ll get back to the historical average of 70 to 80 days in the fourth quarter.

Raymond A. Myers – Emerging Growth Equities, Ltd

A final question for Bob if I may, can you discuss the environment of the large pharma market versus the mid market? You specifically mentioned a couple of mid market biotechs in your prepared remarks which is typically the wheel house of your primary competitors and I wondered if you were seeing a little shift in market share there?

Robert K. Weiler

No, we’re not seeing a shift in market share. The big guys, I mean if you take a lot of the big companies, you’ve got six of them that are involved in mergers for the last year or so and we’re starting to see conversations from them coming together and what their implementation strategy is going forward. In the past we only had a view through EDC lens, we’re getting views now through data management, higher levels, IRT and we think that once these mergers get kind of settled out that that is going to be a good opportunity for us in all of our products.

But, the market share position and where we’re going in the battle with our point product competitors, we still go out there, we win some, they win some and it’s been that way for a lot of years. We’re making changes to hopefully increase our market share and they’re trying to do the same but right now we have a very, very compelling ICRS offering that really helps customers reduce their overall cost and we’re making that case and it seems to be resonating as it was illustrated on the number of wins that we had that we’re very, very competitive in that mid range where they bought more than one product, they bought two with anticipation of even buying more.

Operator

Your final question comes from [Charles Berati] – Citigroup.

[Charles Berati] – Citigroup

First question just on M&A generally among pharma manufacturers and also CROs specifically the PPD Excel acquisition, I wonder if that has any impact on your at all? Then on the large pharma M&A that’s been announced if you can comment on any impact you foresee from that?

Robert K. Weiler

Yes, I think from a large pharma standpoint one of the things that you’re going to see is you see Pfizer Wyeth or Merck Schering or Roche Genentech, you’re seeing them try to consolidate around systems that are going to give them real R&D benefits. I mean Pfizer Wyeth announced about $1.5 billion I believe, $1.2 to $1.5 billion reduction in R&D and that’s clearly going to move in to how do you do that and how do you harmonize technologies?

So, when we look at these companies we’re starting to see more direction of what they’re thinking which I think will take place in 2010. As far as the CROs, the CROs just get bigger by scale. PPD happens to be a strong ORACLE shop. We do sell them some trials and we do, do business with them somewhat but I would say we are secondary there and ORACLE is number one so the impact on that one probably wouldn’t have that much affect on us.

[Charles Berati] – Citigroup

Back on the large pharma M&A and the rationalization of that R&D, how should we think about the reduction in overall R&D spend and the implication that may mean fewer trials to be conducted with what you referenced which was the increase in necessity to employ some of your technologies to help them run the trials they are running more productively?

Robert K. Weiler

The companies that we talked to are doing everything they can to get more trials to be run to get through the system. If you think of the pressures they have, pharmaceutical industries is committed to $80 billion in price discounting over the next 10 years in the healthcare bill. You’ve got $137 billion coming off patents by 2013. They recognize that they have to get their costs down and to get their costs down they have major, major cost initiatives and to get the cost down so they can do trials.

One of the things that is very, very high in an IT budget in a pharmaceutical company is existing maintenance on existing products, integrations between multiple products, support of the integrations of multiple products. Anything that you can do to improve that cycle time, save them money so that they can do more trials, they’re very, very interested in listening to that story.

[Charles Berati] – Citigroup

So your point, just to bottom line it is your reduction in total R&D spend will be more than offset by the increase in demand for the technology solutions that you’re offering to them.

Robert K. Weiler

Yes. It’s not total dark clouds, one of the things that the pharmaceutical industry widely support the healthcare is that if mandatory healthcare comes in for another 46 million people or 35 million people, whatever the number you want to use, that’s good revenue opportunity for them. They are seeing tremendous revenue opportunity growth in China, India, in Asia, in other places in the market. They’re trying to balance it, they have a tough act but they know that technology is part of the answer not something that’s going to get put away.

[Charles Berati] – Citigroup

Speaking of outside the US, in the 2Q you mentioned an fx 14% headwind in service margins, did you comment on the fx impact this quarter?

Christopher Menard

No I did not.

[Charles Berati] – Citigroup

Was there anything that you can share with us on that?

Christopher Menard

For the third quarter at the op income level we were pretty much neutral. We had about a $1.2 million reduction in revenues which was offset by about a $1.2 million reduction in expenses if I compare it to the same period last year. So, a very small impact at the operating income level.

[Charles Berati] – Citigroup

How about compared with 2Q, the previous quarter?

Christopher Menard

Compared to the second quarter we had a revenue loss of about $1.4 million or about 3.5% but we had an expense pick up of about $1.8 million which was about 5%. So these are for the second quarter not a comparison. In the second quarter we picked up about $400,000 at the operating income level which would be about 9.5%.

[Charles Berati] – Citigroup

So there was less of an impact this quarter than from the 2Q ’09?

Christopher Menard

That’s correct.

[Charles Berati] – Citigroup

Finally, number of live trials this quarter?

Christopher Menard

Live trials are just over 1,000 which is about a 15% increase compared to the same period last year.

[Charles Berati] – Citigroup

Can you just confirm to us, I don’t know if you mentioned when you will give 2010 guidance and anything you want to tell us at this point about headwinds or tailwinds that we should be thoughtful of before people run away with estimates that may not make sense later on?

Christopher Menard

We do a very bottoms up bookings forecast which is how we turn the revenue forecast around for next year and we’ll probably be doing our call the first week of February and at that time we’ll give guidance for next year.

[Charles Berati] – Citigroup

As we’re already modeling it, anything that we should be aware of to add back in or take out of this year’s results before we use it as a jumping point for 2010 or unusual things in 2010 that we should be thoughtful of?

Christopher Menard

No, nothing we haven’t talked about over the last couple of calls.

Operator

That concludes the Q&A session. I’d now like to turn the call back over for closing to Bob Weiler.

Robert K. Weiler

Thank you for your questions. We’re very excited also in the fourth quarter that we are having our international user conference next week in Boston. We’re also having our Japanese user conference in November. A lot of customer activity and a lot of roll out activity for acquisitions and I think this is a very exciting time for Phase Forward. Thank you for your questions and see you out there.

Operator

That concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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