Medidata Solutions, Inc.
Medidata Solutions, Inc. (Form: 10-Q, Received: 11/09/2012 06:05:06)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________
FORM 10-Q
  _____________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-34387
_____________________________________
Medidata Solutions, Inc.
(Exact name of registrant as specified in its charter)
  _____________________________________
Delaware
13-4066508
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
79 Fifth Avenue, 8th Floor
New York, New York
10003
(Address of principal executive offices)
(Zip Code)
(212) 918-1800
(Registrant’s telephone number, including area code)
  _____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     ý   Yes     ¨   No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     ý   Yes     ¨   No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
 
Accelerated filer
ý
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ¨   Yes     ý   No
As of October 31, 2012 , the registrant had 25,911,084 share s of common stock outstanding.


Table of Contents

MEDIDATA SOLUTIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
For the quarterly period ended September 30, 2012
Table of Contents
 
 
 
Page
PART I
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 


- i -

Table of Contents

PART I FINANCIAL INFORMATION
Item 1.     Financial Statements (Unaudited)
MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(Amounts in thousands, except per share data)
 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
37,404

 
$
45,214

Marketable securities
86,230

 
62,463

Accounts receivable, net of allowance for doubtful accounts of $688 and $882, respectively
31,627

 
22,970

Prepaid commission expense
2,032

 
1,743

Prepaid expenses and other current assets
7,853

 
4,380

Deferred income taxes
5,401

 
10,896

Total current assets
170,547

 
147,666

Restricted cash
388

 
388

Furniture, fixtures and equipment, net
9,233

 
9,825

Goodwill
15,386

 
15,164

Intangible assets, net
2,159

 
3,425

Deferred income taxes – long-term
11,563

 
11,581

Other assets
2,929

 
1,786

Total assets
$
212,205

 
$
189,835

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,640

 
$
3,861

Accrued payroll and other compensation
10,833

 
9,854

Accrued expenses and other
5,806

 
5,886

Deferred revenue
49,926

 
51,225

Capital lease obligations
57

 
114

Total current liabilities
70,262

 
70,940

Noncurrent liabilities:
 
 
 
Deferred revenue, less current portion
11,488

 
12,037

Deferred tax liabilities
627

 
629

Capital lease obligations, less current portion
114

 
136

Other long-term liabilities
1,004

 
1,976

Total noncurrent liabilities
13,233

 
14,778

Total liabilities
83,495

 
85,718

Commitments and contingencies

 

Stockholders’ equity:
 
 
 
Preferred stock, par value $0.01 per share; 5,000 shares authorized, none issued and outstanding

 

Common stock, par value $0.01 per share; 100,000 shares authorized, 26,247 and 25,053 shares issued; 25,890 and 24,888 shares outstanding, respectively
262

 
250

Additional paid-in capital
153,639

 
137,556

Treasury stock, 357 and 165 shares, respectively
(5,626
)
 
(2,186
)
Accumulated other comprehensive income (loss)
149

 
(362
)
Accumulated deficit
(19,714
)
 
(31,141
)
Total stockholders’ equity
128,710

 
104,117

Total liabilities and stockholders’ equity
$
212,205

 
$
189,835

The accompanying notes are an integral part of the condensed consolidated financial statements.

- 2 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands, except per share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues
 
 
 
 
 
 
 
Application services
$
43,973

 
$
35,940

 
$
123,910

 
$
108,372

Professional services
11,872

 
10,365

 
35,807

 
28,892

Total revenues
55,845

 
46,305

 
159,717

 
137,264

Cost of revenues(1)(2)
 
 
 
 
 
 
 
Application services
8,402

 
7,279

 
24,099

 
21,471

Professional services
7,497

 
6,224

 
22,190

 
18,476

Total cost of revenues
15,899

 
13,503

 
46,289

 
39,947

Gross profit
39,946

 
32,802

 
113,428

 
97,317

Operating costs and expenses:
 
 
 
 
 
 
 
Research and development(1)
11,239

 
7,306

 
31,822

 
21,511

Sales and marketing(1)(2)
12,147

 
8,788

 
34,793

 
26,519

General and administrative(1)
9,721

 
9,140

 
28,170

 
27,522

Total operating costs and expenses
33,107

 
25,234

 
94,785

 
75,552

Operating income
6,839

 
7,568

 
18,643

 
21,765

Interest and other (expense) income:
 
 
 
 
 
 
 
Interest expense
(71
)
 
(30
)
 
(120
)
 
(97
)
Interest income
65

 
64

 
196

 
227

Other (expense) income, net
(7
)
 
244

 
(17
)
 
242

Total interest and other (expense) income, net
(13
)
 
278

 
59

 
372

Income before income taxes
6,826

 
7,846

 
18,702

 
22,137

Provision for income taxes
2,773

 
364

 
7,275

 
1,472

Net income
$
4,053

 
$
7,482

 
$
11,427

 
$
20,665

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.32

 
$
0.47

 
$
0.88

Diluted
$
0.16

 
$
0.31

 
$
0.45

 
$
0.84

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
24,773

 
23,752

 
24,400

 
23,579

Diluted
25,682

 
24,491

 
25,292

 
24,683

(1)    Stock-based compensation expense included in cost of revenues and operating costs and expenses is as follows:
Cost of revenues
$
483

 
$
361

 
$
1,292

 
$
922

Research and development
289

 
226

 
787

 
523

Sales and marketing
761

 
553

 
2,128

 
1,464

General and administrative
1,318

 
1,297

 
3,956

 
3,564

Total stock-based compensation
$
2,851

 
$
2,437

 
$
8,163

 
$
6,473

(2)    Amortization of intangible assets included in cost of revenues and operating costs and expenses is as follows:
Cost of revenues
$
318

 
$
318

 
$
955

 
$
770

Sales and marketing
129

 
126

 
387

 
374

Total amortization of intangible assets
$
447

 
$
444

 
$
1,342

 
$
1,144

The accompanying notes are an integral part of the condensed consolidated financial statements.

- 3 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Amounts in thousands)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
4,053

 
$
7,482

 
$
11,427

 
$
20,665

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
423

 
(158
)
 
483

 
(45
)
Unrealized gain (loss) on marketable securities
49

 
(51
)
 
48

 
(89
)
Other comprehensive income (loss):
472

 
(209
)
 
531

 
(134
)
Income tax related to unrealized gain on marketable securities
(20
)
 

 
(20
)
 

Other comprehensive income (loss), net of tax
452

 
(209
)
 
511

 
(134
)
Comprehensive income, net of tax
$
4,505

 
$
7,273

 
$
11,938

 
$
20,531

The accompanying notes are an integral part of the condensed consolidated financial statements.

- 4 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in thousands)
 
Nine Months Ended
September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
11,427

 
$
20,665

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,997

 
5,902

Stock-based compensation
8,163

 
6,473

Amortization of discounts or premiums on marketable securities
1,032

 
944

Deferred income taxes
5,493

 
(113
)
Amortization of debt issuance costs
45

 
45

Excess tax benefit associated with equity awards
(957
)
 

Contingent consideration adjustment
277

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(5,689
)
 
14,949

Prepaid commission expense
(841
)
 
785

Prepaid expenses and other current assets
(2,538
)
 
318

Other assets
(1,525
)
 
(509
)
Accounts payable
(646
)
 
(251
)
Accrued payroll and other compensation
979

 
(2,920
)
Accrued expenses and other
388

 
(26
)
Deferred revenue
(4,652
)
 
(19,963
)
Other long-term liabilities
(251
)
 
(43
)
Net cash provided by operating activities
16,702

 
26,256

Cash flows from investing activities:
 
 
 
Purchases of furniture, fixtures and equipment
(3,923
)
 
(2,896
)
Purchases of available-for-sale securities
(84,758
)
 
(93,918
)
Proceeds from sale of available-for-sale securities
60,007

 
85,712

Acquisition of business, net of cash acquired

 
(5,166
)
Decrease in restricted cash

 
144

Net cash used in investing activities
(28,674
)
 
(16,124
)
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
6,975

 
2,202

Excess tax benefit associated with equity awards
957

 

Payment of acquisition-related earn-out
(251
)
 

Repayment of obligations under capital leases
(105
)
 
(605
)
Acquisition of treasury stock
(3,440
)
 
(1,712
)
Net cash provided by (used in) financing activities
4,136

 
(115
)
Net (decrease) increase in cash and cash equivalents
(7,836
)
 
10,017

Effect of exchange rate changes on cash and cash equivalents
26

 
7

Cash and cash equivalents – Beginning of period
45,214

 
16,025

Cash and cash equivalents – End of period
$
37,404

 
$
26,049

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
33

 
$
40

Income taxes
$
2,464

 
$
1,524

Noncash activities:
 
 
 
Furniture, fixtures and equipment acquired through capital lease obligations
$
26

 
$

Furniture, fixtures, and equipment acquired but not yet paid for at period-end
$
942

 
$
214

Issuance of notes payable in connection with acquisition-related earn-out payments
$
171

 
$

Contingent consideration associated with acquisition of business, at fair value
$

 
$
1,819

The accompanying notes are an integral part of the condensed consolidated financial statements.

- 5 -


MEDIDATA SOLUTIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 
1.    ORGANIZATION

Medidata Solutions, Inc. (the “Company”) provides cloud-based drug development solutions that optimize the efficiency of its customers’ clinical development processes. The Company’s solutions allow its customers to increase the value of their clinical development by more efficiently and effectively designing, planning and managing key aspects of the clinical trial process, including study and protocol design, trial planning and budgeting, site negotiation, clinical portal, trial management, randomization and trial supply management, clinical data capture and management, safety events capture, medical coding, clinical business analytics, and data flow and interoperability among multiple trial applications.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Except to the extent updated or described below, the Company’s significant accounting policies as of September 30, 2012 are the same as those at December 31, 2011 , which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 13, 2012.

Basis of Presentation — The accompanying interim condensed consolidated balance sheets as of September 30, 2012 and December 31, 2011 , the condensed consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 , the condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2012 and 2011 , and the condensed consolidated statements of cash flows for the nine months ended September 30, 2012 and 2011 are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the SEC for interim financial reporting. Accordingly, certain information and footnote disclosures have been condensed or omitted pursuant to SEC rules that would ordinarily be required by GAAP for complete financial statements. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes thereto for the fiscal year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2012.

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments consisting of normal recurring accruals considered necessary to present fairly the Company’s financial position as of September 30, 2012 , results of its operations for the three and nine months ended September 30, 2012 and 2011 , comprehensive income for the three and nine months ended September 30, 2012 and 2011 , and cash flows for the nine months ended September 30, 2012 and 2011 . The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 .

Revenue Recognition —The Company derives its revenues from the sale of application services and the rendering of professional services. The Company recognizes revenue when all of the following conditions are satisfied: (1) persuasive evidence of an arrangement exists; (2) service has been delivered to the customer; (3) amount of the fees to be paid by the customer is fixed or determinable; and (4) collection of the fees is reasonably assured or probable.

Application Services
The Company typically enters into multi-study and single-study arrangements that include the sale of software licenses that provide the customer the “right to use” the software, as well as hosting and other support services, to be provided over a specified term. Multiple study arrangements grant the customer the right to manage a predetermined number of clinical trials simultaneously for a term typically ranging from three to five years. Single-study arrangements allow customers to use the Company's technology on a per trial basis.

The Company provides its software as a service and recognizes revenues in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-10-S99,  Revenue Recognition-SEC Materials . Revenues from application service arrangements are recognized ratably over the term of the arrangement, beginning with the commencement of the arrangement term, which correlates with the activation of the hosting services, assuming all other revenue recognition criteria are met. The term of the arrangement includes optional renewal periods, if such renewal periods are likely to be exercised.
    

- 6 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

Revenue for multi-study arrangements and several of the Company's trial planning software solutions where the customer has the ability to self host, or the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to either run the software on its own hardware or contract with another unrelated party to host the software, is recognized in accordance with ASC 985-605, Software-Revenue Recognition.

Professional Services
The Company also provides a range of professional services that its customers have the ability to utilize on an as-needed basis. These services generally include training, implementation, interface creation, trial configuration, data testing, reporting, procedure documentation and other customer-specific services. Professional services do not result in significant alterations to the underlying software.

In certain situations, when professional services are sold separate and apart from application services, they are recognized as services are rendered, or using a proportional performance method based on services performed for fixed fee professional services.

Multiple-Element Arrangements
The Company may also enter into arrangements to provide a combination of its offerings of application services and professional services.

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13,  Multiple Deliverable Revenue Arrangements . ASU No. 2009-13 amended the guidance on arrangements with multiple deliverables under ASC 605-25,  Revenue Recognition-Multiple-Element Arrangements , to:

eliminate the separation criteria that requires entities to establish objective and reliable evidence of fair value for undelivered elements;

eliminate the residual allocation method which will be replaced by the relative selling price allocation method for all arrangements; and

establish a selling price hierarchy to help entities allocate arrangement consideration to the separate units of account. The selling price hierarchy is defined as follows:

Vendor-specific objective evidence (“VSOE”)—the price charged for a deliverable when it is sold separately.

Third-party evidence (“TPE”)—the price of the vendor's or any competitor's largely interchangeable products or services in standalone sales to similarly situated customers.

Estimated selling price (“ESP”)—the price best estimated by the vendor and at which the vendor would transact if the deliverable would have been sold by the vendor regularly on a standalone basis.

The Company adopted ASU No. 2009-13 on January 1, 2011. As a result, the revenues for the majority of the Company's multiple-element arrangements entered into or materially modified in 2011 or later are recognized in accordance with the provisions of ASU No. 2009-13.
 
To qualify as a separate unit of accounting under ASC 605-25, the delivered item must have value to the customer on a standalone basis. The significant deliverables under the Company's multiple-element arrangements are application services and professional services.


- 7 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

The Company determined that the application services have standalone value as such services are often sold separately without professional services. Since the Company provides cloud-based application services, the service components, including license, hosting and support, are combined and accounted for as a separate unit of accounting. The Company uses ESP to determine the selling pricing for application services when sold in multiple-element arrangements, as the Company does not have VSOE for these application services and TPE is not a practical alternative due to differences in features and functionality as compared with other companies' offerings.

The Company also determined that the professional services have standalone value because those services are sold separately by other vendors. The Company uses ESP to determine the selling price for professional services when sold in multiple-element arrangements. Due to insufficient reliable pricing data, the Company is unable to establish VSOE. While other vendors offer similar services, they represent a small component of the vendor's overall offerings. As a result, the Company is unable to reliably determine third party selling prices on a stand-alone basis.

The Company determines its single-point ESP for application services and professional services as follows:
Application services—the Company has developed an internal pricing tool that provides price quotes for application services configurations. Any new and potential customer application service arrangements must be priced through the utilization of the Company's internal pricing tool. The Company has established an internal committee to monitor compliance and evaluate pricing data on a periodic basis. This evaluation includes the review of actual historical pricing data, market conditions consideration and the review of pricing strategies and practices. Any necessary pricing modification made to the internal pricing tool is supported by the result of such evaluation. Accordingly, the Company's ESP for application services is obtained from this internal pricing tool.
Professional services—the Company evaluates internal historical professional services pricing data to determine average pricing rates by type of professional services rendered. These averages are utilized to determine ESP for professional services and are reviewed and updated at least annually.
The Company believes the effect of changes in either the selling price, or the method, or assumptions used to determine ESP for application services and professional services will not have significant effect on the allocation of the arrangement consideration as the ESP for the above deliverables are based on historical pricing data.

For multiple-element arrangements entered into or materially modified in 2011 or later, the Company allocates the arrangement consideration based on their related ESP. Revenues for deliverables under application services are recognized ratably over the term of the arrangement, beginning with the commencement of the arrangement term, which correlates with the activation of the hosting services, assuming all other revenue recognition criteria are met. Revenues for deliverables under professional services are recognized using a proportional performance method as services are rendered.

For multiple-element arrangements entered into prior to 2011, the Company accounts for these arrangements as a combined single unit of accounting, which include application services and professional services, and the related revenues are recognized ratably beginning with the commencement of the arrangement term, assuming all other remaining revenue recognition criteria are met. Revenues for any deliverables included in multiple-element arrangements that are within the scope of ASC 985-605 will continue to be recognized under such accounting standards.

The change in accounting policy in connection with the adoption of ASU No. 2009-13 accelerates the timing of professional services revenue recognition in multiple-element arrangements. For multiple-element arrangements entered into in 2011 or later, the Company recognizes professional services revenues as rendered, subject to the proportional performance methodology, as a separate unit of accounting. For multiple-element arrangements entered into prior to 2011 but materially modified in 2011 or later, the Company recognizes professional services revenues as rendered (based upon the proportional performance method) starting from the date of the modification, and any deferred professional services revenue, as previously required under the former accounting policy, is evaluated and potentially recognized as revenues based upon the completion of detailed review of the total consideration provided in the modified arrangement. See “Deferred Revenue” below for additional information. Finally, the change in accounting policy impacts application services revenue recognition in multiple-element arrangements to the extent that the start of revenue recognition for application services is not dependent upon the delivery of professional services, which was a requirement under the Company's former single unit of accounting revenue recognition policy for multiple-element arrangements.


- 8 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

For multiple-element arrangements entered into prior to 2011, management's estimate of fair value for professional services is used to derive a reasonable approximation for presenting application services and professional services separately in its consolidated financial statements.

Deferred Revenue
Deferred revenue consists of billings or payments received in advance of revenue recognition and is recognized as the revenue recognition criteria are met. Amounts that have been invoiced are initially recorded in accounts receivable and deferred revenue. The Company invoices its customers in accordance with the terms of the underlying contract, usually in installments in advance of the related service period. Accordingly, the deferred revenue balance does not represent the total contract value of outstanding arrangements. Payment terms are net 30 to 45 days. Deferred revenue that will be recognized during the subsequent 12-month period is recorded as current deferred revenue and the remaining portion as non-current deferred revenue.

In some instances, customers elect to renew their application services arrangements prior to the original termination date of the arrangement. The renewed application services agreement provides support for in-process clinical trials, and includes the “right to use” the software for initial clinical studies. As such, the unrecognized portion of the deferred revenue associated with the initial arrangement is aggregated with the consideration received upon renewal and recognized as revenues over the renewed term of the application services arrangements.

In connection with the adoption of ASU No. 2009-13 on January 1, 2011, the recognizable portion of any remaining deferred revenue associated with multiple-element arrangements that are materially modified in 2011 or later is calculated based on an allocation of the total arrangement consideration (which includes the consideration of the modified arrangement plus the remaining balance of deferred revenue) to the remaining deliverables on the basis of their relative selling price. If the total arrangement consideration exceeds the sum of the total selling prices for the remaining deliverables, the surplus is recognized as revenues in the period of modification. If the total arrangement consideration does not exceed the sum of the total selling prices for the remaining deliverables, the shortfall is considered a discount and allocated to the remaining deliverables utilizing a relative-selling price method.

Accounts Receivable — Accounts receivable are recorded at original invoice amount less an allowance that management believes will be adequate to absorb estimated losses on existing accounts receivable. The allowance is based on an evaluation of the collectability of accounts receivable and prior bad debt experience. Accounts receivable are written off when deemed uncollectible. Unbilled receivables consist of revenue recognized in excess of billings, substantially all of which is expected to be billed and collected within one year. As of September 30, 2012 and December 31, 2011, unbilled accounts receivable of $3.0 million and $0.8 million , respectively, are included in accounts receivable on the Company's consolidated balance sheets.

Income Taxes — The Company uses the asset and liability method of accounting for income taxes, as prescribed by ASC 740, Income Taxes , which recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
All of the taxes accrued on the Company's undistributed earnings from its foreign subsidiaries are included in U.S. current income taxes under Internal Revenue Code Section 956. As a result, no deferred income tax liability associated with the Company's undistributed earnings was recorded.
In addition, the Company follows ASC 740-10 for the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the consolidated financial statements. Under ASC 740-10, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.
 
For the provision for income taxes at interim periods, the Company follows ASC 740-270, Income Taxes — Interim Reporting , and has developed an estimate of the annual effective tax rate based upon the facts and circumstances known at the time. The Company’s effective tax rate is based on expected income, statutory rates and permanent differences applicable to the Company in the various jurisdictions in which the Company operates.

- 9 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

Segment Information — As defined by ASC 280, Segment Reporting , the Company operates as a single segment, as the chief operating decision maker makes operating decisions and assesses performance based on one single operating unit. The Company recorded revenues in the following geographic areas for the three and nine months ended September 30, 2012 and 2011 (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
United States of America
$
37,315

 
$
30,377

 
$
105,172

 
$
87,554

Japan
7,170

 
6,167

 
21,441

 
17,947

United Kingdom
3,821

 
1,866

 
9,775

 
9,809

Switzerland
2,955

 
2,390

 
8,779

 
7,881

Other
4,584

 
5,505

 
14,550

 
14,073

Total
$
55,845

 
$
46,305

 
$
159,717

 
$
137,264

Revenues by geographic area are presented based upon the country in which revenues were generated. No individual country other than the United States, Japan, the United Kingdom and Switzerland represented 5% or more of net revenues for any of the periods presented.
The following table summarizes long-term assets by geographic area as of September 30, 2012 and December 31, 2011 (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Long-term assets:
 
 
 
United States of America
$
33,460

 
$
33,697

United Kingdom
7,748

 
7,906

Japan
450

 
566

Total
$
41,658

 
$
42,169

 
Recently Issued Accounting Pronouncements — In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs . The amendments in this ASU generally represent clarification of ASC 820-10, Fair Value Measurements and Disclosures , but also include instances where a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements has changed. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The Company adopted ASU No. 2011-04 on January 1, 2012 and the adoption did not have a material impact on its consolidated financial statements.
 
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income , which removes the presentation options contained in ASC 220, Comprehensive Income , and requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the format of statement of operations used today, and the second statement would include components of other comprehensive income. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05, to defer indefinitely the effective date of the specific requirement to present items that are reclassified out of accumulated other comprehensive income to net income alongside their respective components of net income and other comprehensive income. All other provisions of ASU No. 2011-05 are effective for interim and annual periods beginning after December 15, 2011, and must be applied retrospectively for all periods presented in the financial statements. The Company adopted the applicable provisions of ASU No. 2011-05 on January 1, 2012. The adoption did not have a material impact on its consolidated financial statements other than merely a change in their presentation.
 

- 10 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment , which simplifies how entities test goodwill for impairment. ASU No. 2011-08 permits an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU No. 2011-08 is effective for interim and annual reporting periods beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU No. 2011-08 on January 1, 2012 and the adoption did not have a material impact on its consolidated financial statements.

3.    MARKETABLE SECURITIES
The Company manages its cash equivalents and marketable securities as a single investment portfolio that is intended to be available to meet the Company’s current cash requirements. Cash equivalents consist principally of investments in money market funds. Marketable securities, which the Company classifies as available-for-sale securities, primarily consist of high quality commercial paper, corporate bonds, U.S. government debt obligations, and bank certificates of deposit. Marketable securities with remaining effective maturities of twelve months or less from the balance sheet date are classified as short-term; otherwise, they are classified as long-term on the consolidated balance sheet. The following table provides the Company’s marketable securities by security type as of September 30, 2012 and December 31, 2011 (in thousands):
 
 
As of September 30, 2012
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Commercial paper and corporate bonds
$
62,087

 
$
17

 
$
(6
)
 
$
62,098

U.S. Treasury and U.S. government agency debt securities
21,423

 
7

 

 
21,430

Bank certificates of deposit
2,700

 
2

 

 
2,702

Total
$
86,210

 
$
26

 
$
(6
)
 
$
86,230

 
 
As of December 31, 2011
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Commercial paper and corporate bonds
$
44,168

 
$
1

 
$
(29
)
 
$
44,140

U.S. Treasury and U.S. government agency debt securities
13,122

 
5

 

 
13,127

Bank certificates of deposit
5,200

 

 
(4
)
 
5,196

Total
$
62,490

 
$
6

 
$
(33
)
 
$
62,463


Contractual maturities of the Company’s marketable securities as of September 30, 2012 and December 31, 2011 are summarized as follows (in thousands):
 
 
As of September 30, 2012
 
As of December 31, 2011
 
Cost
 
Estimated
Fair
Value
 
Cost
 
Estimated
Fair
Value
Due in one year or less
$
86,210

 
$
86,230

 
$
62,490

 
$
62,463

 
The following table provides the fair market value and the gross unrealized losses of the Company’s marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by security type as of September 30, 2012 and December 31, 2011 (in thousands):
 
 
In Loss Position for Less than 12 Months
 
As of September 30, 2012
 
As of December 31, 2011
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
Commercial paper and corporate bonds
$
26,882

 
$
(6
)
 
$
24,868

 
$
(29
)
Bank certificates of deposit

 

 
5,196

 
(4
)
Total
$
26,882

 
$
(6
)
 
$
30,064

 
$
(33
)

- 11 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)


None of the Company’s marketable securities has been in a continuous unrealized loss position for more than twelve months as of September 30, 2012 and December 31, 2011 .
At September 30, 2012 , the Company had an insignificant amount of gross unrealized losses primarily due to a decrease in the fair value of certain corporate bond securities. The Company regularly reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary include:
the length of time and extent to which fair value has been lower than the cost basis;
the financial condition, credit quality and near-term prospects of the investee; and
whether it is more likely than not that the Company will be required to sell the security prior to recovery.
As the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company has determined that the gross unrealized losses on such investments at September 30, 2012 are temporary in nature. Accordingly, the Company did not consider that its investments in marketable securities were other-than-temporarily impaired as of September 30, 2012 .
During the three and nine months ended September 30, 2012 , the Company did not record any net realized gains or losses from the sale of marketable securities. During the three and nine months ended September 30, 2011 , the Company recorded an insignificant amount of net realized losses and gains, respectively, from the sale of marketable securities.

4.    FAIR VALUE
ASC 820-10, Fair Value Measurements and Disclosures , establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value and enhances disclosure requirements for fair value measurements. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820-10 are described as follows:
 
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 - Other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, include:
quoted prices for similar assets or liabilities in active markets;
quoted prices for identical or similar assets or liabilities in markets that are not active;
inputs other than quoted prices that are observable for the asset or liability;
inputs that are derived principally from or corroborated by observable market data by correlation or other means.
If the asset or liability has a specified (contractual) term, the Level 2 inputs must be observable for substantially the full term of the asset or liability.
Level 3 - Unobservable inputs to the valuation methodology and significant to the fair value measurement for the asset or liability.
 

- 12 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

Financial assets (excluding cash balances) measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 are summarized as follows (in thousands):
 
 
As of September 30, 2012
 
As of December 31, 2011
 
Fair Value Measurement Using
 
Fair Value Measurement Using
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
24,823

 
$

 
$

 
$
24,823

 
$
28,637

 
$

 
$

 
$
28,637

Total cash equivalents
24,823

 

 

 
24,823

 
28,637

 

 

 
28,637

Commercial paper and corporate bonds

 
62,098

 

 
62,098

 

 
44,140

 

 
44,140

U.S. Treasury and U.S. government agency debt securities

 
21,430

 

 
21,430

 
5,510

 
7,617

 

 
13,127

Bank certificates of deposit

 
2,702

 

 
2,702

 

 
5,196

 

 
5,196

Total marketable securities

 
86,230

 

 
86,230

 
5,510

 
56,953

 

 
62,463

Total financial assets
$
24,823

 
$
86,230

 
$

 
$
111,053

 
$
34,147

 
$
56,953

 

 
$
91,100

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$

 
$

 
$
1,799

 
$
1,799

 
$

 
$

 
$
1,522

 
$
1,522


The Company’s financial assets that are measured at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy. Investments in money market funds and U.S. Treasury debt securities have been classified as Level 1 since these securities are valued based upon $1.00 net asset value per share or unadjusted quoted prices in active markets. Investments in commercial paper, corporate bonds, U.S. government agency debt securities, and bank certificates of deposit have been classified as Level 2 since these securities are valued based on quoted prices in less active markets or significant inputs which are directly or indirectly observable. The valuation techniques used to measure the fair values of corporate bonds, U.S. government agency debt securities, and bank certificates of deposit were derived from the inputs of market prices from multiple sources at each reporting period. The fair value was then determined based on a consensus price or a weighted average price for each security. For the remaining financial assets classified as Level 2, substantially all of the securities had a short maturity within one year with high credit ratings. Therefore, the valuation techniques used to measure the fair values were primarily derived from accretion of purchase price to its face value over the term of maturity or quoted market prices for similar instruments if available. During the nine months ended September 30, 2012 and 2011, there were no transfers of financial assets between Level 1 and Level 2.
The contingent consideration associated with acquisition-related earn-out payments (as described in Note 5, “Acquisition”) is classified as Level 3. The fair value of the contingent consideration was estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market. The significant inputs in the Level 3 measurement not supported by market activity included the Company’s probability assessments of expected future cash flows associated with its related acquisition during the earn-out payments measurement period, appropriately discounted considering the uncertainties associated with the obligation, and calculated in accordance with the terms of the purchase agreement. Significant assumptions include a discount rate of 11% , which is derived from the Company’s estimated weighted average cost of capital of 16% net of a 5% risk adjustment. Changes in the Company’s expectations related to the achievement of the performance-based criteria specified in the purchase agreement may affect these assumptions, resulting in an increase or decrease in the fair value of the contingent consideration liability.


- 13 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities during the first nine months of 2012 (in thousands):
 
 
Contingent
Consideration
 
 
Balance at January 1, 2012
$
1,522

Change in fair value
277

Balance at September 30, 2012
$
1,799

    
For the three and nine months ended September 30, 2012 , the Company recorded an adjustment of $0.1 million and $0.3 million , respectively, to the contingent consideration obligation as a result of the recurring measurement of its fair value at each reporting period using the income approach. This fair value adjustment was recorded in general and administrative expenses in the Company’s consolidated financial statements. During the third quarter of 2012, the triggering event for the calendar year 2012 contingent consideration measurement period was met. As a result, the $1.0 million portion of the contingent consideration associated with the earn-out which will become payable to the sellers on December 31, 2012 has been recorded in accrued expenses and other on the Company's consolidated balance sheet as of September 30, 2012 , with the remaining $0.8 million recorded in other long-term liabilities.
The carrying amounts of all other current financial assets and current financial liabilities reflected in the consolidated balance sheets approximate fair value due to their short-term nature. The Company does not have non-financial assets or liabilities that have been measured at fair value on a nonrecurring basis as of September 30, 2012 .

5.    ACQUISITION

On July 1, 2011, the Company acquired Clinical Force Limited (“Clinical Force”), a UK-based provider of clinical trial management systems (“CTMS”). With this acquisition, the Company expanded its service offerings to include a clinical trial management solution, which enables customers to reduce the financial and operational management burden of clinical trials, streamline clinical processes and increase visibility to timely information that enhances governance and decision making. In exchange for all outstanding shares of Clinical Force, the Company paid consideration consisting of $5.2 million cash at closing, plus additional performance-based earn-out payments of up to $2.6 million , which had a fair value of approximately $1.8 million as of the acquisition date. The earn-out payments are contingent upon the achievement of future billing targets for the CTMS application, calculated over three measuring periods beginning at December 31, 2011 and continuing for each of the next two calendar years thereafter.
In allocating the purchase price based on estimated fair values, the Company recorded $5.6 million of goodwill, $2.1 million of identifiable intangible assets, and $0.7 million of net liabilities. Clinical Force’s operations have been included in the Company’s consolidated financial statements since the date of acquisition on July 1, 2011.

6.    GOODWILL AND INTANGIBLE ASSETS
The change in the carrying amount of goodwill during the first nine months of 2012 is as follows (in thousands):
 
Balance as of January 1, 2012
$
15,164

Foreign currency translation adjustments
222

Balance as of September 30, 2012
$
15,386

 










- 14 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

    
Intangible assets are summarized as follows (in thousands):
 
 
As of September 30, 2012
 
As of December 31, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Acquired technology
$
4,095

 
$
(2,709
)
 
$
1,386

 
$
4,021

 
$
(2,023
)
 
$
1,998

Database
1,900

 
(1,726
)
 
174

 
1,900

 
(1,441
)
 
459

Customer relationships
2,064

 
(1,465
)
 
599

 
2,044

 
(1,076
)
 
968

Total
$
8,059

 
$
(5,900
)
 
$
2,159

 
$
7,965

 
$
(4,540
)
 
$
3,425


Annual amortization for the next five years is expected to be as follows (in thousands):
Remainder of year ending December 31, 2012
$
450

Years ending December 31,
 
2013
822

2014
540

2015
282

2016
46

2017
19


7.    STOCK-BASED COMPENSATION
In May 2012, the Company amended and restated the 2009 Long-Term Incentive Plan (as amended and restated, the “Plan”) to increase the number of shares of common stock that the Company may issue under the Plan by 1.5 million shares to a total of 4.0 million shares.

The Company accounts for the stock-based compensation in accordance with ASC 718, Compensation — Stock Compensation . For the three and nine months ended September 30, 2012 and 2011 , the components of stock-based compensation expense were summarized in the following table (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Stock options
$
1,057

 
$
1,092

 
$
3,002

 
$
3,205

Restricted stock awards
1,794

 
1,345

 
5,161

 
3,268

Total stock-based compensation
$
2,851

 
$
2,437

 
$
8,163

 
$
6,473

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes pricing model with the following weighted-average assumptions:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Expected volatility
46
%
 
51
%
 
46
%
 
50
%
Expected life
6 years

 
6 years

 
6 years

 
6 years

Risk-free interest rate
0.94
%
 
1.39
%
 
0.96
%
 
1.85
%
Dividend yield

 

 

 



- 15 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

The following table summarizes the activity under the stock option plans as of September 30, 2012 , and changes during the nine months then ended (in thousands, except per share data):
 
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term
(years)
 
Aggregate
Intrinsic
Value
Outstanding at January 1, 2012
2,355

 
$
13.70

 
 
 
 
Granted
396

 
27.71

 
 
 
 
Exercised
(787
)
 
8.86

 
 
 
 
Forfeited
(55
)
 
17.83

 
 
 
 
Expired
(7
)
 
19.22

 
 
 
 
Outstanding at September 30, 2012
1,902

 
$
18.48

 
7.46
 
$
43,793

Exercisable at September 30, 2012
1,047

 
$
15.23

 
6.36
 
$
27,505

Vested and expected to vest at September 30, 2012
1,842

 
$
18.29

 
7.41
 
$
42,755


The weighted-average grant-date fair value of stock options granted during the three months ended September 30, 2012 and 2011 was $15.85 and $9.19 , respectively. The weighted–average grant-date fair value of stock options granted during the nine months ended September 30, 2012 and 2011 was $12.34 and $10.78 , respectively. The total intrinsic value of stock options exercised during the three months ended September 30, 2012 and 2011 was $6.5 million and $1.1 million , respectively. The total intrinsic value of stock options exercised during the nine months ended September 30, 2012 and 2011 was $16.0 million and $4.7 million , respectively.
The following table summarizes the status of the Company’s nonvested restricted stock awards as of September 30, 2012 , and changes during the nine months then ended (in thousands, except per share data):
 
 
Number of
Shares
 
Weighted-
Average
Grant-Date
Fair Value
Nonvested at January 1, 2012
961

 
$
19.02

Granted
407

 
27.98

Vested
(316
)
 
18.08

Forfeited
(71
)
 
18.58

Nonvested at September 30, 2012
981

 
$
23.07

 
As of September 30, 2012 , there was a total of $29.2 million of unrecognized compensation cost related to all non-vested stock-based compensation awards granted, as recorded in accordance with ASC 718. This cost is expected to be recognized over a weighted-average remaining period of 2.89 years for stock options and 2.92 years for restricted stock awards. The total fair value of shares vested during the three months ended September 30, 2012 and 2011 was $1.8 million and $1.3 million , respectively. The total fair value of shares vested during the nine months ended September 30, 2012 and 2011 was $11.9 million and $8.1 million , respectively.

8.    EARNINGS PER SHARE
The Company follows ASC 260, Earnings Per Share , in calculating earnings per share. Basic earnings per share is calculated by dividing net income available to common stockholders by the weighted-average number of shares outstanding during the period. The holders of unvested restricted stock awards do not have nonforfeitable rights to dividends or dividend equivalents and therefore, such unvested awards do not qualify as participating securities and are excluded from the basic earnings per share calculation. Diluted earnings per share includes the determinants of basic net income per share and, in addition, gives effect to the potential dilution that would occur if securities or other contracts to issue common stock are exercised, vested or converted into common stock unless they are anti-dilutive.

- 16 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings per share for the three and nine months ended September 30, 2012 and 2011 are shown in the following table (in thousands, except per share data):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Numerator
 
 
 
 
 
 
 
Net income
$
4,053

 
$
7,482

 
$
11,427

 
$
20,665

Denominator
 
 
 
 
 
 
 
Denominator for basic earnings per share:
 
 
 
 
 
 
 
Weighted average common shares outstanding
24,773

 
23,752

 
24,400

 
23,579

Denominator for diluted earnings per share:
 
 
 
 
 
 
 
Dilutive potential common shares:
 
 
 
 
 
 
 
Stock options
656

 
610

 
636

 
822

Restricted stock awards
253

 
129

 
256

 
282

Weighted average common shares outstanding with assumed conversion
25,682

 
24,491

 
25,292

 
24,683

Basic earnings per share
$
0.16

 
$
0.32

 
$
0.47

 
$
0.88

Diluted earnings per share
$
0.16

 
$
0.31

 
$
0.45

 
$
0.84

Total number of anti-dilutive shares of stock options and nonvested stock excluded from calculation of diluted earnings per share
378

 
1,635

 
469

 
347


9.    INCOME TAXES
The Company’s effective tax rate for the three and nine months ended September 30, 2012 was 41% and 39% , respectively, and differed from the federal statutory rate of 35% primarily due to state and local income taxes.
The Company’s effective tax rate for the three and nine months ended September 30, 2011 was 5% and 7% , respectively, and differed from the federal statutory rate of 35% primarily due to state and local income taxes, stock-based compensation, and release of valuation allowance related to the expected utilization of previously valued attributes based on projected taxable income in 2011.
 
The Company had approximately $2.1 million of gross unrecognized tax benefits as of December 31, 2011 . For the nine months ended September 30, 2012 , there was no change relating to the Company’s tax positions. The Company's 2010 Federal income tax return is currently under examination by the IRS and it has yet to notify the Company if there are any issues relating to this examination.

10.    COMMITMENTS AND CONTINGENCIES

Legal Matters — The Company is subject to legal proceedings and claims that arise in the ordinary course of business. From time to time, third parties have asserted and may in the future assert intellectual property rights to technologies that are important to the Company’s business and have demanded and may in the future demand that the Company license their technology. The Company records an estimated liability for these matters when an adverse outcome is considered to be probable and can be reasonably estimated. Although the outcome of the litigation cannot be predicted with certainty and some lawsuits, claims, or proceedings may be disposed of unfavorably to the Company, which could materially and adversely affect its financial condition or results of operations, the Company does not believe that it is currently a party to any material legal proceedings.

- 17 -

MEDIDATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited)

On March 4, 2011, DataTrak International, Inc. filed a complaint for alleged patent infringement against the Company in DataTrak International v. Medidata Solutions, C.A. No. 1:11-cv-00458 in the U.S. District Court for the Northern District of Ohio. The complaint asserts infringement of U.S. Patent No. 7,464,087 (the “’087 Patent”), which claims a method and system for unifying data from a variety of sources. The complaint asserts that the Company infringes upon the patent owned without providing any details concerning the alleged infringement, and it seeks unspecified damages and injunctive relief. On October 28, 2011, the Company filed an application for ex parte reexamination of the ’087 Patent with the U.S. Patent and Trademark Office (the “PTO”). On December 16, 2011, the PTO issued a non-final rejection of the validity of all claims of the ’087 Patent. On the same date, the district court granted the Company’s motion to stay the case pending reexamination of the patent-in-suit. On April 6, 2012, the PTO issued its final office action rejecting all asserted claims of the ’087 Patent. In July 2012, DataTrak filed a notice of appeal to the Board of Patent Appeals and Interferences. If this appeal is not successful and the decision is ultimately upheld, it will result in the elimination of the litigation. The Company believes that it has valid defenses to the lawsuit and intends to defend itself vigorously in the event the stay of the case is lifted. The probability of a favorable or unfavorable outcome to the Company in the event the stay of the case is lifted is unknown nor can the liability that could potentially result from a negative outcome be reasonably estimated. As a result, the Company has not recorded any accrual associated with this litigation. Additionally, given the status of the proceedings, the complexities of the facts in dispute and the multiple claims involved, the Company is unable to estimate a range of loss related to this litigation.
On July 31, 2012, DataTrak was issued U.S. Patent No. 8,234,294 (the “’294 Patent”), which is closely related to the ’087 Patent previously asserted against the Company. On July 31, 2012, the Company filed a lawsuit against DataTrak in the U.S. District Court for the District of New Jersey seeking a declaratory judgment of patent invalidity and non-infringement concerning the ’294 Patent. The Company intends to vigorously pursue its claims and defenses concerning the ’294 Patent. The ultimate outcome of this litigation cannot presently be determined, nor can the liability that could potentially result from a negative outcome be reasonably estimated. As a result, the Company has not recorded any accrual associated with this litigation. Additionally, given the status of the proceedings, the complexities of the facts in dispute and the multiple claims involved, the Company is unable to estimate a range of loss related to this litigation.
Contractual Warranties — The Company typically provides contractual warranties to its customers covering its product and services. To date, any refunds provided to customers have been immaterial.
Change in Control Agreements — In January 2009, the Company entered into change in control agreements with its chief executive officer and certain other executive officers. These agreements provide for payments to be made to such officers upon involuntary termination of their employment by the Company without cause or by such officers for good reason as defined in the agreements, within a period of 2 years following a change in control. The agreements provide that, upon a qualifying termination event, such officers will be entitled to (a) a severance payment equal to the officer’s base salary plus target bonus amount; (b) continuation of health benefits for 12 months ; (c) immediate vesting of any remaining unvested equity awards; and (d) a tax gross up payment under Section 280G of the Internal Revenue Code sufficient to reimburse the officer for 50% of any excise tax payable as a result of any termination payments following a change in control, if applicable. In March 2012, the Company amended the agreements with its named executive officers to eliminate the tax gross-up payments.


- 18 -


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

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

- 19 -

Table of Contents

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

- 20 -

Table of Contents

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

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

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

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

- 21 -

Table of Contents

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

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

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






- 22 -

Table of Contents

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

Three Months Ended September 30, 2012 Compared with Three Months Ended September 30, 2011
Revenues
 
 
Three Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Application services
$
43,973

 
78.7
%
 
$
35,940

 
77.6
%
 
$
8,033

 
22.4
%
Professional services
11,872

 
21.3
%
 
10,365

 
22.4
%
 
1,507

 
14.5
%
Total revenues
$
55,845

 
100.0
%
 
$
46,305

 
100.0
%
 
$
9,540

 
20.6
%

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

- 23 -

Table of Contents

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

Cost of Revenues
 
Three Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Cost of revenues:
 
 
 
 
 
 
 
 
 
 
 
Application services
$
8,402

 
15.0
%
 
$
7,279

 
15.7
%
 
$
1,123

 
15.4
%
Professional services
7,497

 
13.4
%
 
6,224

 
13.4
%
 
1,273

 
20.5
%
Total cost of revenues
$
15,899

 
28.4
%
 
$
13,503

 
29.1
%
 
$
2,396

 
17.7
%

Total cost of revenues . Total cost of revenues increased $2.4 million, or 17.7%, to $15.9 million for the three months ended September 30, 2012 from $13.5 million for the same period in 2011.
Cost of application services revenues . Cost of application services revenues increased $1.1 million, or 15.4%, to $8.4 million for the three months ended September 30, 2012 from $7.3 million for the same period in 2011. The increase was primarily due to higher technology-related expenses associated with our multi-year software-related licenses and service contracts entered into during the second quarter of 2012. The increase was also driven by the increase in hosting costs resulting from increased headcount and outside consultants to support our business growth.
Cost of professional services revenues . Cost of professional services revenues increased $1.3 million, or 20.5%, to $7.5 million for the three months ended September 30, 2012 from $6.2 million for the same period in 2011. The increase was primarily driven by higher personnel-related costs resulting from an increase in headcount to support our high demand for servicing of new products as well as demand from our new customers. In addition, reimbursable travel and entertainment expenses were also higher due to an overall increase in professional services activities.

Operating Costs and Expenses
 
 
Three Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
11,239

 
20.1
%
 
$
7,306

 
15.8
%
 
$
3,933

 
53.8
%
Sales and marketing
12,147

 
21.8
%
 
8,788

 
19.0
%
 
3,359

 
38.2
%
General and administrative
9,721

 
17.4
%
 
9,140

 
19.7
%
 
581

 
6.4
%
Total operating costs and expenses
$
33,107

 
59.3
%
 
$
25,234

 
54.5
%
 
$
7,873

 
31.2
%

Total operating costs and expenses . Total operating costs and expenses increased $7.9 million, or 31.2%, to $33.1 million for the three months ended September 30, 2012 from $25.2 million for the same period in 2011. Costs increased in each department with the larger increases in research and development and sales and marketing.
Research and development expenses . Research and development expenses increased $3.9 million, or 53.8%, to $11.2 million for the three months ended September 30, 2012 from $7.3 million for the same period in 2011. The increase was primarily due to an increase in personnel-related costs of $2.7 million, which was attributable to significant increases in staffing levels in order to accelerate the enhancement and broadening of our product offerings. The increase was also due to higher consulting fees and rent expense. We believe our investments in research and development position us to capitalize on the opportunities we see in our markets.

- 24 -

Table of Contents

Sales and marketing expenses . Sales and marketing expenses increased $3.4 million, or 38.2%, to $12.2 million for the three months ended September 30, 2012 from $8.8 million for the same period in 2011. The increase was primarily due to higher personnel-related costs of $2.6 million, resulting from increased staffing levels associated with the expansion of the reach and capability of our global sales organization in support of our overall growth initiatives. In addition, sales incentive compensation costs were also higher as a result of higher sales performance versus a year ago. Higher travel-related costs in support of increased selling and marketing-related activities also impacted expenses.
General and administrative expenses . General and administrative expenses increased $0.6 million, or 6.4%, to $9.7 million for the three months ended September 30, 2012 from $9.1 million for the same period in 2011. The increase was primarily due to certain accounts receivable write-offs and costs associated with some value added investments in training to support our current pace of growth.
Income Tax Expense
Income tax expense increased $2.4 million to $2.8 million for the three months ended September 30, 2012 from $0.4 million for the same period in 2011. The increase was the result of a higher effective tax rate at 41% versus 5% a year ago, following the reversal of our valuation allowance in the fourth quarter of 2011. At September 30, 2011, we maintained a valuation allowance against the majority of our domestic net deferred tax assets. Our U.S. Federal income tax liability for the three months ended September 30, 2011 was substantially covered by our net operating loss carryforwards.

Nine Months Ended September 30, 2012 Compared with Nine Months Ended September 30, 2011
Revenues
 
 
Nine Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Application services
$
123,910

 
77.6
%
 
$
108,372

 
79.0
%
 
$
15,538

 
14.3
%
Professional services
35,807

 
22.4
%
 
28,892

 
21.0
%
 
6,915

 
23.9
%
Total revenues
$
159,717

 
100.0
%
 
$
137,264

 
100.0
%
 
$
22,453

 
16.4
%
Total revenues . Total revenues increased $22.4 million, or 16.4%, to $159.7 million for the nine months ended September 30, 2012 from $137.3 million for the same period in 2011. The increase in revenues was primarily due to a $15.5 million increase in revenues from application services and a $6.9 million increase in revenues from professional services. During the first nine months of 2012, we added 74 new customers, to reach a total of 333 customers as of September 30, 2012. At the start of 2012, we had approximately $135 million of 2012 full year application services backlog. As of September 30, 2012, the total 2012 remaining application services backlog was approximately $44 million .
Application services revenues . Revenues from application services increased $15.5 million, or 14.3%, to $123.9 million for the nine months ended September 30, 2012 from $108.4 million for the same period in 2011. The majority of the increase in application services revenues was derived from increased activity among our existing large customers and midmarket customers, primarily resulting from new studies and renewals. We also benefited from strong demand from both new and existing customers for multiple products. The revenues from products other than our principal offering, Medidata Rave, or non-Rave revenues, grew 145% compared with prior period. Our application services revenues for the nine months ended September 30, 2011 included a $2.5 million one-time revenue acceleration associated with two customer contract renewals as a result of our adoption of ASU No. 2009-13, of which $0.8 million was accelerated from future periods in 2011 and 2012. Excluding this impact, revenues from new customers accounted for 45% of the total year on year increase in application services revenues.
Professional services revenues . Revenues from professional services increased $6.9 million, or 23.9%, to $35.8 million for the nine months ended September 30, 2012 from $28.9 million for the same period in 2011. The increase in professional services revenues was due to high demand for servicing of new products. The majority of our professional services were recognized as delivered in current year as compared with the same period in prior year, following our adoption of ASU No. 2009-13 on January 1, 2011. Our professional services revenues for the nine months ended September 30, 2011 included a $3.5 million one-time revenue acceleration associated with two customer contract renewals as a result of our adoption of ASU No. 2009-13, of which $1.8 million was accelerated from future periods in 2011 and 2012. Excluding this impact, revenues from new customers accounted for 46% of the total increase in professional services revenues.

- 25 -

Table of Contents

Cost of Revenues
 
 
Nine Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Cost of revenues:
 
 
 
 
 
 
 
 
 
 
 
Application services
$
24,099

 
15.1
%
 
$
21,471

 
15.6
%
 
$
2,628

 
12.2
%
Professional services
22,190

 
13.9
%
 
18,476

 
13.5
%
 
3,714

 
20.1
%
Total cost of revenues
$
46,289

 
29.0
%
 
$
39,947

 
29.1
%
 
$
6,342

 
15.9
%
Total cost of revenues . Total cost of revenues increased $6.4 million, or 15.9%, to $46.3 million for the nine months ended September 30, 2012 from $39.9 million for the same period in 2011.
Cost of application services revenues . Cost of application services revenues increased $2.6 million, or 12.2%, to $24.1 million for the nine months ended September 30, 2012 from $21.5 million for the same period in 2011. The increase was primarily due to higher technology-related expenses associated with our multi-year software-related licenses and service contracts entered into during the second quarter of 2012. The increase was also driven by the increase in hosting costs resulting from increased headcount and outside consultants to support our business growth.
Cost of professional services revenues . Cost of professional services revenues increased $3.7 million, or 20.1%, to $22.2 million for the nine months ended September 30, 2012 from $18.5 million for the same period in 2011. The increase was primarily driven by higher personnel-related costs resulting from an increase in headcount to support our high demand for servicing of new products. In addition, reimbursable travel and entertainment expenses were also higher due to an overall increase in professional services activities.

Operating Costs and Expenses
 
 
Nine Months Ended September 30,
 
2012
 
2011
 
Change
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
%
 
(Amount in thousands)
Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
31,822

 
19.9
%
 
$
21,511

 
15.7
%
 
$
10,311

 
47.9
%
Sales and marketing
34,793

 
21.8
%
 
26,519

 
19.3
%
 
8,274

 
31.2
%
General and administrative
28,170

 
17.6
%
 
27,522

 
20.1
%
 
648

 
2.4
%
Total operating costs and expenses
$
94,785

 
59.3
%
 
$
75,552

 
55.1
%
 
$
19,233

 
25.5
%
Total operating costs and expenses . Total operating costs and expenses increased $19.2 million, or 25.5%, to $94.8 million for the nine months ended September 30, 2012 from $75.6 million for the same period in 2011. Costs increased in each department with the larger increases in research and development and sales and marketing.
Research and development expenses . Research and development expenses increased $10.3 million, or 47.9%, to $31.8 million for the nine months ended September 30, 2012 from $21.5 million for the same period in 2011. The increase was primarily due to an increase in personnel-related costs of $7.6 million, which was attributable to significant increases in staffing levels in order to accelerate the enhancement and broadening of our product offerings. The increase was also due to higher recruiting expenses driven by the increase in headcount, as well as higher consulting fees and rent expense. We believe our investments in research and development position us to capitalize on the opportunities we see in our markets.
Sales and marketing expenses . Sales and marketing expenses increased $8.3 million, or 31.2%, to $34.8 million for the nine months ended September 30, 2012 from $26.5 million for the same period in 2011. The increase was primarily due to higher personnel-related costs of $6.3 million, resulting from increased staffing levels associated with the expansion of the reach and capability of our global sales organization in support of our overall growth initiatives. In addition, sales incentive

- 26 -

Table of Contents

compensation costs were also higher as a result of higher sales performance versus a year ago. Higher travel-related costs and professional fees, in support of increased selling and marketing-related activities, also impacted expenses.
General and administrative expenses . General and administrative expenses increased $0.7 million, or 2.4%, to $28.2 million for the nine months ended September 30, 2012 from $27.5 million for the same period in 2011. The increase was primarily due to higher personnel-related costs driven by an increase in stock-based compensation cost, as well as an adjustment of the fair value of the acquisition-related contingent consideration liability. The increase was partially offset by lower legal fees resulting from our legal settlement with Datasci in December 2011.
Income Tax Expense
Income tax expense increased $5.8 million to $7.3 million for the nine months ended September 30, 2012 from $1.5 million for the same period in 2011. The increase was the result of a higher effective tax rate at 39% versus 7% a year ago, following the reversal of our valuation allowance in the fourth quarter of 2011. At September 30, 2011, we maintained a valuation allowance against the majority of our domestic net deferred tax assets. Our U.S. Federal income tax liability for the nine months ended September 30, 2011 was substantially covered by our net operating loss carryforwards.

Liquidity and Capital Resources
Our principal sources of liquidity were cash, cash equivalents and marketable securities of $123.6 million at September 30, 2012 and $107.7 million at December 31, 2011. Cash and cash equivalents decreased $7.8 million during the first nine months of 2012 primarily due to net purchases of marketable securities, partially offset by increased billings from our strong sales activities and collections from our accounts receivable, and proceeds from stock option exercises. We manage our cash equivalents and marketable securities as a single investment portfolio that is intended to be available to meet our current cash requirements. Cash equivalents substantially consist of investment in money market funds. Marketable securities, which we classify as available-for-sale securities, primarily consist of high quality commercial paper, corporate bonds, U.S. government debt obligations, and bank certificates of deposit. Marketable securities with remaining effective maturities of twelve months or less from the balance sheet date are classified as short-term; otherwise, they are classified as long-term on the consolidated balance sheet. Our investment policy for this investment portfolio generally requires investments in securities with less than one year to maturity.
We have a $10.0 million revolving line of credit under our senior secured credit facility, as amended, that matures in September 2013. Except for the $0.3 million reduction of the available amount due to standby letters of credit issued in connection with the office leases executed under our credit agreement, the revolving line of credit remains undrawn. As of September 30, 2012, approximately $9.7 million of the revolving line of credit was still available for future borrowings. Due to the structure of the credit agreement, any future borrowings under the revolving line of credit will be classified as a current liability. As of September 30, 2012, the effective interest rate for our senior secured credit facility, as amended, was 2.73% , if borrowing under the U.S. London Interbank Offer Rate, or LIBOR, option. We are in compliance with all covenants under our senior secured credit facility, as amended, as of September 30, 2012.