Executives
Timothy Dolan - Senior Managing Director, Integrated Corporate Relations, Inc.
Robert K. Weiler - President, Chief Executive Officer
Rodger Weismann - Senior Vice President, Chief Financial Officer
Analysts
Nabil Elsheshai - Pacific Crest Securities
Raghavan Sarathy - Ferris Baker Watts
Len Podolsky - Piper Jaffray
Richard Close - Jefferies
Andrey Glukhov - Brean Murray
Asher Dewhurst - FBR
Raymond Myers - Emerging Growth Equities
Don Hooker – UBS
Steven Crowley - Craig-Hallum Capital Group
Richard Davis - Needham
Stephen Shankman – Natexis
Phase Forward Incorporated (PFWD) Q4 2007 Earnings Call January 31, 1969 9:00 PM ET
Operator
Good day, ladies and gentlemen and welcome to the Phase Forward Incorporated Fourth Quarter Fiscal Year 2007 Earnings Conference Call. (Operator Instructions)
I will now like to turn the presentation over to your host for today’s call. Mr. Tim Dolan.
Timothy Dolan
Thank you. Please note that various remarks 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
I’ll begin the call by saying that we are very pleased with the company’s performance inthe fourth quarter, which was a strong finish to a highly successful year for Phase Forward.
During 2007 we added 55 new direct customers, in addition to the 38 we added in the prior year. The additions in 2007 included multiple clients spanning the global pharmaceutical, biotech, medical device, CROs, and academic sectors. And they range from the smallest to some of the largest life science companies inthe world.
Our direct customer count does not include customers of CROs that use our solutions, which at our last count in 2007 exceeded 65.
We believe our proven track record of delivering highly scalable and complex deployments for companies of all sizes, serves as a strong motivating factor that influences customers to adopt Phase Forward, and has made us a strategic partner of choice to many of our customers.
Our business momentum is strong, and the industry fundamentals remain solid, and these combined factors make us optimistic about our outlook as we begin 2008. This is reflected inthe 2008 financial outlook that Rodger will share with you ina moment, which calls for another year of over 20% revenue growth.
Now, let me take you through the summary results for the fourth quarter. Total revenue came inat $37.8 million, representing a 25% year-over-year growth and exceeding the high-end of our guidance.
From a profitability perspective, non-GAAP operating income was $5.3 million representing a growth of 28% on a year-over-year basis. On a full year basis, the company generated revenue of $134.3 million in 2007, representing an increase of 26% on a year-over-year basis, up from 22% year-over-year growth in 2006, and 18% year-over-year growth in 2005.
We believe this growth pattern is reflective of the momentum in the market for clinical trial automation solutions combined with Phase Forward’s leadership position. I’m also pleased to report that 2007 annual bookings of $195.8 million represents a 43% increase over 2006, and brings our year-end backlog to $279.1 million.
There were numerous factors that contributed to our growth in 2007 which we believe will also help us to position the company well for the long-term. For starters, EDC adoption accelerated in 2007 resulting in many more trials being done in EDC. Within this framework we continue to be successful in winning strategic EDC relationships with some of the largest pharmaceutical companies inthe world, often in highly competitive situations.
During 2007, these wins included names such as Eisai, Abbott Laboratories, Dainippon Sumitomo, and Novartis Vaccines who joined a list of strategic customer relationships that include other industry leaders such as GlaxoSmithKline, Merck, Eli Lilly, Novo Nordisk, Johnson & Johnson, Schering-Plough, among others.
We were also pleased to build on our earlier customer growth in 2007 by establishing new InForm EDC relationships inthe fourth quarter with customers such as Aerovance, Children’s Hospital of Boston, Epix Pharmaceuticals, and Biotronic, to name a few.
These new customers and strategic wins are important because we believe they are significant validations of the industrial strength of Phase Forward’s technology and our industry leadership position in domain expertise, global service capabilities, and the scalability of our solutions. We also believe that these successes would not be possible without the references provided by our customers.
Companies looking for a technology solution provider to help their clinical trial and safety efforts conduct exhaustive comparative evaluations. We are pleased that our track record of successfully supporting and scaling large number of studies across all development phases and therapies has translated into strong customer growth we saw in 2007.
We also continue to earn follow-on business in 2007 from our existing customers, examples included additional ASP trials from long-standing customers such as Genzyme and Allergan and larger add-on engagements with Quintiles and Millennium.
Even some of the new customers we won in early 2007 were quick to strengthen their relationship with Phase Forward by awarding us additional ASP trials and larger add-on engagements later inthe year, such as Novartis Vaccines, Kyphon in Q3, and ev3 in Q4.
In addition to maintaining our strong leadership position among the world’s leading pharmaceutical companies, an important component to our long-term growth strategy is expanding and deepening our relationships with CROs. We saw a 52% year-over-year growth in revenues from CROs in 2007, which represents 16% of revenues for the year, up from 14% in 2006.
During the fourth quarter, we continue to make solid progress in this area. We signed another multi-year, multi-million dollar agreement with PAREXEL, one of the world’s largest CROs for InForm use and related services. You may recall that earlier in the year, we announced that PAREXEL had extended its alliance with us through a similar multi-year commitment signed inthe first quarter of 2007, which also elevated InForm to the preferred EDC-solution status at PAREXEL.
Also on the CRO front in the fourth quarter we expanded our relationships with other CRO partners, such as Pharmalink and Prologue Research. And received initial order from six new CRO partners including Montreal Heart Institute, Everest Clinical Research and [Robotus] Clinical Trials on the InForm front; and Sentrx Research Pharmaceutical Services and Paramax with our Clintrace and Clintrial solutions.
Every new CRO brings indirect customers who are experiencing our technology, which arein addition to our own direct customer count. We believe the relationships we established and expanded inthe past year have not only contributed to our results in 2007, they also provide Phase Forward with a significant long-term opportunity to grow with our customers as they increase their usage of our InForm EDC solution over time, as well as their adoption of our other solutions such as those inthe safety area.
We continue to see solid interest in our portfolio of safety solutions from customers like the Department of Defense, Barrier Ingleheim, and Otsuka, who all made purchases during the fourth quarter.
On the product front, we announce the immediate availability of a new version of WebSDM, which is capable of reading data directly from our InForm EDC solution by enabling data manage to evaluate data more thoroughly atan earlier stage inthe clinical trial process. The combined products can help to detect anomalies prior to submission.
This release will also enable our InForm customers to directly leverage our clinical trial signal detection product to conduct ongoing review of trends and safety analysis during the clinical development process. As a reminder, WebSDM is used by the FDA to validate data submissions made inthe CDISC SDTM format.
We are also seeing growing interest in our Clintrace safety solution, especially inthe CRO in emerging company segments based on its modern, web-based architecture and ease of deployment. We continue to leverage the expertise of our safety division to further improve functionality and integration with the remainder of our suite of solutions.
We believe this will help us drive demand and further differentiate Phase Forward from competitors with narrow value propositions. In addition to expanding our product capabilities through internal development, we are also focused on acquiring complementary technologies and companies to expand our value proposition and market opportunity.
During the fourth quarter we acquired privately-held Green Mountain Logic, a vendor of process automation software for managing Phase 1 clinical trials, which will broaden our offerings inthe Phase 1 space. We’re still quite early in bringing Green Mountain Logic’s LabPas solution to market, but we are receiving positive, proactive interest from prospective customers, as well as positive feedback from early implementation customers.
We plan on continuing to explore additional acquisition opportunities as they may arise and to build on our experience in acquiring and integrating businesses that enhance Phase Forward’s reach across the clinical and safety operations of our customer base. Atthe end of the year we are proud of how broadly our InForm EDC solution continues to be successfully deployed in highly complex and scalable trial environments in terms of size, design complexity, duration, and global spread.
We have supported users in 105 countries and estimate that our InForm EDC solution has now been used in over 2000 trials to date. In 2007 alone we had over 22,000 user registrations of our EDC e-learning solutions, up from approximately 8000 in 2006.
In 2007 we saw rapid expansion of our broader InForm related offerings, through customers adopting additional modules, such as central coding, which is now being used in over 40 live production trials; strong demand for integrations with third-party applications leveraging our adapter and InPhase technologies; and increased use of our e-learning solutions.
We believe this adoption validates the investments we are making in enhancing our technologies as demonstrated by our announcement early this week of a significant new release in Central Coding and our release of Central Designer earlier inthe year.
We are also proud of the progress we are making on other solution fronts, such as increased interest in our safety solution, which we continued to enhance in 2007 as demonstrated by the new versions of CTSD and WebSDM, and the expansion of our product portfolio through our recent acquisition of LabPas Phase 1 management solutions.
As we look to 2008, we will continue to focus on key areas that helped to contribute a strong performance in 2007 namely, ensuring customer success in highly complex environments, increasing our presence within our blue-chip customer base, diversifying our business across multiple market segments, and growing our business internationally and with CRO’s.
In summary, we are very pleased with the company’s financial performance inthe fourth quarter and full year 2007. The company is executing ata high level across our key growth initiatives, which combined with solid industry fundamentals, makes us confident about our outlook as we begin the New Year.
With that, let me turn it over to Rodger will go over the financials in more details.
Rodger Weismann
Let me provide some further detail on the fourth quarter and full year 2007 financial statements. And then we will close with our first quarter and full year guidance before turning it over to the operator for Q&A.
Beginning with the P&L, total revenues for the fourth quarter of 2007 is $37.8 million, an increase of 25% year-over-year and above the high end of our previously issued guidance range. Within total revenue InForm license, application hosting, and other related revenues were $27.4 million, representing 72% of total revenue, an increase of 30% on a year-over-year basis.
Overall license revenues inthe fourth quarter came in at $13.4 million, representing 35% of total revenue and 19% year-over-year growth. We saw continued strength in our Q4 services revenue of $24.4 million, growing at 29% year-over-year due to the strong growth in our InForm ASP business which at 45% of total revenues is up 41% from Q4 of 2006.
Turning to costs and profitability, 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. Our non-GAAP results exclude non-cash expenses associated with FAS 123R, an amortization of intangible assets associated with the acquisitions of Green Mountain Logic which closed on October 30th, and Lincoln Technologies.
Non-GAAP gross margin was 58% inthe fourth quarter of 2007, down from the third quarter in the same period a year ago when the margin was 63%. This was due to a combination of higher percentage of revenue being related to services and lower services margins compared to prior quarters, as we continue to make investments to handle increases in current and forecasted ASP related business.
Some of these are made well in advance of the time trials go live and as we must recruit and train project managers and trial-design consultants before the design phase of the trials initiated. In addition, to handle the increase number of customers and trial volumes, some of the investments require step-function increases to hardware, software licenses, and data center expansion. These are investments that we expect to gain leverage on in 2008.
From an operating expense perspective, total non-GAAP expenses in Q4 were $16.7 million, a 12% increase from $14.9 million inthe same period a year ago. Our non-GAAP income from operations inthe fourth quarter was $5.3 million, an increase of 28% on a year-over-year basis, and representing a non-GAAP operating margin of 13.9%.
Operating margin was down in Q4, since expenses came in higher than expected due to several factors that were each relatively small individually, such as the impact of LabPas which was not in our original guidance, a higher than expected amount of billable pass-through expense which contributes no margin, higher-than-normal severance costs, and longer training and ramp-up time of new services personnel. Many of these factors are not expected to recur in Q1 of 2008.
While we had previously anticipated realizing a non-GAAP tax rate of approximately 10-11% inthe fourth quarter, our tax provision included a tax benefit of $9.6 million or $0.22 per share due to additional and full release of the remaining valuation allowance against our NOLs, and other net tax credits of $1.6 million or $0.04 per share that were not in our projected tax rate.
As a result, our tax provision for the quarter was a net credit of $10.7 million. This helped to drive non-GAAP net income to $18.2 million in the quarter or $0.41 on a per-share basis, compared to $0.19 inthe fourth quarter of 2006, which included a tax benefit of $0.07. All earnings-per-share references are to diluted earnings per share.
Looking at our fourth quarter 2007 results on a GAAP basis, GAAP net income was $15.7 million, including the impact of $2.2 million related to FAS 123R stock-based compensation expenses, and $230,000 in amortization of intangibles related to the acquisition of Lincoln Technologies and Green Mountain Logic, and the write-off of $300,000 of Green Mountain Logic in-process R&D.
We generated GAAP earnings per share of $0.36 in the fourth quarter of 2007 compared to $0.15 inthe fourth quarter of 2006. GAAP EPS was impacted by a $0.22 benefit from the additional release of the evaluation allowance against our NOLs and the $0.04 net tax credits.
From a full year perspective, we delivered revenue of $134.3 million, representing an increase of 26% on a year-over-year basis and ahead of our initial guidance of $124-129 million. Our full year non-GAAP operating income was $19.7 million, representing an increase of 50% on a year-over-year basis, and our non-GAAP operating margin of 14.7% was consistent with our guidance of 14-15%.
Non-GAAP EPS was $0.87, including the two tax adjustments totaling $0.26 and ahead of our initial guidance of $0.47 to $0.51. On a GAAP basis we delivered full-year EPS of $0.72, including the $0.26 related to the tax adjustments and better than our original guidance of $0.33 to $0.37.
Moving to the balance sheet, cash, cash-equivalents, and short-term investments totaled a $182.6 million at the end of the fourth quarter, a decrease of $4.3 million from the end of the third quarter.
For the quarter, the company generated $8.8 million in cash from operations, which was offset by $5.7 million of capital expenditures, the $5.4 million purchase of Green Mountain Logic, and the final $3.5 million payment for Lincoln Technologies. For the year the company generated $42.4 million in cash from operations, while spending $13.4 million of capital expenditures.
In addition, the company generated $92.8 million from the sale of stock, $89 million of which came from our secondary stock offering.
Total deferred revenue was $67.1 million atthe end of the quarter, an increase of $16.5 million on a year-over-year basis and up $7.1 million compared to the end of the prior quarter. This increase to deferred revenue was a major contributor to the higher-than-expected cash from operations. We do not currently anticipate such a significant increase in 2008.
During 2007 we had a number of large, upfront commitments. However, it is very difficult to predict whether customers will choose a term license or ASP service offering, and if they choose an ASP offering, whether they will make a large upfront commitment or buy the trial over time.
Account receivable increased $7.5 million from the end of the prior quarter, ending the year at $35.5 million. This led to DSOs of 86 days, up from 74 days atthe end of the prior quarter. Our fourth quarter DSOs have historically been over 90, due to seasonality of customer invoicing.
Total bookings were $195.8 million for the year, up 43% over 2006 and above the high-end of our latest guidance. This represents the second year of exceptional bookings growth, following a 52% growth in 2006 over 2005. In-form related bookings over $158.5 million were up 48% over 2006, and represent 81% of the total. Within total bookings, ASP bookings were $95.8 million, and increased 37% compared to 2006.
As a reminder, Phase Forward defines bookings as firm commitments and contracts that have been signed by both parties, and excludes potential bookings from unsigned deals, letters of intent, and expected follow-on awards or renewals, even if we have been given a verbal award. These bookings resulted ina year-end backlog of $279 million.
As we have discussed over the past year, it’s important to appreciate that several factors influence bookings and backlog increases and decreases. The level and growth of service bookings can vary period-to-period, depending on whether customers make a significant up-front commitment or buy on a trial-by-trial basis. In addition, the amount of license bookings are contingent on a customer’s choice of term, which typically varies from three to five years.
Other factors, such as the number and term of renewals, can also have a significant impact on bookings during a given period. Further, acquisitions with different business models make comparability of bookings from period-to-period more difficult; these differences ultimately have little to no impact on our revenue.
Thus, although backlog reflects future revenues to be recognized over a period of years, growth in our total bookings and backlog quarter-to-quarter and year-to-year are not a meaningful way of trying to forecast future revenue growth, as they are not necessarily indicative of current business trends.
As a result we believe revenue is a more accurate way to track and measure the growth in our business, although we expect bookings to continue to increase in 2008, we will no longer be reporting bookings for backlog inthe future. However, we will provide the visibility we have coming from our backlog into both our full-year and next quarter’s revenue guidance.
With that let me now 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 the acquisitions of Lincoln and Green Mountain Logic and all FAS 123R stock-based compensation expense.
Looking atthe year as a whole, revenues are expected to be between $165 and $169 million, an increase of between 23% and 26%. Approximately 75% of these revenues are anticipated to come from beginning backlog.
Service revenues are expected to continue to increase as a percent of total revenues during the year, driven primarily by the growth in our InForm ASP business. It could exceed 70% by the fourth quarter, up from 65% in Q4 of 2007.
Turning to profitability for 2008, we’re forecasting gross margins to be between 58% and 59% and operating expenses to be between 41% and 42% of revenues. Our gross margins are expected to remain fairly constant from Q4 of ‘07 through 2008, as our service margins are expected to increase over the course of the year, offsetting the effect of the shift of the service mix of our business.
Within operating expenses, we expect sales and marketing to be between 15% and 16%, R&D between 14% and 15%, and G&A between 11.5% and 121.5%. As a result, we expect non-GAAP operating margin to be between 16% and 17% for the year.
Due to the full release of our tax benefits in 2007, our anticipated book tax rate is expected to be between 37% and 39%, while our cash rate is expected to remain inthe 3-5% range.
Although we expect a continuing increase to the services component of our business, our target operating margin over the next three to four years remains inthe range of 18-21%. This will now be achieved by gross margins inthe 60-62% range and operating expenses between 40% and 42%.
Looking at non-operating items, and with the current interest rate environment, it is difficult to forecast interest rate and thus interest income. But for purposes of our guidance, we have assumed a 3% and 3.25% rate for the year 2008.
Using an estimate of stock-based compensation expense between $8 and $8.5 million, we expect GAAP EPS to be between $0.33 and $0.36. On a non-GAAP basis, excluding the stock-based compensation expense and acquisition purchase price amortization of $720,000, and assuming a non-GAAP tax rate ina range of 37-39%, non-GAAP EPS is expected to be between $0.46 and $0.49.
We expect to spend between $20 and $24 million in capital expenditures, split about evenly between expanding our production capacity and building out and furnishing a new corporate headquarters, which we plan to move into late in 2008.
Looking now atthe first quarter of 2008, revenues are estimated to be between $37.0 and $37.6 million with approximately 90% anticipated to be recognized from beginning backlog. We expect gross margins to be between 56.5% and 57.5%, and operating expenses as a percent of revenues to be between 40% and 41%.
As result we expect non-GAAP operating income to be between $5.5-6.0 million. Our non-GAAP tax rate is anticipated to be between 37% and 39%, and stock-based compensation expense is estimated to be approximately $1.9 million.
GAAP earnings are expected to be between $0.07 and $0.08 per diluted share, with non-GAAP earnings expected to be between $0.10 and $0.11 per diluted share.
In summary, our fourth quarter and full-year 2007 results were strong and we have confident as we enter 2008.
With that let me turn it back to the operator to begin the Q&A session.
Question-and-Answer Session
(Operator Instructions) Your first question comes from the line of Nabil Elsheshai - Pacific Crest Securities.
Nabil Elsheshai - Pacific Crest Securities
I guess Rodger or Bob, if step back and you look at ‘07 and the growth drivers; it seemed a little bit like the last couple of years has been a bit of a land grab, especially atthe high-end of the market.
If you look out at ‘08 and ‘09, do you anticipate it being the same sort of thing or do you think most of the large guys have lined up and it’s more a matter of taking advantage of your installed base, and getting more larger percentages of trials, and maybe getting after the mid-market?
Robert K. Weiler
I think its combination of a number of things. First, a lot of the market share positions are settling out because many of the people have made their strategic decisions over the last couple of years, and a lot of that growth that we foresee of those customers that have chosen us as strategic partners, ramping up their adoption either through ASP trials or converting to enterprise adoption, depending upon their own internal processes and how they want to do that ASP or internal adoption.
The second thing we’re seeing is that new companies coming in, much of our business is coming from the five, six, seven, eight trial type segment, which arethe smaller companies which are really embracing EDC. As they just start the trials are going EDC; they are not converting from paper; they are not doing hybrid trials; they’re not doing anything like that; they just go ahead directly to EDC.
And lastly we are seeing CROs. The CROs have really in 2007 embraced EDC and as I mentioned in my call on the script earlier is that we’ve had over just inthe last little more than a year, CROs have brought us over 65 companies that what we call indirect; that we haven’t really touched at all.
So the large ramp up of the successful CROs and the success they are having is really promoting EDC as well. So it’s really the three factors. There are a few other larger opportunities out there, but many of the strategic decisions have already been made.
Nabil Elsheshai - Pacific Crest Securities
Rodger what’s your assumptions on share count for ‘08, if you can give us that?
Rodger Weismann
We are estimating a slow growth in the number of shares outstanding, so I think it averages around 44.5 million for the year.
Operator
Your next question comes from the line of Raghavan Sarathy - Ferris Baker Watts.
Raghavan Sarathy - Ferris Baker Watts
Bob, if you look at last year, you seem to have won more than your fair share of large deals. Looking ahead, do you see any change in the competitive landscape in terms of EDC vendors and the ability to continue to gain market share?
Robert K. Weiler
I believe we can continue to gain market share. We do believe that we won more than our fair share of the larger deals as well as the smaller deals and we don’t see anything in the future. I mean if you look where we’re at, our customer base is getting stronger; we’re having more success with more trials.
We are over 2000 InForm trials right now having been done. We are hosting many, many trials, more than that, actually. Our product is robust. It’s deep, we continue to enhance and add.
Our suite in solutions that we are starting to sell also have more impact. In my comments I mentioned the fact that we had WebSDM. The new release now goes directly to be able to read information directly from InForm, allowing a tremendous amount of functionality for safety analysis of the clinical trial that there is essentially no one inthe market that has anywhere near that type of competitive offering.
And I think this business is truly built around success and people want to make sure their trials work, they scale, they have performance and that is the position that we enjoy right now. So, I would hope we could build on that during 2008.
Raghavan Sarathy - Ferris Baker Watts
And then with regards to Oracle, I understand that Oracle has released its new product and some other customers are testing it. I was wondering if you see any opportunity taking some customers away from Oracle.
Robert K. Weiler
Maybe you have information I don’t. Usually you don’t hear that somebody released a new product and does that create an opportunity to replace them. My view on Oracle has always been this: is that they have some excellent customers that they’ve had since Oracle clinical days that have used Oracle products; they will continue to use Oracle products and they will be kind of flagship customers for Oracle.
The question however is with Oracle’s new product if you don’t already have an investment in that we don’t see that product being that competitive inthe new customers. We don’t see that product winning new business. And then to pick up on what you said, we have had a number of their customers come to us and want to evaluate our product side-by-side, while they are looking at that RDC product. So we will see how that holds up.
Raghavan Sarathy - Ferris Baker Watts
Rodger, can you update us on the available NOLs at the end of the year and when do you expect to pay cash taxes at the full rate?
Rodger Weismann
As I mentioned for book purposes there are no more NOLs. We booked allthe benefits for tax return purposes, which is basically for cash purposes. The balance is about $70 million after we filed the 2007 return.
And again, the part of it is how longdo we expect that to last? That gets more problematic to try and forecast that. We need forecast 2008 and ‘09 income and one of thebig variables of forecasting how long that will last is the amount of disqualifying disposition of incentive stock options, which are allowed as a tax return deduction even though it doesn’t go through the P&L. And those are very hard to forecast, depending on when people sell, and stock prices, and all that. Having said that we expect it to last at least two, but it could be three or four years.
Raghavan Sarathy - Ferris Baker Watts
Can you give us the interest rate? I was wondering if you could give us the dollar amount for the total interest and other income.
Rodger Weismann
We haven’t given a cash flow forecast for the year, so I could speak very roughly and this is not a cash flow forecast, but if you took an average balance of $200 million. So this would exclude any effect of a potential acquisition. The average cash balance of about $200 million times 3.75% comes to $7.5 million.
Raghavan Sarathy - Ferris Baker Watts
What was the contribution from consulting and customer support?
Rodger Weismann
The customer support was 10% and the consulting was 9%.
Operator
Your next question comes from the line of Len Podolsky - Piper Jaffray.
Len Podolsky - Piper Jaffray
Bob, can you give us an update on your view of market penetration, please?
Robert K. Weiler
Yes, I think 2007 was what we all thought was going to bethe tipping year and certainly it was. We think that it was about 45% of new trial starts that was forecasted is about where it’s at. And I think we are going to see 2008 that number move north of 50% more like probably inthe 55-60% of all new trials starting using EDC, with that accelerating towards the end of the year.
So, I think this steady progression and the chart I think you’ve seen us put up many times, which is theIDC chart of the market, the market penetration of new trials starts, seems to be spot-on.
Len Podolsky - Piper Jaffray
What about on the safety side?
Robert K. Weiler
Actually, we’re starting to see interesting; a lot of people have safety products already, so it’s been somewhat of a saturated market. However, we are starting to see that for many of the products that are out there, frankly including our old Clintrace product, we are starting to see people looking up to refresh that and doing more evaluations.
And we are starting to see that get stronger, being driven by also our signal detection products that are also gaining hold. So I think from a standpoint of market size, we still think that market is about $100 million in size and is probably, on a given year’s standpoint, somewhere around $30-35 million.
Len Podolsky - Piper Jaffray
Are there any more elephant deals out there inthe EDC market?
Robert K. Weiler
We just don’t talk about elephant deals. And the good news is that a number of years ago, in 2004 and 2005, it’s all everyone talked about. With the ability to add such impact on your numbers, if you look at our numbers and our growth right now, so much of what we are getting now is coming from smaller ASP non-commitment deals.
But yes, there are probably one or two every year large deals that will surface and I don’t think 2008 is going to be an exception to that. Will we win them all, maybe? Will we win some, probably? You don’t know. It’s a competitive environment, but we feel we’ll win our share.
Len Podolsky - Piper Jaffray
Could you just quickly go through the Q1 guidance? I missed all those breakouts. That’s just for gross margin and OpEx.
Rodger Weismann
Yes, the gross margin is between 56.5% and 57.5%, and operating expenses between 40% and 41%.
Len Podolsky - Piper Jaffray
You mentioned that there was some severance costs inthe quarter; could you give us a little more detail, where those came from?
Rodger Weismann
We prefer not to comment on exactly where that came from.
Operator
And next question comes from the line of Richard Close - Jefferies.
Richard Close - Jefferies
Bob or Rodger, I wondered if you could recap, I think you made a comment with respect to some of the upside coming from follow-along and add-on engagements. And I was just curious if you could just elaborate a little bit more on that.
And then if we look atthe bookings in initial guidance for ‘07 I think it was $135-150 and then where you came in. If you could sort of break out how that variance was broken out between maybe new customers that you didn’t know initially versus add-on customers?
Robert K. Weiler
Let me answer the second question first. The increase from the guidance from the early part of the year really rested on three, or somewhat four, four criteria. The first was some deals that were in our pipeline. We forecast it from our grass roots up, came in, and frankly were much larger than we had anticipated. So you had kind of a bigger deal component to the forecast coming through the second half of the year.
The second part was it is very difficult as much as we like to look at outside pundits and guess ourselves to what the adoption rate was going to be. In the beginning or this time last year it was really hard to say with certainty that that adoption rate was going to accelerate in 2007 and we didn’t start seeing that until the second half of the year.
The third factor was the acceleration of adoption and implementation by the CROs. That the CROs start stepping up, making commitments as well as delivering products and ordering a lot more trials from us than I think even they had anticipated.
And then lastly was the emergence of the replacement market, where we had a number of customers that were with our competitors that signed up for multi-million dollar, multi-year contracts with us that weren’t in our original forecast. So those were kind of four drivers of why our bookings guidance went up during the year and then ultimately we exceeded that bookings guidance. The first part of the question what was the first part again?
Richard Close - Jefferies
The add-on again, you mention follow-on or add-on engagements.
Robert K. Weiler
Yes. I mean this goes back to what we were saying as early as 2005 and 2006, is that many companies were making strategic decisions with us. But they would come back and say, we’re going to give you an initial order, and it might have only been 1 or $2 million. And then they would come back and sayall right, we have seven trials going live in September, we want to put an order in for you to do those seven trials.
As well as, we had customers that signed up early inthe year, like Novartis Vaccines, that put an initial order in, but their ramp up was going so quickly, they came back atthe end of the year, and did multi-trial orders as well.
That also happened with some of the CROs that had initial commitments atthe beginning of the year that they thought would last maybe a year or two, by the end of the year, they had already eaten through it and came back and gave us another multiple-year order.
So this is what we’re kind of seeing, we’re seeing this build up of those companies that made strategic decisions over the last couple of years, starting to gain traction using EDC for pretty much all their trials. And we’re benefiting from that by orders during the year that is very hard for both our customers and ourselves to forecast. But I think the inertia of EDC and everybody moving to that direction, we’ll see that continue in the 2008.
Richard Close - Jefferies
With respect to, Rodger, you threw out a number and I missed it. I believe it was 70% of the revenue guidance for ‘08 you expect to come from the beginning backlog, was that correct?
Rodger Weismann
Yes, 75% from the beginning backlog.
Richard Close - Jefferies
That number hasn’t change much over the past couple of years, has it?
Rodger Weismann
That’s correct. It’s I think the last two years it’s been somewhere between like 74% and 77%. That’s been a fairly narrow range. I think back more than two or three years ago was a little broader range, so year-to-year it might vary inthe 70-80% range.
Richard Close - Jefferies
Is there any way or any reason that number would go down, approach the low 70s, or dip into the 60s at allin terms of essentially giving you more visibility than you currently have?
Rodger Weismann
You mean that would give us less visibility as the number dropped. Yes, I mean even as there has been a slight shift to more services and ASP, which turns to revenue sooner. That percent coming out of the backlog for the next 12 months really hasn’t changed very much. So, I don’t see anything really shifting it significantly.
I mean I think if order came in that was very, very large license order that had a very long term to it that would take longer for it to convert to revenues.
Richard Close - Jefferies
Pulling back on the booking’s guidance in the backlog, giving those numbers, that begs the question, have you seen any change in the environment or anytime a metric is pulled back somewhat like that. But how would you characterize I guess your business today here inthe first month of 2008 as compared to last year, January 2007? Is this better business for you guys, is the market opportunity increased, hasit decreased, is itthe same, characterization along those lines?
Rodger Weismann
The not giving guidance on bookings has more to do with the composition of the type of bookings that come inat different periods of time. And depending on what’s in that mix bookings fluctuations can have nothing to do with the strength of the business in a particular period of time, which is why we think that number doesn’t make sense anymore.
So I think you need to look more to the revenue side of the business and we’re quite bullish on the revenue. Our guidance was 23-26% overall growth, compared to the 26% that we saw in 2007. So if anything, we see I think next year as stronger, continuing strength than we saw inthe last two years. I don’t know if you want to comment more on that, Bob?
Robert K. Weiler
No, I think, whenever, we’re cognizant of the concerns that some people have when you back away from a number. I think that it could be read into, while the number is, we discredited it somewhat, we felt it was appropriate to do it when the number was very, very strong as it was this year.
I think during my script and Rodger’s script you heard a number of comments about our optimistic outlook for ‘08 and future years, a number of comments that we felt our business was very strong. We feel our product and position is very strong. We think the market dynamics are probably as strong, if not stronger than they have been inthe past.
So, we felt that surrounded by the positive revenue guidance that we’re giving that that would calm any fears that we anticipate a slowing of any sort in our bookings going forward. We just don’t think it’s a valid number for people who try to do waterfalls and build models out of. So, I would caution anyone to read into any negative on our position on the business based on dropping that number.
Operator
The next question comes from the line of Andrey Glukhov - Brean Murray.
Andrey Glukhov - Brean Murray
Bob, one of the things that we’ve seen in 2007 is your sales force productivity really stepped up. If you look atthe number of bookings per rep, what are your sales force hiring plans going into the year? And I guess directionally, if you comment on, are you increasing the quotas and if you are, can you help us with the magnitude of that increase?
Robert K. Weiler
The thing that we are probably going to add to the first part of the situation is, we’re probably going to add about three sales people two or three, tops, non-exclusive, I mean, exclusive of any acquisitions that we might do. So if we doan acquisition obviously that would change it, but from a normal standpoint, we think that we probably add somewhere in about four, maybe going from 29 to about 33, which will be about a 10% increase in our sales force.
As far as quotas, they’re going up as they always doin any sales organization. But I really don’t like giving quotas out publicly. So, but they’re going up to represent our goals for the year, and I will say that they, we do grasp grounds-up forecast and our sales force buys into the quotas, and sales managers buy into the quotas in the plans. So I think we arein good shape.
Andrey Glukhov - Brean Murray
And as far as I guess the acquisitions are concerned, you guys proceeded fairly cautiously for the first couple of quarters. Are you starting to see evaluation expectations on the part of your targets moderate? And by the same token, if not, are you guys starting to do anything, sort of an internal R&D trying to accelerate some additional products, so that in case you do not acquiring anything, we’re going to see some radically new products in 2009, 2010?
Robert K. Weiler
Well, I think the only thing we want to talk about that point is that you look at our R&D number that Rodger mentioned in his script to give you a feel for where we believe our R&D expenses are and there’s always on-going products.
We’ve been doing a lot of things. We mentioned coming out of R&D, which doesn’t geta lot of fanfare, was our central coding product. So we talked about it; we announced it; we geta value for that every time we sell that with a trial. And we have 40 trials live with that product now, so our R&D efforts really starting to paya lot of dividends.
Our adaptors are around using for integrations are making an impact. So if you look at our R&D historically it’s been 15-16% of revenues and as our revenues grow that number gets, as an absolute, larger for us to do more things. So other than that I don’t want to talk about what our R&D plans are.
I would hope that some of the companies that we’re looking at, particularly with the market considerations and what’s going on inthe marketplace right now, that their market expectations or their valuations may move. I think 2007 the market was very hot and everybody was feeling very, very good about themselves. And we saw a lot of people having what we thought were unreasonable expectations of valuations.
We are not bottom fishers; we are willing to pay for a good company, but it has to be realistic as well. Maybe with the market acting the way it’s been will be sobering. I’m not so sure what the IPO market is going to look like in 2008. So, I think that’s going to limit some options for other companies that we’d like to talk to. So I think if people get realistic I think the gaps can close and hopefully we will do some in 2008.
Andrey Glukhov - Brean Murray
Rodger, as far as the backlog and bookings metric, do you guys plan to report itin arrears, in other words are we going to see backlog once a year inthe K?
Rodger Weismann
I don’t think so. No.
Operator
Your next question comes from the line of Asher Dewhurst with FBR.
Asher Dewhurst – FBR
Back to Len’s question on market adoption, there was a CRO press release recently; it said they are doing about 70% of their new trials with EDC. I assumed that was awfully high and you kind of confirmed that with that 45%, but is it safe to assume that CROs are above that 44% are adopting EDC at a much faster rate?
Robert K. Weiler
No, actually I think what that happened is, I’ve seen that report. What I think that tends to be is that the CROs geta little ahead of themselves, because we’ve been using that as a great barometer for us to look ahead. And what that tends to be is the number of trials that they are bidding.
So, they’ll look and say how many trials we’re bidding EDC and that converts to we’re doing that in EDC. And it spans the gamut, if you take Quintiles as an example. They’re probably bidding over 90% of all their trials now are EDC, and if they had their way it will be 100% and they’re fairly public about that. So, you take that versus some others that are only doing 10-20% you get this average craziness going on.
What we look at is a great number. If they are saying now that they are doing about 70% that means in 2008 the number I talked about, 60% maybe a little higher in actual implementations. But they tend to bea little ahead of the regular market, but they include what they’re bidding as opposed to what we look at, which is actually bought and started.
Asher Dewhurst – FBR
And is there any segment of the market that’s really lagging in EDC adoption, small, biotech, or anything like that?
Robert K. Weiler
No I think 2007 the year, we started seeing it take off everyplace. We started seeing the small companies starting it and having never done a trial before going right into EDC. We’ve seen large pharmaceutical companies really trying to ramp up, and get to 80%, 90% of all of their trials and that’s being successful.
So I can’t look at an area and say boy, they are really far behind. Everyone seems to be going along in the right direction, somewhat at little different paces, but going along inthe right directions.
Operator
Your next question comes from the line of Raymond Myers - Emerging Growth Equities.
Raymond Myers - Emerging Growth Equities
Most of the questions have been answered, but let me ask a high level one, I guess for Bob. Could you describe the pricing environment capacity particularly in line with consolidations that we seem to seeing as the market coalesces around, just a handful of the larger and in fact even some of the smaller, but still viable, growing competitors?
Robert K. Weiler
Pricing has been fairly consistent. One of things that we’re seeing over the last number of years, the average ASP price for us has gone up to $400,000. Now that’s more to signal that pricing in its fundamentals has remained stable, but the trials are getting bigger, more complex. And things like with central coding we’re able to add more functionality into those trials which we’re unable to price for. Sothe pricing tends to be fairly significant.
When you seea major price discount or a major price kind of deal where somebody hasa very, very low price, it’s usually not a healthy situation for that company. What you have is a pharmaceutical company gets nervous of why you are bidding this so much lower than everyone else. And it’s usually that they are trying to raise cash or they are trying to do winthe business. And when you are dealing with a drug that’s going to be generating about $1 billion a year worth of revenue, the difference in $50,000 or $100,000 in the trial is really insignificant.
So, while the procurement people tend to beat us all up significantly and try to pound us to the best dollar, which is their job, the actual value of what we’re providing is tremendous compared to the value, the cost that would be paid with paper or in relation to the overall cost of the drug being successful. So, it’s rare that someone would come in and say “I’m buying because of price”. They generally make their decision based on their opportunities for risk and success.
Raymond Myers - Emerging Growth Equities
My impression throughout 2007 was that capacity inthe industry has been getting rather tight as demand has continued to be high. And is that what we’re seeing? Do you agree and then relate that to what we’re seeing, and what you mentioned the investment and that’s causing some decline in gross margin. Are you trying to increase your capacity to meet that demand?
Robert K. Weiler
Absolutely, and we’re trying to stay ahead of that capacity. One of the things, we’ve visibility in the business; we know when these trial are starting; we have a pretty good grip on how many trials we’re going to be doing in 2008. We saw the ramp up in 2007.
We have formulaic hiring when we know we have so many trials coming; we know how many production people we need; we know how many servers we need; we know what that takes. We had a step function that you are seeing in the short-term margins here where, we had to hire more senior people, such as a vice president of production, another one to help with our growth.
We’ve had to acquire licenses from software that used in our systems, like Oracle and Microsoft, and allthe things you have to do ina growing company. And we want to make sure we’re ahead of the curve, because the thing that differentiates Phase Forward from our competitors is that we’re able to build trials quickly, we’re able to deliver them, and they run, they run globally.
We’ve made investments in things like Akamai for internet acceleration because what we found is that when customers are doing trials in China, and the Far East, and into India that you have a normal internet-based latency that all companies would have. But we’re able to use our financial strength to be able to invest in those products, to make partnerships with people like Akamai to provide high end performance for those global trials, and no one else is doing that.
So those are the types of things that we believe that if we want to maintain and grow our leadership position we have to be able to be ina position to service our customers. And when our customers come to us and they say, “We want to do 40 trials” we have to be there to be able to do it. We cannot say “Gee, I’m sorry, we’re out of capacity”.
So that’s why you’re seeing some step functions as you’ve seen inthe past during our growth, you’ve seen step functions there every 18 months or so when we make the strong investments in our future and that’s a reflection on our confidence, the business is going forward.
Raymond Myers - Emerging Growth Equities
Let me ask you one more question about a specific CRO. What’s your relationship then with Covance? Are they a major purchaser of trials from Phase Forward?
Robert K. Weiler
Coban’s is been using a number of players. Their primary provider had been a company called Data Labs that they’ve been using a number of their trials. They’ve done a number of trials with us, are doing a number of trials with us and underway for their customers. So we have a relationship with them.
They will probably sometime in 2008 decide on a vendor of which they’ll start putting a lot of their efforts and resources behind. And we feel that we will be competing for that in a competitive environment. We would hope to win it. Not sure that we will, not sure that we won’t. Every deal is very competitive and until it’s awarded you don’t know. We do have the benefit that the trials that are running with them right now are going very well. So, we’ll see how that turns out.
Operator
Your next question comes from the line of Don Hooker - UBS.
Don Hooker - UBS
Is there any kind of quantitative metrics that you can talk about in terms of revenue per trial or things like that to give us sort of a sense of where pricing is going?
Rodger Weismann
Yes. It’s roughly about $400,000 per ASP trials. That’s our average and once again it’s an average. Yes, some trials are $1 million, $1.2 million; we have others that are $175,000. The way that is determined is by the scope of the number of data items, it can bethe number of patients, the number of sites, the required number of eCRFs, and the number of rules. So itall comes out as an average of about $400,000 and that is up from about $325,000 in 2004.
So, we are seeing that as well. Also as I mentioned the number of patients, the number of investigators, the number of sites, because you have your help desk, you have your user fees and things like that. So, that’s the metrics that we use to determine our pricing.
The way it works on an enterprise license you take a number of their trials; you take the number of that average; you see what they are doing; what it looks like. And you essentially add it up to whatever millions of dollars that the customers are willing to commit.
Don Hooker - UBS
And one last little details in terms of central designer, which I recall there is some excitement around that, you mentioned there were 40 trials I think you mentioned running on that.
Robert K. Weiler
No, no. Let me correct that. There is two products they are talking about. Central Coding, which is what is used to take your EDC information and go against the [mederic] dictionaries. That’s a product that we announced last year, and that is Central Coding and there are 40 live of that. Our Central Designer, we announced in June, which is a tool to speed up the delivery; the building of trials in a collaborative environment is what was launched in June.
Don Hooker - UBS
Can you talk about how many customers are up on that now?
Robert K. Weiler
We aren’t going to talk about our customers. We will say that, we do have trials live resulting from being built in that product. And our goal through the end of 2008 is that allthe trials that we build will be on Central Designer, and that we would be expect the 100% by the fourth quarter, during the fourth quarter.
Operator
Your next question comes from the line of Steven Crowley - Craig-Hallum Capital Group.
Steven Crowley - Craig-Hallum Capital Group
First of all, Rodger and Bob, you talked about service being a bigger part of this train going forward given the tremendous success you had with ASP model and other service offerings. You also talked about some training curve issues. It sounded like that might be short-term in nature. I’m wondering how this all dovetailed into the specific margin expansion you might be able to see in service gross margins?
Robert K. Weiler
I indicated that we expected the service gross margin to basically increase every quarter. Now, it’s possible depending on the timing of certain deals within a quarter, things don’t necessarily go up exactly each quarter, but that’s our current expectation and what’s built into our current internal plan.
So that some of the step function increases that we made in Q3 and Q4 of this year 2007, we expect to get returns from, and some of those investments are sort of like straight lines. I mean, our example is we took advantage of some attractive pricing and bought kind of a three year license for software and sort of have big step-function increase when we bought it, but it stays level over time.
So, our service margin is inthe neighborhood, I think it was 37.5% inthe current quarter; this is the non-GAAP service margin. And I would expect that to be well north of 40% by the fourth quarter of 2008.
Steven Crowley - Craig-Hallum Capital Group
It seems like the training issue you mentioned is really just a short-term front-end issue also.
Rodger Weismann
Yes. I certainly hope it is, and if it’s not we’ll end up building it into our model that it takes a little longer to get people up to speed.
Steven Crowley - Craig-Hallum Capital Group
And the impact of Central Designer, it hasn’t been obvious inthe numbers so far. Might it become obvious over the next year?
Rodger Weismann
Well, I think it becomes obvious as probably one of the elements that will drive the service margin well north of 40% by the end of the year. There is a definite lag effect to that. Because when you start building the trials, using Designer doesn’t show up in revenue that savings until you actually go live. So there is a lag effect to when Bob’s comment that our goal is to have all new trials being built in Designer, even that effect will lag into 2009, because they are being built but they are not live yet.
Steven Crowley - Craig-Hallum Capital Group
Bob, as to Lincoln Technologies you made some very positive qualitative comments about the whole suite of quality and PharmacoVision’s products. It seems like there is –an interest in broader adoption. One of the keys to driving that market size is to get more quality drug safety products on more people’s desks at your customers. Where are we in that cycle and how does that translate to your business?
Robert K. Weiler
Well, I think it’s what people are doing with the trials and this could cause along so I’ll keep this brief. So we mentioned for instance the DoD, the Department of Defense, they’re not just doing regular trials; they are doing longitudinal trials, which is another whole avenue for people to be able to kind of look atthe data.
The DoD has the largest electronic medical record database inthe world, one database of all the military. And to be able to do longitudinal studies, to be able to mind that, and the enthusiasm which they are talking about that at the epidermal seminars is just catching on.
We have Barrier Ingleheim, Otsuka as new customers. So we’re seeing more and more of our new customers as well as existing customers taking the product, experimenting it, and following the adoption curve. So we think its gaining traction and the more and more people are out there talking about this is a good tool, I think benefits everyone.
Steven Crowley - Craig-Hallum Capital Group
Interest income was obviously a variable that’s surprising some of us with models. Have you had a major interest rate reset in your portfolio of investments or are you conservatively looking out ata future reset of where it’s down to 3.75%?
Rodger Weismann
Well, most of our portfolio is invested fairly short-term, and short-term rates have significantly declined over the last couple of months. Two months agoit was 5%, and now I think it’s down to like 4.3%, 4.2% ina lot of short-term paper and funds.
And so that already in a short period of time, it’s a fairly big drop and with the Fed fund rate drop yesterday, it could go down some more. And who knows what’s going to happen beyond that? So we just put a stake inthe ground for purposes of the forecasting and came up with 3.75%, but I don’t have a magic ball in interest rates for 2008.
Steven Crowley - Craig-Hallum Capital Group
So you are doing some conservative, logical prognostication, but prognostication nonetheless?
Rodger Weismann
Right.
Operator
Your next question comes from the line of Richard Davis - Needham.
Richard Davis - Needham
With regard to Virtusa, the relationship you announced on your Indian subsidiary that you created; I think it was like around Thanksgiving. Could you just give us a quick sense of your long-term vision for that market and early traction you’re seeing there?
Robert K. Weiler
The Virtusa opportunity is one where we’ve been using consultants inIndia to help us with a lot of the trial bill-type work. And one of the things that happens is what they do is as we get variations in our trials, they are able to absorb of that capacity for us.
One of the things that we realized that we want to expand that with our relation with Virtusa, we opened up our own subsidiary, started off with two to three people ina hybrid model where the Virtusan employees will turn over to Phase Forward employees. And we’re going to expand that as the capacity is needed.
So, the second part of it is that we recognize that as pharmaceutical companies are moving a lot of their data management, as the CROs are moving lot of their data management and functionalities to India, they are going to want to be serviced out of that. We want to make sure our organization is in place both there and here to meet that need. So, there’s no grandiose plans of moving a whole lot of people there or doing that. We’re just going to grow simultaneously to try to meet the market demand.
Operator
Your next question is from the line of Stephen Shankman - Natexis.
Stephen Shankman - Natexis
For 2008 revenue guidance, can you break out the expected contribution from GML?
Rodger Weismann
I think I indicated that there revenues were inthe neighborhood of a million dollars at the time of the acquisition and they won’t be much larger than that in 2008.
Stephen Shankman - Natexis
For full-year 2007 does foreign exchange have any significant impact on the top line?
Rodger Weismann
Yes. I think for the year I think that was about 3% impact on revenue.
Stephen Shankman - Natexis
Positive side.
Rodger Weismann
Yes, positive side.
Stephen Shankman - Natexis
And then any expectation for that in 2008, any internal modeling for that?
Rodger Weismann
No, I don’t have internal expectations on that for 2008. I mean, again, I have to get into forecasting exchange rates.
Stephen Shankman - Natexis
So basically the way you look at it, if you look at our current exchange rates they kind of run that forward throughout the year?
Rodger Weismann
Yes, exactly.
Operator
The next question comes from the line of Raghavan Sarathy - from Ferris Baker Watts.
Raghavan Sarathy - Ferris Baker Watts
Rodger, you said you’re expecting the services to increase to 70% of revenue by fourth quarter. Can you give us some sense where do you may start the year from the first quarter, it seems like you are looking at 5%?
Rodger Weismann
Actually, I think I said it could exceed 70% actually, it was not a 70% forecast for Q4. I just said it could exceed that by the end of the year. And so, the Q4 of last year was 64.7%. I think well nothing goes up in straight line or steady line on these things. But I would expect fairly rapid increase, like possibly a two percentage points shift every quarter.
Raghavan Sarathy - Ferris Baker Watts
And then in terms of the gross margin compression that you’re seeing, are you going to continue to invest at least in the first half of the year in the infrastructure?
Rodger Weismann
I also indicated that I thought the total gross margin would stay fairly constant through 2008 on a quarterly basis, even though again you get some fluctuations quarter-to-quarter. Since there is always investments going on, but in terms of disproportion investment, no, I don’t see that in the first half of 2008. So, I would expect by the second quarter we would see reasonably significant improvement inthe services margin.
Operator
At this time there are no more questions in the queue. And I would like to turn the call back over to management for closing remarks.
Robert K. Weiler
Thank you for joining us inthe call. Talk to you next quarter. Good evening.
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