Medidata Solutions, Inc.
Medidata Solutions, Inc. (Form: 10-Q, Received: 11/03/2016 17:09:21)
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, 2016
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
_____________________________________
MEDIDATALOGOCOLOR63015A03.JPG
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.)
 
 
350 Hudson Street, 9th Floor
New York, New York
10014
(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
ý
 
Accelerated filer
¨
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, 2016 , the registrant had 57,633,313 shares of common stock outstanding.


Table of Contents

MEDIDATA SOLUTIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016
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.
 
 


- 1 -

Table of Contents

PART I - FINANCIAL INFORMATION
Item 1.     Financial Statements (Unaudited)

- 2 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
 
September 30,
2016
 
December 31, 2015
 
(Amounts in thousands, except per share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
65,165

 
$
49,562

Marketable securities
264,903

 
220,126

Accounts receivable, net of allowance for doubtful accounts of $2,064 and $1,992, respectively
114,886

 
90,590

Prepaid commission expense
2,830

 
1,670

Prepaid expenses and other current assets
22,301

 
21,165

Deferred income taxes
104

 
88

Total current assets
470,189

 
383,201

Restricted cash
5,759

 
5,755

Furniture, fixtures and equipment, net
54,296

 
51,043

Marketable securities – long-term
154,161

 
209,041

Goodwill
30,232

 
18,797

Intangible assets, net
5,489

 
1,172

Deferred income taxes – long-term
50,668

 
12,128

Other assets
14,972

 
3,043

Total assets
$
785,766

 
$
684,180

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,185

 
$
6,283

Accrued payroll and other compensation
24,740

 
23,744

Accrued expenses and other
20,394

 
15,469

Deferred revenue
77,252

 
75,582

Total current liabilities
123,571

 
121,078

Noncurrent liabilities:
 
 
 
1.00% convertible senior notes, net
259,851

 
249,487

Deferred revenue, less current portion
3,312

 
2,993

Deferred tax liabilities
446

 
414

Other long-term liabilities
19,475

 
26,052

Total noncurrent liabilities
283,084

 
278,946

Total liabilities
406,655

 
400,024

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; 200,000 shares authorized; 61,214 and 59,455 shares issued; 57,599 and 56,311 shares outstanding, respectively
612

 
594

Additional paid-in capital
403,765

 
364,973

Treasury stock, 3,615 and 3,144 shares, respectively
(113,070
)
 
(100,806
)
Accumulated other comprehensive loss
(3,715
)
 
(3,404
)
Retained earnings
91,519

 
22,799

Total stockholders’ equity
379,111

 
284,156

Total liabilities and stockholders’ equity
$
785,766

 
$
684,180


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

- 3 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(Amounts in thousands, except per share data)
Revenues
 
 
 
 
 
 
 
Subscription
$
101,560

 
$
88,878

 
$
288,288

 
$
251,556

Professional services
18,501

 
14,235

 
50,621

 
42,081

Total revenues
120,061

 
103,113

 
338,909

 
293,637

Cost of revenues (1)(2)
 
 
 
 
 
 
 
Subscription
16,095

 
12,489

 
46,024

 
36,316

Professional services
13,133

 
10,304

 
36,929

 
31,564

Total cost of revenues
29,228

 
22,793

 
82,953

 
67,880

Gross profit
90,833

 
80,320

 
255,956

 
225,757

Operating costs and expenses
 
 
 
 
 
 
 
Research and development (1)
28,028

 
24,192

 
84,523

 
68,622

Sales and marketing (1)(2)
27,789

 
25,881

 
80,856

 
75,923

General and administrative (1)
20,089

 
19,143

 
57,866

 
61,655

Total operating costs and expenses
75,906

 
69,216

 
223,245

 
206,200

Operating income
14,927

 
11,104

 
32,711

 
19,557

Interest and other income (expense)
 
 
 
 
 
 
 
Interest expense
(4,220
)
 
(4,038
)
 
(12,530
)
 
(11,993
)
Interest income
1,005

 
739

 
2,809

 
1,885

Other (expense) income, net
(7
)
 
3

 
(8
)
 
(65
)
  Total interest and other expense, net
(3,222
)
 
(3,296
)
 
(9,729
)
 
(10,173
)
Income before income taxes
11,705

 
7,808

 
22,982

 
9,384

Provision for income taxes
4,347

 
3,127

 
4,839

 
3,033

Net income
$
7,358

 
$
4,681

 
$
18,143

 
$
6,351

Earnings per share
 
 
 
 
 
 
 
Basic
$
0.13

 
$
0.09

 
$
0.33

 
$
0.12

Diluted
$
0.13

 
$
0.08

 
$
0.32

 
$
0.11

Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
55,670

 
53,933

 
55,395

 
53,615

Diluted
57,738

 
56,687

 
57,272

 
55,985

(1)    Stock-based compensation expense included in cost of revenues and operating costs and expenses is as follows:
Cost of revenues
$
1,154

 
$
1,246

 
$
3,603

 
$
3,805

Research and development
2,292

 
2,105

 
6,809

 
5,904

Sales and marketing
1,633

 
2,343

 
5,349

 
7,170

General and administrative
5,379

 
6,408

 
15,394

 
21,029

Total stock-based compensation
$
10,458

 
$
12,102

 
$
31,155

 
$
37,908

(2)    Amortization of intangible assets included in cost of revenues and operating costs and expenses is as follows:
Cost of revenues
$
314

 
$
79

 
$
707

 
$
438

Sales and marketing
84

 
30

 
193

 
89

Total amortization of intangible assets
$
398

 
$
109

 
$
900

 
$
527

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

- 4 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(Amounts in thousands)
Net income
$
7,358

 
$
4,681

 
$
18,143

 
$
6,351

Other comprehensive income (loss)
 
 
 
 
 
 
 
Foreign currency translation adjustments
(376
)
 
(564
)
 
(1,028
)
 
(391
)
Unrealized (loss) gain on marketable securities
(548
)
 
(389
)
 
1,159

 
(186
)
Other comprehensive (loss) income
(924
)
 
(953
)
 
131

 
(577
)
Income tax effect of unrealized gain or loss on marketable securities
139

 
155

 
(442
)
 
87

Other comprehensive loss, net of tax
(785
)
 
(798
)
 
(311
)
 
(490
)
Comprehensive income, net of tax
$
6,573

 
$
3,883

 
$
17,832

 
$
5,861


























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

- 5 -

Table of Contents

MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
Cash flows from operating activities
(Amounts in thousands)
 
Net income
$
18,143

 
$
6,351

 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
 
Amortization of intangible assets and depreciation
10,901

 
7,941

 
Stock-based compensation
31,155

 
37,908

 
Amortization of discounts or premiums on marketable securities
2,268

 
3,667

 
Deferred income taxes
3,768

 
(1,235
)
 
Amortization of debt issuance costs
959

 
958

 
Amortization of debt discount
9,405

 
8,859

 
Provision for doubtful accounts
863

 
539

 
Loss on fixed asset disposal
15

 

 
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
(32,414
)
 
(32,284
)
 
Prepaid commission expense
(3,096
)
 
374

 
Prepaid expenses and other current assets
(1,747
)
 
(5,268
)
 
Other assets
(5,443
)
 
1,814

 
Accounts payable
(1,883
)
 
(1,235
)
 
Accrued payroll and other compensation
863

 
3,376

 
Accrued expenses and other
10,525

 
1,644

 
Deferred revenue
10,661

 
22,842

 
Other long-term liabilities
(6,577
)
 
1,902

 
Net cash provided by operating activities
48,366

 
58,153

(1)
Cash flows from investing activities
 
 
 
 
Purchases of furniture, fixtures and equipment
(15,872
)
 
(11,017
)
 
Purchases of available-for-sale securities
(214,670
)
 
(207,126
)
 
Proceeds from sale of available-for-sale securities
223,664

 
190,656

 
Purchase of cost method investment
(4,000
)
 

 
Acquisition of business, net of cash acquired
(17,186
)
 

 
Net decrease (increase) in restricted cash
80

 
(464
)
 
Net cash used in investing activities
(27,984
)
 
(27,951
)
 
Cash flows from financing activities
 
 
 
 
Proceeds from exercise of stock options
4,269

 
5,770

 
Proceeds from employee stock purchase plan
5,190

 
4,675

 
Repayment of notes payable
(100
)
 
(32
)
 
Repayment of obligations under capital leases

 
(26
)
 
Acquisition of treasury stock
(14,437
)
 
(16,915
)
 
Net cash used in financing activities
(5,078
)
 
(6,528
)
(1)
Effect of exchange rate changes on cash and cash equivalents
299

 
(12
)
 
Net increase in cash and cash equivalents
15,603

 
23,662

 
Cash and cash equivalents – Beginning of period
49,562

 
39,517

 
Cash and cash equivalents – End of period
$
65,165

 
$
63,179

 
(1) As a result of the Company's early adoption of Accounting Standards Update No. 2016-09, which requires excess tax benefit on equity awards to be presented as an operating activity, the consolidated statement of cash flows for the nine months ended September 30, 2015 has been adjusted to reflect an offsetting increase of $1,706 thousand to net cash provided by operating activities and net cash used in financing activities. Refer to Note 1, "Summary of Significant Accounting Policies — Recently Adopted Accounting Pronouncements" for further information.





- 6 -



The accompanying notes are an integral part of the condensed consolidated financial statements.
MEDIDATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
 
Nine Months Ended September 30,
 
2016
 
2015
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
2,882

 
$
2,876

Income taxes
$
1,514

 
$
595

 
 
 
 
Noncash investing activities:
 
 
 
Furniture, fixtures, and equipment acquired but not yet paid for at period-end
$
1,833


$
2,682


































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

- 7 -

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


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Medidata Solutions, Inc., together with its consolidated subsidiaries (collectively, the "Company"), is the leading global provider of cloud-based solutions for clinical research in life sciences, offering platform technology that transforms clinical development and increases the value of its customers' research investments. The Company was organized as a New York corporation in June 1999 and reincorporated as a Delaware corporation in May 2000.
Except to the extent updated or described below, the Company’s significant accounting policies as of September 30, 2016 are the same as those at December 31, 2015 , which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed with the Securities and Exchange Commission (“SEC”) on February 29, 2016 .
Basis of Presentation — The accompanying interim condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015 , the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 , the condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2016 and 2015 , and the condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. 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 U.S. 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, 2015 included in the Company’s Annual Report on Form 10-K filed with the SEC on February 29, 2016 .
Except for the changes resulting from early adoption of Accounting Standards Update ("ASU") No 2016-09, which is described in the "Recently Adopted Accounting Pronouncements" section of this Note, 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, 2016 , results of its operations for the three and nine months ended September 30, 2016 and 2015 , comprehensive income for the three and nine months ended September 30, 2016 and 2015 , and cash flows for the nine months ended September 30, 2016 and 2015 . The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 .
Income Taxes The Company’s interim period provision for income taxes is computed by using an estimate of the annual effective tax rate, adjusted for discrete items taken into account in the relevant period, if any. Each quarter, the annual effective income tax rate is recomputed and if there are material changes in the estimate, a cumulative adjustment is made.
Accounts Receivable Accounts receivable are recorded at original invoice amount less an allowance that management believes will be adequate to absorb estimated losses on uncollectible accounts. This 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, 2016 and December 31, 2015 , unbilled accounts receivable of $14.1 million and $10.3 million , respectively, were included in accounts receivable on the Company's consolidated balance sheets. In general, there is a direct relationship between the Company's accounts receivable balance and its transaction volume.
Recently Adopted Accounting Pronouncements In August 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-15,  Presentation of Financial Statements—Going Concern . This new guidance formally establishes management's responsibility to evaluate at each reporting period whether there is substantial doubt about the entity's ability to continue as a going concern for a period of one year after the date the financial statements are issued, and to provide related footnote disclosures. ASU No. 2014-15 is effective for annual reporting periods ending after December 15, 2016, and for interim and annual periods thereafter. The Company will adopt ASU No. 2014-15 for the annual reporting period ending December 31, 2016, and the adoption is not expected to have a material impact on its consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. ASU No. 2015-03 requires that debt issuance costs be presented not as an asset but as a reduction of the carrying amount of the related debt liability, similar to a debt discount. ASU No. 2015-03 is effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods, with early adoption permitted. The Company adopted ASU No. 2015-03 retrospectively on January 1, 2016, and the adoption did not have a material impact on its consolidated financial statements, aside from a balance sheet reclassification. Refer to Note 6 , "Debt," for details.
In April 2015, the FASB issued ASU No. 2015-05,  Customer's Accounting for Fees Paid in a Cloud Computing Arrangement , which provides guidance on whether an entity should account for the fees paid as a customer under a cloud computing arrangement as a license of internal-use software or as a service contract. ASU No. 2015-05 is effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods, with early adoption permitted. The Company adopted ASU No. 2015-05 prospectively on January 1, 2016, and the adoption did not have a material impact on its

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

consolidated financial statements as the Company accounts for all subscription fees paid under its cloud computing arrangements as service contracts.
In May 2015, the FASB issued ASU No. 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). ASU No. 2015-07 removes the requirement to categorize within the fair value hierarchy those investments that are measured at fair value using net asset value per share as a practical expedient and requires that sufficient information be provided to permit reconciliation of the fair value of assets categorized within the fair value hierarchy to amounts presented on the balance sheets. ASU No. 2015-07 is effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods, with early adoption permitted. The Company adopted ASU No. 2015-07 retrospectively on January 1, 2016, and the adoption did not have a material impact on its consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liability, and classification on the statement of cash flows. ASU No. 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period; if an entity adopts the amendments in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. The Company's early adoption of ASU No. 2016-09 in the third quarter of 2016 impacted its consolidated financial statements as follows:
The new guidance requires excess tax benefits and tax deficiencies on equity awards, which were formerly recognized in additional paid-in capital, to be recognized in the income statement when the awards vest or are settled; adoption of this portion of ASU No. 2016-09 resulted in recognition of deferred tax assets for all excess tax benefits that had not been previously recognized because the related tax deduction had not reduced income taxes payable. This was effected through a $50.6 million cumulative-effect adjustment to opening retained earnings as of January 1, 2016.
The new guidance requires cash flows related to excess tax benefits, which were formerly classified as a financing activity on the statement of cash flows, to be classified as an operating activity; as a result of the adoption of ASU No. 2016-09, the Company has classified the excess tax benefit for the nine months ended September 30, 2016 as an operating activity on the statement of cash flows. Use of the permitted modified retrospective approach has resulted in an offsetting increase of $1.7 million to cash provided by operating activities and cash used in financing activities for the nine months ended September 30, 2015.
Recently Issued Accounting Pronouncements There have been no changes in the expected dates of adoption or estimated effects on the Company's consolidated financial statements of recently issued accounting pronouncements from those disclosed in the Company’s Annual Report on Form 10-K, except as described below.
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which enhances the reporting model for financial instruments by amending certain aspects of existing guidance on recognition, measurement, presentation, and disclosure to provide financial statement users with more decision-useful information. ASU No. 2016-01 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Company will adopt ASU No. 2016-01 on January 1, 2018, and is presently evaluating the impact of the adoption on its consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which replaces previous lease guidance in its entirety with Accounting Standards Codification ("ASC") 842, Leases. The new guidance requires lessees to recognize lease assets and lease liabilities for those arrangements classified as operating leases under previous guidance, with the exception of leases with a term of twelve months or less. The new guidance also adds quantitative and qualitative disclosure requirements around leasing activities. ASU No. 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, and requires a modified retrospective approach. Early adoption is permitted. The Company will adopt ASU No. 2016-02 on January 1, 2019, and is presently evaluating the impact of the adoption on its consolidated financial statements.
In August 2015, the FASB issued ASU No. 2016-15, Cash Flows - Classification of Certain Cash Receipts and Cash Payments , which addresses the diversity in practice around presentation of certain cash receipts and payments in the statement of cash flows. ASU No. 2016-15 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Company does not expect the adoption to have a material impact on its consolidated financial statements and may consider early adoption, which is permitted in any interim or annual period.

- 9 -

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

2. STOCKHOLDERS' EQUITY
Common Stock — Common stockholders are entitled to one vote for each share of common stock held. Common stockholders may receive dividends if and when the Board of Directors determines, at its sole discretion.
Treasury Stock — From time to time, the Company grants nonvested restricted stock awards ("RSAs"), restricted stock units ("RSUs"), and performance-based restricted stock units ("PBRSUs") to its employees pursuant to the terms of its Second Amended and Restated 2009 Long-Term Incentive Plan (the “2009 Plan”). Under the provisions of the 2009 Plan, unless otherwise elected, participants fulfill their related income tax withholding obligation by having shares withheld at the time of vesting. On the date of vesting, the Company divides the participant's income tax withholding obligation in dollars by the closing price of its common stock and withholds the resulting number of vested shares. The shares withheld are then transferred to the Company's treasury stock at cost for future reissuance. During the nine months ended September 30, 2016 and 2015 , the Company withheld 338,523 shares at an average price of $36.22 and 338,792 shares at an average price of $50.27 , respectively, in connection with the vesting of equity awards.
Nonvested RSAs forfeited by plan participants are transferred to the Company's treasury stock at par. During the nine months ended September 30, 2016 and 2015 , 132,626 and 80,752 forfeited shares, respectively, were transferred to treasury stock at their par value of $0.01 .
3. INVESTMENTS
Marketable Securities
Marketable securities, which the Company classifies as available-for-sale securities, primarily consist of high quality commercial paper, corporate bonds, and U.S. government debt obligations. 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, 2016 and December 31, 2015 (in thousands):
 
As of September 30, 2016
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Commercial paper and corporate bonds
$
386,881

 
$
33

 
$
(471
)
 
$
386,443

U.S. government agency debt securities
32,639

 

 
(18
)
 
32,621

Total
$
419,520

 
$
33

 
$
(489
)
 
$
419,064

 
As of December 31, 2015
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Commercial paper and corporate bonds
$
401,824

 
$

 
$
(1,522
)
 
$
400,302

U.S. government agency debt securities
28,958

 
2

 
(95
)
 
28,865

Total
$
430,782

 
$
2

 
$
(1,617
)
 
$
429,167

Contractual maturities of the Company’s marketable securities as of September 30, 2016 and December 31, 2015 are summarized as follows (in thousands):
 
As of September 30, 2016
 
As of December 31, 2015
 
Cost
 
Estimated
Fair
Value
 
Cost
 
Estimated
Fair
Value
Due in one year or less
$
265,154

 
$
264,903

 
$
220,492

 
$
220,126

Due in one to five years
154,366

 
154,161

 
210,290

 
209,041

Total
$
419,520

 
$
419,064

 
$
430,782

 
$
429,167

At September 30, 2016 , the Company had $0.5 million of gross unrealized losses primarily due to a decrease in the fair value of certain corporate bonds.

- 10 -

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

The Company regularly reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Investments that are impaired are those that are considered to have losses that are other-than-temporary. 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 until maturity, the Company has determined that the gross unrealized losses on such investments at September 30, 2016 are temporary in nature. Accordingly, the Company did not consider its investments in marketable securities to be other-than-temporarily impaired as of September 30, 2016 .
The following tables provide the fair market value and the gross unrealized losses of the Company's marketable securities with unrealized losses, aggregated by security type, as of September 30, 2016 and December 31, 2015 (in thousands):
 
In Loss Position for Less than 12 Months
 
As of September 30, 2016
 
As of December 31, 2015
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
Commercial paper and corporate bonds
$
259,180

 
$
(364
)
 
$
359,566

 
$
(1,443
)
U.S. government agency debt securities
22,824

 
(15
)
 
25,863

 
(95
)
Total
$
282,004

 
$
(379
)
 
$
385,429

 
$
(1,538
)
 
In Loss Position for More than 12 Months
 
As of September 30, 2016
 
As of December 31, 2015
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
Commercial paper and corporate bonds
$
82,509

 
$
(107
)
 
$
38,726

 
$
(79
)
U.S. government agency debt securities
4,797

 
(3
)
 

 

Total
$
87,306

 
$
(110
)
 
$
38,726

 
$
(79
)
During the three and nine months ended September 30, 2016 and 2015 , the Company recorded an insignificant amount of net realized gains from the sale of marketable securities.
Cost Method Investment
In August 2016, the Company purchased shares of Series B Preferred Stock of SHYFT Analytics, Inc. ("SHYFT") via a private placement. This investment is accounted for under the cost method and is included in other assets on the Company's consolidated balance sheet as of September 30, 2016 at its purchase price of $4.0 million .
The Company's vice chairman, Steven Hirschfeld, has served on the board of directors of SHYFT since 2014 in an individual capacity and not as a representative of the Company.

- 11 -

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

4. FAIR VALUE
The following table summarizes, as of September 30, 2016 and December 31, 2015 , our financial assets that are measured at fair value on a recurring basis, according to the fair value hierarchy described in our significant accounting policies included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (in thousands):
 
As of September 30, 2016
 
As of December 31, 2015
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
Cash
62,867

 

 
62,867

 
48,917

 

 
48,917

Money market funds
2,298

 

 
2,298

 
645

 

 
645

Commercial paper

 

 

 

 

 

Total cash and cash equivalents
65,165

 

 
65,165

 
49,562

 

 
49,562

Commercial paper and corporate bonds

 
386,443

 
386,443

 

 
400,302

 
400,302

U.S. government agency debt securities

 
32,621

 
32,621

 

 
28,865

 
28,865

Total marketable securities

 
419,064

 
419,064

 

 
429,167

 
429,167

Total financial assets measured at fair value on a recurring basis
65,165

 
419,064

 
484,229

 
49,562

 
429,167

 
478,729

As of September 30, 2016 and December 31, 2015 , the Company had no financial liabilities measured at fair value on a recurring basis, and none of its financial assets measured at fair value on a recurring basis relied upon Level 3 inputs.
Investments in commercial paper, corporate bonds, and U.S. government agency debt securities have been classified as Level 2 as they are valued using quoted prices in less active markets or other directly or indirectly observable inputs. Fair values of corporate bonds and U.S. government agency debt securities were derived from a consensus or weighted-average price based on input of market prices from multiple sources at each reporting period. With regard to commercial paper, all of the securities had high credit ratings and one year or less to maturity; therefore, fair value was derived from accretion of purchase price to face value over the term of maturity or quoted prices for similar instruments if available. During the nine months ended September 30, 2016 and 2015 , there were no transfers of financial assets between Level 1 and Level 2.
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.
5. GOODWILL AND INTANGIBLE ASSETS
On April 1, 2016 , the Company acquired Intelemage, LLC ("Intelemage"), a medical image sharing and workflow management company for a net purchase price of $17.2 million , broadening its offerings with the addition of digital image management technology. The acquisition resulted in the recognition of the following intangible assets (in thousands):
 
 
Acquisition-Date Fair Value
 
Weighted-Average Useful Life
Acquired technology
 
$
3,750

 
4 years
Customer relationships
 
1,472

 
6 years
Total
 
$
5,222

 
 
The change in the carrying amount of goodwill during the nine months ended September 30, 2016 was as follows (in thousands):
Balance as of January 1, 2016
$
18,797

Additions related to acquisition of Intelemage
$
12,007

Foreign currency translation adjustments
(572
)
Balance as of September 30, 2016
$
30,232


- 12 -

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

Total intangible assets are summarized as follows (in thousands):
 
As of September 30, 2016
 
As of December 31, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Acquired technology
$
8,780

 
$
(4,851
)
 
$
3,929

 
$
5,223

 
$
(4,336
)
 
$
887

Customer relationships
3,585

 
(2,116
)
 
1,469

 
2,165

 
(1,994
)
 
171

Non-competition agreements
150

 
(59
)
 
91

 
150

 
(36
)
 
114

Total
$
12,515

 
$
(7,026
)
 
$
5,489

 
$
7,538

 
$
(6,366
)
 
$
1,172

Amortization of intangible assets for the next five years is expected to be as follows (in thousands):
Remainder of year ending December 31, 2016
$
398

Years ending December 31,
 
2017
1,569

2018
1,488

2019
1,230

2020
498

2021
245

6. DEBT
The Company's 1.00% convertible senior notes (the "Notes"), issued in August 2013, consisted of the following components as of September 30, 2016 and December 31, 2015 (in thousands):
 
September 30,
2016
 
December 31,
2015
Equity component, net of equity issue costs
$
60,222

 
$
60,222

Liability component:
 
 
 
Principal
287,500

 
287,500

Less: unamortized debt discount
(25,307
)
 
(34,712
)
Less: unamortized debt issuance costs
(2,342
)
 
(3,301
)
Net carrying amount
$
259,851

 
$
249,487

On January 1, 2016, the Company retrospectively adopted ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires unamortized debt issuance costs to be presented as a reduction of the carrying amount of the related debt liability, similar to a debt discount. This resulted in the reclassification of $3.3 million in unamortized debt issuance costs from other assets to 1.00% convertible senior notes on the Company's consolidated balance sheet as of December 31, 2015 .
As of September 30, 2016 and December 31, 2015 , the estimated fair value of the Notes was $332.9 million and $313.0 million , respectively. The Company considers this disclosure to be a Level 2 measurement because it is based upon a recent modeled bid-price quote for the Notes, reflecting activity in a less than active market. As of September 30, 2016 , the Notes are not convertible. Based on the closing price of the Company's common stock on September 30, 2016 of $55.76 , which is less than the Notes' initial conversion price of $58.05 , the if-converted value of the Notes was less than their principal amount.
As of September 30, 2016 , the remaining life of the Notes was approximately 22 months .

- 13 -

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

The following table sets forth total interest expense recognized related to the Notes for the three and nine months ended September 30, 2016 and 2015 (in thousands except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Contractual interest expense
$
718

 
$
719

 
$
2,156

 
$
2,156

Amortization of debt issuance costs
320

 
319

 
959

 
958

Amortization of debt discount
3,181

 
2,997

 
9,405

 
8,859

Total
$
4,219

 
$
4,035

 
$
12,520

 
$
11,973

 
 
 
 
 
 
 
 
Effective interest rate
6.5
%
 
6.5
%
 
6.5
%
 
6.5
%
7. STOCK-BASED COMPENSATION
For the three and nine months ended September 30, 2016 and 2015 , the components of stock-based compensation expense were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Stock options
$
947

 
$
1,070

 
$
3,000

 
$
3,906

Restricted stock awards and units
6,571

 
5,031

 
18,312

 
14,334

Performance-based restricted stock units
2,264

 
4,964

 
7,133

 
16,546

Employee stock purchase plan
676

 
1,037

 
2,710

 
3,122

Total stock-based compensation
$
10,458

 
$
12,102

 
$
31,155

 
$
37,908

Stock Options
The fair value of each stock option granted during the three and nine months ended September 30, 2016 and 2015 was estimated on the date of grant using a Black-Scholes pricing model with the following weighted-average assumptions:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Expected volatility
44
%
 
43
%
 
43
%
 
43
%
Expected life
6 years

 
6 years

 
6 years

 
6 years

Risk-free interest rate
1.20
%
 
1.69
%
 
1.42
%
 
1.69
%
Dividend yield

 

 

 

The following table summarizes the status of the Company's stock options as of September 30, 2016 , 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, 2016
1,940

 

$21.73

 
 
 
 
Granted
134

 
41.33

 
 
 
 
Exercised
(238
)
 
17.89

 
 
 
 
Forfeited
(6
)
 
40.54

 
 
 
 
Expired
(22
)
 
58.09

 
 
 
 
Outstanding at September 30, 2016
1,808

 

$23.18

 
5.37
 

$59,233

Exercisable at September 30, 2016
1,413

 

$17.13

 
4.48
 

$54,809

Vested and expected to vest at September 30, 2016
1,759

 

$22.59

 
5.27
 

$58,682


- 14 -

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

The weighted-average grant-date fair value of stock options granted during the three months ended September 30, 2016 and 2015 was $23.15 and $19.99 , respectively. The weighted-average grant-date fair value of stock options granted during the nine months ended September 30, 2016 and 2015 was $17.92 and $21.81 , respectively. The total intrinsic value of stock options exercised during the three months ended September 30, 2016 and 2015 was $4.4 million and $1.7 million , respectively. The total intrinsic value of stock options exercised during the nine months ended September 30, 2016 and 2015 was $7.4 million and $14.1 million , respectively. The total fair value of stock options vested during the three months ended September 30, 2016 and 2015 was $1.7 million and $1.1 million , respectively. The total fair value of stock options vested during the nine months ended September 30, 2016 and 2015 was $3.8 million and $3.5 million , respectively. As of September 30, 2016 , there was $6.8 million in unrecognized compensation cost related to all non-vested stock options granted. This cost is expected to be recognized over a weighted-average remaining period of 2.55 years .
R estricted Stock Awards and Units
The following table summarizes the status of the Company’s nonvested time-based RSAs and RSUs as of September 30, 2016 , 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, 2016
1,355

 

$40.82

Granted
1,138

 
37.90

Vested
(481
)
 
33.94

Forfeited
(138
)
 
41.76

Nonvested at September 30, 2016
1,874

 

$40.75

The total fair value of RSAs and RSUs vested during the three months ended September 30, 2016 and 2015 was $1.5 million and $2.1 million , respectively. The total fair value of RSAs and RSUs vested during the nine months ended September 30, 2016 and 2015 was $18.4 million and $29.3 million , respectively. As of September 30, 2016 , there was $60.4 million in unrecognized compensation cost related to all nonvested RSAs and RSUs granted. This cost is expected to be recognized over a weighted-average remaining period of 2.72 years .
Performance-Based Restricted Stock Units
No PBRSUs were granted during the three months ended September 30, 2016 and 2015 .
During the nine months ended September 30, 2016 , the Company granted 223 thousand PBRSUs ("2016 TSR PBRSUs") with market conditions based on the Company's total stockholder return ("TSR") relative to that of the Russell 2000 Index over the three-year period ending December 31, 2018, vesting in full in three years with the number of PBRSUs ultimately earned ranging from zero to 200% of the target number of shares . The Company also granted an insignificant number of other PBRSUs with performance conditions based on achievement of certain individual performance objectives.
During the nine months ended September 30, 2015 , the Company granted 242 thousand PBRSUs ("2015 TSR PBRSUs") with market conditions based on the Company's TSR relative to that of the Russell 2000 Index over the one-, two-, and three-year periods ending December 31, 2015, 2016, and 2017, respectively, vesting in equal parts over three years with the number of PBRSUs ultimately earned ranging from zero to 200% of the target number of shares .
The fair value of PBRSUs with market conditions granted during the nine months ended September 30, 2016 and 2015 was estimated as of the date of grant using a Monte Carlo valuation model with the following weighted average assumptions:
 
2016 TSR PBRSUs
 
2015 TSR PBRSUs
Expected volatility - Medidata
48
%
 
46
%
Expected volatility - comparison index
43
%
 
41
%
Expected life
2.84 years

 
2.88 years

Risk-free interest rate
0.91
%
 
0.99
%
Dividend yield

 


- 15 -

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

The following table summarizes the status of the Company’s PBRSUs based upon expected performance as of September 30, 2016 , and changes during the nine months then ended (in thousands, except per share data):
 
Revenue
 
TSR
 
Other
 
Total Number of Shares
 
Weighted-Average Grant Date Fair Value
Nonvested at January 1, 2016
136

 
347

 
7

 
490

 
$
49.86

Granted (based on performance at 100% of targeted levels)

 
223

 
16

 
239

 
46.45

Adjustment related to expected performance

 
215

 

 
215

 
56.48

Vested
(136
)
 
(164
)
 
(2
)
 
(302
)
 
38.50

Forfeited

 
(6
)
 
(1
)
 
(7
)
 
65.23

Nonvested at September 30, 2016

 
615

 
20

 
635

 
$
56.05

The total fair value of PBRSUs vested during the three months ended September 30, 2016 and 2015 was $0.1 million and $0.1 million , respectively. The total fair value of PBRSUs vested during the nine months ended September 30, 2016 and 2015 was $10.1 million and $10.7 million , respectively. As of September 30, 2016 , there was $12.6 million in unrecognized compensation cost related to all nonvested PBRSUs. This cost is expected to be recognized over a weighted-average remaining period of 1.60 years .
Employee Stock Purchase Plan
The fair value of shares granted under the Company's employee stock purchase plan ("ESPP") was estimated using a Black-Scholes pricing model with the following weighted-average assumptions:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Expected volatility
41
%
 
49
%
 
42
%
 
49
%
Expected life
1.35 years

 
1.45 years

 
1.46 years

 
1.49 years

Risk-free interest rate
0.54
%
 
0.35
%
 
0.53
%
 
0.34
%
Dividend yield

 

 

 

During the nine months ended September 30, 2016 , 89 thousand shares were purchased under the ESPP at a weighted-average price of $38.35 . During the nine months ended September 30, 2015 , 86 thousand shares were purchased under the ESPP at a weighted-average price of $37.93 . No shares were purchased under the ESPP during the three months ended September 30, 2016 and 2015 . As of September 30, 2016 , there was $5.4 million in unrecognized compensation cost related to ESPP shares. This cost is expected to be recognized over a weighted-average remaining period of 1.59 years .
During the second quarter of 2016, the Company increased the number of shares reserved under the ESPP from 0.3 million to 0.8 million .
Modifications
Net incremental expense associated with modifications to stock options, RSAs, RSUs, and PBRSUs during the three and nine months ended September 30, 2016 was $0.1 million and $0.5 million in the aggregate, respectively, and immaterial on an individual basis.
No equity awards were modified during the three months ended September 30, 2015 . During the nine months ended September 30, 2015 , net incremental expense associated with modifications was $1.3 million as a result of the Company's CFO transition in the second quarter of 2015.

- 16 -

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

8. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The changes in the balances of each component of accumulated other comprehensive loss during the nine months ended September 30, 2016 are as follows (in thousands):
 
Foreign currency translation adjustments
 
Unrealized gains (losses) on marketable securities
 
Total
Balance as of January 1, 2016
$
(2,405
)
 
$
(999
)
 
$
(3,404
)
Other comprehensive income, net of tax
(1,028
)
 
717

 
(311
)
Balance as of September 30, 2016
$
(3,433
)
 
$
(282
)
 
$
(3,715
)
For the nine months ended September 30, 2016 and 2015 , reclassifications of items from accumulated other comprehensive loss to net income were insignificant.
9. 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 RSAs 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 antidilutive. As the Company intends to settle the principal amount of the Notes (see Note 6 , "Debt") in cash upon conversion, their dilutive effect, if any, will be reflected in diluted earnings per share using the treasury stock method, which considers the number of shares that would be required to settle any premium above principal at the average stock price for the period. During the three and nine months ended September 30, 2016 and 2015 , the average price of the Company's stock was below the conversion price of the Notes; as a result the Notes were not dilutive for these periods.
A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015 is shown in the following table (in thousands, except per share data):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Numerator
 
 
 
 
 
 
 
Net income
$
7,358

 
$
4,681

 
$
18,143

 
$
6,351

Denominator
 
 
 
 
 
 
 
Denominator for basic earnings per share:
 
 
 
 
 
 
 
Weighted average common shares outstanding
55,670

 
53,933

 
55,395

 
53,615

Denominator for diluted earnings per share:
 
 
 
 
 
 
 
Dilutive potential common shares:
 
 
 
 
 
 
 
Stock options
976

 
856

 
977

 
921

Restricted stock awards and units
681

 
361

 
570

 
496

Performance-based restricted stock units
386

 
1,532

 
330

 
951

Employee stock purchase plan
25

 
5

 

 
2

Weighted average common shares outstanding with assumed conversion
57,738

 
56,687

 
57,272

 
55,985

Basic earnings per share
0.13

 
$
0.09

 
$
0.33

 
$
0.12

Diluted earnings per share
0.13

 
$
0.08

 
$
0.32

 
$
0.11


- 17 -

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

Antidilutive common stock equivalents excluded from the calculation of diluted earnings per share for the three and nine months ended September 30, 2016 and 2015 are shown in the following table (in thousands, except per share data):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Stock options
458

 
411

 
627

 
355

Restricted stock awards and units
20

 
13

 
30

 
5

Performance-based restricted stock units

 

 

 
1

Employee stock purchase plan

 
243

 
262

 
243

Total
478

 
667

 
919

 
604

10. INCOME TAXES
The Company had approximately $3.7 million and $8.1 million of gross unrecognized tax benefits as of September 30, 2016 and December 31, 2015 , respectively. The $4.4 million decrease in gross unrecognized tax benefits during the nine months ended September 30, 2016 was primarily the result of the Internal Revenue Service ("IRS") concluding its examination of the Company's 2012 federal income tax return. The Company redetermined its unrecognized tax benefits, including similar items in open tax years, based on the agreed adjustments with the IRS and other associated information and analysis, resulting in a discrete item in the period.
11. COMMITMENTS AND CONTINGENCIES
Legal Matters The Company is subject to legal proceedings and claims that arise in the ordinary course of business and 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.
On March 4, 2011, DataTrak International, Inc. ("DataTrak") 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 "NDOH District Court"). The complaint asserted infringement of U.S. Patent No. 7,464,087 (the “'087 Patent”). On November 6, 2015, the NDOH District Court granted the Company's motion to dismiss DataTrak's complaint on the grounds that the '087 Patent is invalid for lack of patentable subject matter under 35 U.S.C. §101. On January 5, 2016, the Company entered into a settlement agreement resolving all related aspects of its litigation with DataTrak. No monies were exchanged.
Contractual Warranties The Company typically provides contractual warranties to its customers covering its solutions and services. To date, any refunds provided to customers have been immaterial.
Change in Control Agreements The Company has 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 sum of the officer’s base salary and target bonus amount (except that such payment for the Company's chief executive officer and president would be two times such sum); (b) continuation of health benefits for one year (except that such continuation for the Company's chief executive officer and president would be for two years); and (c) immediate vesting of remaining unvested equity awards, unless otherwise specified in the equity award agreements.

- 18 -

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


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 ("Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended ("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, 2015 filed with the Securities and Exchange Commission ("SEC") on February 29, 2016 .
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, 2015 .
Overview
We are the leading global provider of cloud-based solutions for life sciences, transforming clinical development through our applications and data analytics. We are committed to powering smarter treatments and healthier people while advancing the competitive and scientific goals of our life sciences customers worldwide. Our industry-leading technology platform, the Medidata Clinical Cloud®, is the primary technology solution powering clinical trials for 17 of the world's top 25 global pharmaceutical companies, bringing new levels of productivity and quality to the clinical testing of promising medical treatments, from study design and planning through execution, management and reporting.
Subscription revenues, which are comprised of fees from clients accessing our cloud-based solutions, represented 85% of our revenues for the first nine months of 2016. Professional services revenues, which are derived from the provision of services that help our clients realize higher value in their clinical development processes, represented 15% of total revenues.
Third Quarter and Year-to-Date 2016 Highlights
Total revenues increased 16% and 15% compared with the third quarter and first nine months of 2015, respectively.
Professional services revenues increased 30% and 20% compared with the third quarter and first nine months of 2015, respectively. For the third quarter of 2016, professional services revenues were a record $18.5 million .
Operating income increased 34% and 67% compared with the third quarter and first nine months of 2015, respectively.
Cash flow from operations for the trailing twelve months ended September 30, 2016 were $78.8 million compared with $77.6 million for the comparable period ending September 30, 2015.
We added 222 new customers during the first nine months of 2016— 56% more than the number added during the same period last year— to end the third quarter with 789 customers.

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Results of Operations
Revenues
Revenues for the three- and nine-month periods ended September 30, 2016 and 2015 were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Revenues:
(amounts in thousands except percentages)
Subscription
$
101,560

 
$
88,878

 
14.3
%
 
$
288,288

 
$
251,556

 
14.6
%
Percentage of total revenues
84.6
%
 
86.2
%
 
 
 
85.1
%
 
85.7
%
 
 
Professional services
18,501

 
14,235

 
30.0
%
 
50,621

 
42,081

 
20.3
%
Percentage of total revenues
15.4
%
 
13.8
%
 
 
 
14.9
%
 
14.3
%
 
 
Total revenues
$
120,061

 
$
103,113

 
16.4
%
 
$
338,909

 
$
293,637

 
15.4
%
Year-over-year growth in subscription revenues was driven by major platform customer wins and strong sales growth among both new and existing customers, with strong contributions from our electronic data capture and risk-based monitoring solutions. We added 90 and 222 clients in the three and nine months ended September 30, 2016 , respectively, including those added via the acquisition of Intelemage, to end the quarter with 789 clients, up 38% compared with September 30, 2015 . As of September 30, 2016 , we had remaining subscription backlog of $101 million , representing the future contract value of outstanding arrangements, billed and unbilled, to be recognized during the fourth quarter of 2016, excluding renewals. This reflects an increase of 24% compared with remaining backlog of $82 million at September 30, 2015 .
Year-over-year growth in professional services revenues was driven by increased demand from new and existing customers for implementation and other professional services. High utilization associated with large scale enterprise implementation projects during the quarter resulted in record professional services revenues for the three months ended September 30, 2016 .
Cost of Revenues
Cost of revenues for the three- and nine-month periods ended September 30, 2016 and 2015 was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Cost of revenues:
(amounts in thousands except percentages)
Subscription
$
16,095

 
$
12,489

 
28.9
%
 
$
46,024

 
$
36,316

 
26.7
%
Percentage of total revenues
13.4
%
 
12.1
%
 
 
 
13.6
%
 
12.4
%
 
 
Professional services
13,133

 
10,304

 
27.5
%
 
36,929

 
31,564

 
17.0
%
Percentage of total revenues
10.9
%
 
10.0
%
 
 
 
10.9
%
 
10.7
%
 
 
Total cost of revenues
$
29,228

 
$
22,793

 
28.2
%
 
$
82,953

 
$
67,880

 
22.2
%
Percentage of total revenues
24.3
%
 
22.1
%
 
 
 
24.5
%
 
23.1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
$
90,833

 
$
80,320

 
13.1
%
 
$
255,956

 
$
225,757

 
13.4
%
Gross margin
75.7
%
 
77.9
%
 
 
 
75.5
%
 
76.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subscription margin
84.2
%
 
85.9
%
 
 
 
84.0
%
 
85.6
%
 
 
Professional services margin
29.0
%
 
27.6
%
 
 
 
27.0
%
 
25.0
%
 
 
Year-over-year growth in cost of subscription revenues was driven by increases in vendor software and third-party cloud hosting costs of $1.8 million and $4.6 million for the three and nine months ended September 30, 2016 , respectively, resulting from increased platform activity and platform enhancements, and from investment in hosting infrastructure at our data center in Europe. In addition, our business growth drove a year-over-year headcount increase of roughly 15%, resulting in increases to personnel costs of $1.2 million and $3.4 million for the three and nine months ended September 30, 2016 , respectively. Subscription gross margin decreased to 84.2% and 84.0% for the three and nine months ended September 30, 2016 , respectively, compared with 85.9% and 85.6% for the three and nine months ended September 30, 2015 , respectively, as a result of these infrastructure and skill set investments.

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Year-over-year growth in cost of professional fees was partially driven by increases in consulting costs of $2.0 million and $4.3 million for the three and nine months ended September 30, 2016 , respectively. Personnel costs were also a contributing factor, increasing $0.6 million and $1.1 million for the three and nine months ended September 30, 2016 , respectively, in response to 13% year-over-year headcount growth. Professional services gross margin increased to 29.0% and 27.0% for the three and nine months ended September 30, 2016 , compared with 27.6% and 25.0% for the three and nine months ended September 30, 2015 , respectively, benefiting from effective project mix and more efficient use of resources during the current year.
Overall gross margin decreased to 75.7% and 75.5% for the three and nine months ended September 30, 2016 , respectively, compared with 77.9% and 76.9% for the three and nine months ended September 30, 2015 , respectively, driven by lower subscription margins and a greater mix of professional services in the third quarter and first nine months of 2016.
Operating Costs and Expenses
Operating costs and expenses for the three- and nine-month periods ended September 30, 2016 and 2015 were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Operating costs and expenses:
(amounts in thousands except percentages)
Research and development
$
28,028

 
$
24,192

 
15.9
%
 
$
84,523

 
$
68,622

 
23.2
 %
Percentage of total revenues
23.4
%
 
23.5
%
 
 
 
24.9
%
 
23.4
%
 
 
Sales and marketing
27,789

 
25,881

 
7.4
%
 
80,856

 
75,923

 
6.5
 %
Percentage of total revenues
23.2
%
 
25.1
%
 
 
 
23.8
%
 
25.8
%
 
 
General and administrative
20,089

 
19,143

 
4.9
%
 
57,866

 
61,655

 
(6.1
)%
Percentage of total revenues
16.7
%
 
18.5
%
 
 
 
17.1
%
 
21.0
%
 
 
Total operating costs and expenses
$
75,906

 
$
69,216

 
9.7
%
 
$
223,245

 
$
206,200

 
8.3
 %
Percentage of total revenues
63.3
%
 
67.1
%
 
 
 
65.8
%
 
70.2
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
$
14,927

 
$
11,104

 
34.4
%
 
$
32,711

 
$
19,557

 
67.3
 %
Operating margin
12.4
%
 
10.8
%
 
 
 
9.7
%
 
6.7
%
 
 
The year-over-year growth in research and development expenses was primarily driven by net increases in personnel-related costs of $2.8 million and $11.0 million for the three and nine months ended September 30, 2016 , respectively, resulting from a 19% year-over-year headcount increase due to our hiring of skilled engineering talent. Increased fees for specialized consultants and outside experts of $0.6 million and $3.0 million for the three and nine months ended September 30, 2016 , respectively, associated with investments to enhance the value of our platform, were also a contributor. Stock-based compensation expense increased $0.2 million and $0.9 million for the three and nine months ended September 30, 2016 , respectively.
The year-over-year growth in sales and marketing expenses was predominantly driven by net increases in personnel-related costs of $1.5 million and $6.4 million for the three and nine months ended September 30, 2016 , respectively, resulting from a 7% year-over-year headcount increase to expand our global sales organization and partner team, as well as higher sales bonus achievement. These increases were partially offset by a decrease in stock-based compensation expense of $0.7 million and $1.8 million for the three and nine months ended September 30, 2016 , respectively, due to certain material equity awards having fully vested during the fourth quarter of 2015 and first quarter of 2016.
The year-over-year increase in general and administrative expenses for three months ended September 30, 2016 was driven by a net increase in personnel-related costs of $1.8 million, partially offset by a decrease in stock-based compensation expense of $1.0 million. The year-over-year decrease in general and administrative expenses for the nine months ended September 30, 2016 resulted predominantly from a decrease in stock-based compensation expense of $5.6 million and $1.8 million lower legal fees due to the settlement of patent-related litigation in January 2016, partially offset by a $4.2 million increase in personnel-related costs. Year-over-year, general and administrative headcount increased 11%.
In the first quarter of 2016, the state of New Jersey enacted legislation that allows us to recognize grants associated with the New Jersey Business Employment Incentive Program ("NJ BEIP"), which incentivizes businesses to locate and expand jobs in New Jersey. The benefits of these grants were applied against the underlying salary expense relating to our employees in research and development, sales and marketing, and general and administrative functions in New Jersey in the first quarter, reducing total operating expenses by $2.3 million for the nine months ended September 30, 2016 . The NJ BEIP did not have a material impact on operating expenses for the three months ended September 30, 2016 , and is not expected to have a material impact on future periods.
In 2012, we signed an incentive proposal under New York State's Empire State Development ("ESD") Excelsior Jobs Program ("Excelsior"). Excelsior provides qualifying taxpayers with refundable tax credits related to new or expanding operations in New York State. The 2012 agreement provided for credits of $2.8 million over a ten-year period beginning in 2014, resulting in an

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immaterial quarterly benefit. In the third quarter of 2016, we received and signed a new, larger Excelsior incentive proposal that provides for an additional $17.0 million of credits over a ten-year period beginning in 2016. The benefits of all Excelsior credits are applied against underlying salary expense and reduced total operating expenses by $0.5 million and $1.0 million for the three and nine months ended September 30, 2016 , respectively.
Income Taxes
Provision for income taxes for the three- and nine-month periods ended September 30, 2016 and 2015 was as follows:
 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(amounts in thousands)
Provision for income taxes

$4,347

 

$3,127

 
$
4,839

 
$
3,033

The difference between our effective tax rate and the U.S. statutory rate is primarily due to the relative mix of pre-tax income subject to tax in various jurisdictions, non-deductible expenses, share-based compensation, change in tax reserves, and U.S. tax credits. The benefit from U.S. credits will likely continue to have a favorable impact on our overall effective tax rate in the future. In the first quarter of 2016, the Internal Revenue Service concluded its examination of our 2012 federal income tax return. As a result, we redetermined our unrecognized tax benefits for previously recorded reserves, resulting in a material discrete item in the period.
Our quarterly tax provision and quarterly estimate of the annual effective tax rate are subject to significant variation due to several factors, including variability in accuracy of predictions of pre-tax book and taxable income or loss, the mix of jurisdictions to which they relate, and changes in tax law in the jurisdictions in which we conduct business. We expect our annual effective tax rate for 2016 to be closer to the U.S. statutory rate.
Critical Accounting Estimates
Our condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions about certain items and future events. These estimates inherently involve levels of subjectivity and judgment and may have a material impact on our financial condition or results of operations. Accordingly, actual results could differ from those estimates. Our critical accounting estimates as of September 30, 2016 are the same as those at December 31, 2015 , which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 . Also see Note 1 , "Summary of Significant Accounting Policies," to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, which discusses our significant accounting policies.
Effects of Recently Issued Accounting Pronouncements on Current and Future Trends
Refer to Note 1 , "Summary of Significant Accounting Policies — Recently Issued Accounting Pronouncements," to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. No other recently issued accounting pronouncements have had or are expected to have a material impact on our current or future trends.

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Liquidity and Capital Resources
We believe that our cash flows from operations, cash and cash equivalents, and highly liquid marketable securities will be sufficient to satisfy the anticipated cash requirements associated with our existing operations for the foreseeable future. Our future capital expenditures and other cash requirements could be higher than we currently expect as a result of various factors, including any expansion of our business that we may complete. The following table presents selected financial information related to our liquidity and capital resources as of September 30, 2016 and December 31, 2015 , and the nine-month periods ended September 30, 2016 and 2015 (in thousands):
 
September 30,
2016
 
December 31,
2015
 
Cash, cash equivalents, and marketable securities
$
484,229

 
$
478,729

 
Furniture, fixtures and equipment, net
54,296

 
51,043

 
1.00% convertible senior notes, net
259,851

 
249,487

 
 
 
 
 
 
 
Nine months ended September 30,
 
 
2016
 
2015
 
Cash provided by operating activities
$
48,366

 
$
58,153

(1)
Cash provided by investing activities
(27,984
)
 
(27,951
)
 
Cash used in financing activities
(5,078
)
 
(6,528
)
(1)
 (1) As a result of our early adoption of Accounting Standards Update No. 2016-09, which requires excess tax benefit on equity awards to be presented as an operating activity, the consolidated statement of cash flows for the nine months ended September 30, 2015 has been adjusted to reflect an offsetting increase of $1,706 thousand to net cash provided by operating activities and net cash used in financing activities. Refer to Note 1, "Summary of Significant Accounting Policies — Recently Adopted Accounting Pronouncements" to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for further information.
Cash, Cash Equivalents, and Marketable Securities
For the nine months ended September 30, 2016 , cash provided by operating activities of $48.4 million was driven by strong customer collections, partially offset by operating expenditures and cash interest expense on our 1.00% convertible senior notes. Cash used in investing activities of $28.0 million consisted of a net payment of $17.2 million to acquire Intelemage, LLC ("Intelemage"), cash payments for capital expenditures of $15.9 million , and $4.0 million cost method investment, partially offset by net sales of marketable securities of $9.0 million . Cash used in financing activities of $5.1 million resulted primarily from the acquisition of $14.4 million of treasury stock in connection with equity plan participant tax withholdings upon vesting, partially offset by equity plan proceeds of $9.5 million .
For the nine months ended September 30, 2015 , cash provided by operating activities of $58.2 million was driven by strong customer collections, partially offset by operating expenditures and cash interest expense on our 1.00% convertible senior notes. Cash used in investing activities of $28.0 million consisted of net purchases of marketable securities of $16.5 million and cash payments for capital expenditures of