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PHARSIGHT CORP 10-K 2008
Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended March 31, 2008

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: 001-33846

 

 

PHARSIGHT CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0401273

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

321 E. Evelyn Ave., 3rd Floor

Mountain View, CA 94041-1530

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: 650-314-3800

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.001 par value   The NASDAQ Stock Market LLC

 

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. 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  ¨   Non-accelerated filer  ¨   Smaller reporting company  x
    (Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of Exchange Act)    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant was $7.9 million based on the number of shares held by non-affiliates of the registrant as of September 30, 2007, and based on the reported last sale price of common stock on the NASDAQ Capital Market on September 28, 2007 which is the last business day of the registrant’s most recently completed second fiscal quarter. This calculation does not reflect a determination that persons are affiliates for any other purposes.

The number of shares of the registrant’s Common Stock outstanding as of June 15, 2008: 9,465,218

 

 

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for the Registrant’s 2008 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page
   PART I   

Item 1.

   Business    3

Item 1A.

   Risk Factors    14

Item 1B.

   Unresolved Staff Comments    22

Item 2.

   Properties    22

Item 3.

   Legal Proceedings    23

Item 4.

   Submission of Matters to a Vote of Security Holders    23
   PART II   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   25

Item 6.

   Selected Financial Data    27

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

Item 7A.

   Quantitative and Qualitative Disclosures about Market Risks    45

Item 8.

   Consolidated Financial Statements and Supplementary Data    46

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    82

Item 9A.

   Controls and Procedures    82

Item 9B.

   Other Information    82
   PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance    83

Item 11.

   Executive Compensation    83

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   83

Item 13.

   Certain Relationships and Related Transactions and Director Independence    83

Item 14.

   Principal Accountant Fees and Services    83
   PART IV   

Item 15.

   Exhibits and Financial Statement Schedules    84

Signatures

   85

 

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PART I

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections, including statements regarding the benefits of our products and services, anticipated revenue or operating expenses, anticipated product development, trends in customer demand, industry acceptance of our products and services, growth of our business, expansion opportunities for our products and services, revenue from sales to certain customers and our competitive position. In some cases, these forward-looking statements can be identified by words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “assume,” “potential,” “continue,” “intend,” “hope,” “can,” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including without limitation the business risks discussed under the caption “Item 1A—Risk Factors” in this Annual Report on Form 10-K. These forward-looking statements involve risks and uncertainties that could cause our, or our industry’s, actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activities, performance or achievements expressed or implied in such forward-looking statements. These business risks should be considered in evaluating our prospects and future financial performance. Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our expectations are as of the date we file this Annual Report on Form 10-K, and we do not intend to update any of the forward-looking statements after the date we file this Annual Report on Form 10-K to conform these statements to actual results, unless required by law.

ITEM 1. BUSINESS

General

Pharsight Corporation develops and markets software and provides consulting services that help pharmaceutical and biotechnology companies improve drug development decision making by reducing the costs and time of drug development and commercialization. Our products include proprietary software for clinical trial simulation and computer-aided trial design, the statistical analysis and mathematical modeling of data, the automation of scriptable pharmacokinetic data analysis, the storage, management, and regulatory reporting of derived data and models in data repositories, the validation of regulatory workflows, and the visualization of drug-disease simulations. Pharsight uses expertise in the sciences of pharmacology, drug and disease modeling, biostatistics and strategic decision-making. Our service offerings use this expertise to analyze and report trial results, to interpret and improve the design of scientific experiments and clinical trials, and to optimize clinical trial design and portfolio decisions. By integrating scientific, clinical, and business decision criteria into a dynamic model-based methodology, we help our customers to optimize the value of their drug development programs and portfolios from discovery to post-launch marketing.

Our goal is to enable pharmaceutical and biotechnology companies to reduce the time, cost and risks of drug development activities and improve the value of approved medicines. Our products and services are designed to help our customers use a more rigorous scientific and statistical process to identify earlier drug candidates that will not be successful, to enhance the likelihood that the remaining candidates will successfully complete clinical trials, and to maximize marketing impact upon approval. This process is significant because clinical development time has remained lengthy and unpredictable while the productivity of molecule discovery research has accelerated dramatically in recent years.

Our consulting services are used by 20 of the world’s largest 50 pharmaceutical companies. In addition, 45 of the world’s largest 50 pharmaceutical companies use our software products. Our software products are currently licensed for use on more than 6,700 researcher desktops.

 

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We believe our products and services provide the following benefits to customers:

 

   

Reduced time required for the validated transformation, analysis, and reporting of information required for drug approval;

 

   

More effective trial designs with higher probability of success and greater information yield;

 

   

More rapid, robust and objective decision-making with wider data availability and quantified assessment of value versus risk;

 

   

Improved workflow and organizational efficiency with faster regulatory acceptance of trial results;

 

   

Faster, more cost-effective validation of analysis and reporting workflows;

 

   

More efficient development programs requiring fewer clinical trials and patients, less time and lower cost to reach the market; and

 

   

Strengthened competitive position due to improved product labels and earlier opportunity to establish a competitive franchise.

The following illustrates several typical customer applications of our software products and services:

 

   

In designing phase II clinical trials, companies often face significant uncertainty in selecting the appropriate doses to test. Our products and services integrate information from phase I and pre-clinical activities, information concerning related drugs that have been developed by the customer, information in scientific literature about other drugs in the same therapeutic area, and knowledge of the relevant physiological and disease processes. This information, along with carefully identified assumptions, is used to develop a mathematical model enabling a computer simulation of the proposed trial. Using this approach, customers are often able to identify proposed doses that have little chance of success and should be excluded, or to identify additional doses that are more likely to yield important information.

 

   

In designing phase III clinical trials, companies often face significant uncertainty concerning the most appropriate treatment strategy, patient inclusion/exclusion criteria and/or clinical measurements. Our products and services for phase III clinical trials use an information gathering and modeling approach similar to that described for the phase II clinical trials above, but incorporate phase II data and detailed mathematical models of the intended patient populations. Our products and services are often able to identify patient groups unlikely to show efficacy, or groups with an unacceptable chance of demonstrating side effects, prior to conducting the actual trial. In addition, we may be able to predict which clinical measurements will be most likely to provide conclusive results in the proposed trial.

 

   

In making drug portfolio decisions, companies need to integrate scientific and clinical results, such as those described above, with market and financial information for all of the drug candidates in the development pipeline. We believe that our products and services help companies make better decisions concerning “go/no-go” criteria, prioritization of potential label objectives to be pursued and optimal sequencing of clinical trials within a development program. Our products and services can also help customers adopt a more quantitative and scientific approach to resource allocation among programs within their drug portfolios.

 

   

The production of industry standard pharmacokinetic, or PK, reports required by the United States Food and Drug Administration, or FDA, for a new drug submission are often time consuming, costly, and effort intensive. Much of an individual scientist’s time in a typical client organization may be involved with tasks such as data preparation needed for analysis, display of PK analysis in reports, and the quality control measures needed to ensure correct information is presented to the FDA. These tasks may reduce time available to focus on the quality and impact of the scientific decisions that drive compound development. The lack of industry standards and an integrated software platform to drive the adoption and automation of standards can often lead to lengthy report cycles and delays in regulatory submissions. By deploying our Pharsight Knowledgebase Server, or PKS, suite of applications and

 

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services (WinNonlin, IVIVC Toolkit for WinNonlin, WinNonlin Validation Suite, PKS Reporter, PKS Validation Suite and WinNonlin AutoPilot), we believe our clients can achieve sustainable productivity improvements in their regulatory submission process. Our PKS data repository affords integration to legacy laboratory and clinical data sources, reducing the time needed for data preparation prior to analysis by our clients’ scarce scientific resources. The PKS suite seamlessly integrates PKS with WinNonlin, WinNonlin AutoPilot, PKS Reporter, and third-party applications and provides the opportunity to automate a majority of the standard PK reports required by the FDA.

 

   

We believe many of our clients have achieved significant productivity improvements in creation of standard PK reports, including significant reductions in report cycle time, along with improvements in quality and consistency of analysis and display of analytical results. As a result of these increases in productivity, we believe our clients are able to reallocate resources to other aspects of the drug development process.

 

   

In the production of pharmacokinetic and pharmacodynamic reports for European and US regulatory submissions, pharmaceutical and biotechnology companies may find that they lack internal resources or expertise for data aggregation, analysis, and reporting. Pharsight Reporting and Analyst Services, or RAS, scientists provide these services using methods of production that conform to regulatory requirements.

 

   

Drug Model Explorer, or DMX, supports quantitative decision making when evaluating the benefit and risk of a potential new drug in a pharmaceutical company’s versus competing therapy. Pharsight collaborated with a pharmaceutical company to build model-based projections of the competitive landscape. The modeling effort combined internal study data with published trials and FDA submissions on competing compounds to generate an integrated and quantified assessment of the drug’s likely performance. The client’s clinical development project team used DMX to evaluate and communicate the modeling results. Through DMX, the team explored clinical effects and associated uncertainty for the drug and competitors across multiple endpoints, treatments, and patient populations based on pre-simulated responses from the model-building effort. The results showed that the new drug was unlikely to outperform its main competitor, and development was discontinued in the target patient population. The modeling project supported a more confident decision without investment in additional trials, and allowed team members to re-deploy earlier to other programs. It also provided an enduring, evolving knowledge database to support future development decisions.

Client’s use of our software and leading edge methodology developed by our strategic consulting group greatly enhances the traditional drug-development process, which is heavily dependent upon clinical trials. Although our methodology does not displace the use of human trials in drug development, we believe our software and methodology renders human trials more efficient and relevant. The continued growth of our customer base, the importance ascribed to “Model-Based Drug Development” by the FDA in its Critical Path whitepaper, the increase in the number of contracts with our existing customers, and the increase in our average contract value over time have shown a trend that we believe demonstrates increased acceptance of our methodology and an increased demand for its use. This demand can be met by increased deployment of our software and services, by proprietary solutions developed by our clients, or by increased internal resources within our customers. We believe that these trends, in addition to increasing regulatory requirements from the FDA, demonstrate a potential for increased revenue growth resulting from increased demand for our current products and services, as well as long-term opportunities to expand the breadth and coverage of our future software products and services.

We were incorporated in California in April 1995, and we reincorporated in Delaware in June 2000. In August 2000, we completed our initial public offering and our common stock began trading on the NASDAQ. In November 2002, our common stock ceased to trade on the NASDAQ National Market and began trading on the Over-The-Counter Bulletin Board system. In November 2007, our common stock ceased to trade on the Over-The-Counter Bulletin Board system and began trading on the NASDAQ Capital Market.

 

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Pharsight Products and Services

Pharsight provides both consulting services and computer-based drug model development and database applications. In fiscal 1997, we first offered our WinNonlin, WinNonMix and Trial Simulator applications and scientific services. In fiscal 2001, we combined our scientific, decision support and methodology groups into an integrated group renamed Strategic Consulting Services. In fiscal 2002, we began selling our Pharsight Knowledgebase Server, providing a means of capturing and managing both summary and detailed pharmacokinetic/pharmacodynamic data across a large set of compounds and development phases. In fiscal 2004, we introduced and began selling DMX, software for visualizing drug model simulations. WinNonlin Validation Suite and PKS Validation Suite were introduced in fiscal 2006 to streamline validation of our WinNonlin and PKS products. IVIVC Toolkit for WinNonlin was introduced in fiscal 2007 to expand the capabilities of WinNonlin, enabling the use of WinNonlin for in vivo-in vitro correlations. In fiscal 2008, we launched a new client service offering, Reporting and Analysis Services and introduced WinNonlin AutoPilot to automate the creation of presentation–quality output created through WinNonlin.

In fiscal 2008, 2007 and 2006, revenues from our software product offerings and related services generated 57%, 57% and 59% of our total revenues, respectively, and revenues from our Strategic Consulting Services generated 37%, 43% and 41% of our total revenues, respectively. In fiscal 2008, revenues from our newly launched Reporting and Analysis Services generated 6% of our total revenues. In fiscal 2008, 2007 and 2006, revenues from our software product offerings and related services were approximately $16.2 million, $14.2 million and $13.4 million, respectively, and revenues from our Strategic Consulting Services were was approximately $10.6 million, $10.9 million and $9.3 million, respectively. In fiscal 2008, revenues from our Reporting and Analysis Services were approximately $1.5 million.

We operated in three business segments comprised of Software Products, Strategic Consulting Services and Reporting and Analysis Services during fiscal 2008. Our revenues from external customers, profit and loss and total assets, are set forth in our financial statements, which appear in “Item 8—Financial Statements and Supplementary Data.” Information regarding sales to customers by major geographic regions is set forth in Note 11 to our financial statements, which appears in “Item 8—Consolidated Financial Statements and Supplementary Data.” All of our significant long-lived assets are located within the United States.

Software Products

Our software products and software deployment and integration services provide the analytical tools, data management infrastructure, and conceptual framework to help clinical researchers optimize the decision-making required to perform the clinical testing, analysis, and reporting needed to bring drugs to market. By applying mathematical modeling and simulation to all available information regarding the compound being tested, researchers can reach reportable conclusions faster and clarify and quantify which trial and treatment design factors will influence the success of clinical trials. We have four categories of software products: Analytics Software, Data Management & Compliance Software, Validation Software and Model Visualization Software.

Analytics Software

WinNonlin and WinNonMix. These software applications are used to efficiently analyze clinical and preclinical data, allowing the creation of Pharmacokinetic/Pharmacodynamic, or PK/PD, models and validating the assumptions and information on which the models are based. The analysis and modeling foster better understanding of the data and better decision making with respect to dosage and dosing regimens. Such analysis is cost-effective and either required or encouraged by FDA regulations for new drug submissions.

IVIVC Toolkit for WinNonlin. The IVIVC Toolkit for WinNonlin, or IVIVC Toolkit, expands the capabilities of WinNonlin, enabling the use of WinNonlin for in vivo-in vitro correlations (IVIVC). The Toolkit brings enhanced deconvolution methods, numerical convolution, new plotting capability, and the “IVIVC

 

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Wizard” to pharmacokineticists and formulators. IVIVC Toolkit for WinNonlin allows faster development of new formulations, reduces the likelihood of bioequivalence test failures, and permits easier correlations to predict pharmacokinetics from new in vitro data.

Trial Simulator. Trial Simulator uses information about the PK and PD of the drug under investigation and comparator (including placebo), the patient populations that will be treated, and the likely adhereance of patients to the drug therapy and other protocol requirements, and simulates multiple trial datasets. Statistical tests are then applied to the simulated datasets as though an actual trial had been conducted. The results are used to help design and optimize proposed clinical trial protocols. Poor protocol design may result in ambiguous trial results that fail to identify ineffective candidates early, increase expense and time in identifying successful drugs and expose trial patients to unnecessary risk. Poor protocol dosing decisions may cause the rejection of a candidate drug that might otherwise be approved at an appropriate dose. Computer-aided trial design, using Trial Simulator, cannot guarantee successful trials, but can help to improve the efficiency, required time, and likelihood of definitive and successful results.

Data Management & Compliance Software

Pharsight Knowledgebase Server. PKS provides a means of capturing and managing both summary and detailed PK/PD data across a large set of compounds and development phases. PKS also provides a unified data environment for supporting clinical pharmacology modeling, analysis and reporting activities. PKS is directly integrated with WinNonlin and other industry standard modeling and analysis tools. PKS was developed to help enable compliance with the FDA regulations that require electronic data security and auditing on submissions to the FDA. We believe that industry acceptance of PKS has been positively affected by the client need for efficiency gains, as well as compliance with increased regulatory requirements.

PKS Reporter. PKS Reporter addresses the need for streamlined, systematic, and automated report generation and signature. Using PKS as an underlying source of secure, regulatory-compliant report content, PKS Reporter allows researchers to use familiar tools such as WinNonlin and Microsoft Word to construct, update, review and approve standard clinical pharmacology reports. PKS Reporter is directly integrated with PKS, as both a source of report content and a secure repository for report storage and version control. PKS Reporter links reports in Microsoft Word directly to PKS, where it draws report content from data and modeling results created in WinNonlin Enterprise, NONMEM, SAS and other industry-standard modeling and analysis tools. From within Microsoft Word, researchers can browse the PKS database, loading objects and values drawn from various PKS studies and analysis scenarios. When the source data change, PKS Reporter marks its content as out of date, ready for automatic update. Quality assurance staff can automate the verification of report data by simply opening the document and selecting to have all references checked. Development teams can create standardized report templates specifying report layout, formatting and specific content elements. Report sign-off is smooth and automatically tracked with PKS Reporter’s signature tool and e-mail notification.

WinNonlin AutoPilot. WinNonlin AutoPilot, or Autopilot, is a configurable software application for WinNonlin that automates the creation of presentation-quality clinical pharmacokinetic analysis outputs from study data to be used in standard reports. Using WinNonlin AutoPilot, companies can vastly improve their productivity while improving the quality and consistency of analyses and reports. Autopilot provides the infrastructure and tools to manage and effectively automate common or repetitive data transformations, PK analysis, and creation of report-ready tables and graphs. Because these outputs must reflect the requirements and standard operating procedures of each research organization, Autopilot provides a user-interface that allows extensive configuration of formatting and business rules that apply in the generation of these analyses. Customer-defined configurations do not require changes to the underlying computer code, and are stored in a settings file that enables clear communication of standards and immediate use across the organization, thus improving the consistency, quality, and utility of the outputs.

 

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Validation Software

WinNonlin Validation Suite. The WinNonlin Validation Suite streamlines on-site validation of the WinNonlin product. The Validation Suite provides a selection of automated tests, each of which runs a specific WinNonlin analysis or function and tests the results against standardized, known output. The Validation Suite efficiently and effectively provides documentation of on-site validation activities, through automated generation of validation reports via Microsoft Word. Clients use WinNonlin Validation Suite to reduce effort and time needed for validation planning, testing, and reporting.

PKS Validation Suite. The PKS Validation Suite streamlines on-site validation of the PKS product. The Validation Suite provides document templates, test data, and a collection of automated and manual test scripts. PKS Validation Suite cannot fully validate a client’s PK workflow, as full validation depends on many factors beyond the software, however, when used as a starting point for validation efforts PKS Validation Suite can save significant time needed for validation planning, testing, and reporting.

Model Visualization Software

Drug Model Explorer. DMX is a software program that communicates the essential findings of drug models while freeing the user from the need to understand the drug model’s complex underlying mathematics. With DMX, project teams made up of physicians, marketers, and other non-modelers can visualize and explore key modeled drug attributes, and the uncertainty around those attributes, given the current state of knowledge about a development program. DMX generates views of the simulated data from queries of underlying drug-disease models and simulated responses over a defined problem-space (e.g., treatments, endpoints, covariates and competitors).

We believe that our continued growth depends on ongoing delivery of new products to our current and prospective customers. These new products must address an ever-expanding set of customer needs for clinical development of drugs and thereby expand the number of prospective users within pharmaceutical companies to whom we may sell.

Strategic Consulting Services

Our Strategic Consulting Services consist of consulting, training and process redesign conducted by our clinical and decision scientists in the application and implementation of our core decision methodology. The methodology employed by our services group uses three types of models that can work independently or in concert. Illustrative models are listed below:

 

•    Drug-Disease Models

Our drug-disease models predicatively characterize the distribution of treatment outcomes (safety, efficacy, surrogate outcomes) for a new chemical entity, or NCE, and for competitor compounds as a function of dosing strategy, disease and patient and trial characteristics.

 

•    Trial Models

Our trial models predict probability distributions of outcomes and show how uncertainty can be reduced through dosing strategy, number of treatment arms, type of control, sample population characteristics, sample size and treatment duration.

 

•    Market Models

Our market models characterize the demand for products (market size and share) under different scenarios for patient benefit, cost, compliance, and other factors and their evolution over time.

By using these models in an integrated fashion, our consultants are able to place key development decisions into quantitative terms of uncertainty and value. Drug development is a process by which uncertainty about a drug’s efficacy and safety is progressively reduced. Our methodology enables customers to identify which

 

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uncertainties are greatest and matter most, and then to design development programs, trial sequences, and individual trials in such a way that those trials systematically and cost effectively reduce the identified uncertainties.

This methodology is valuable at all stages of development. The integration of our models at the asset strategy phase (overall positioning of a new drug) and program/trial strategy phase (focusing on a specific disease endpoint or other indicator) enables us to help our customers position their drugs as competitively as possible in the market to do so while avoiding unnecessary trials (and only as large, lengthy and costly as is required), and to redeploy resources away from unpromising compounds at the earliest possible decision point.

The following chart depicts typical issues that we are asked to address in strategic consulting projects throughout development and post marketing:

 

Phase I

  

Phase II/Phase III

  

Phase IV

•       Bridge animal results to humans.

  

•       Balance efficacy with side effects.

  

•       Explore new indications and label changes.

•       Explore dose ranging and population variability.

  

•       Explore trial sensitivity to patient compliance and dropout.

  

•       Plan life-cycle strategy, e.g. generic defense and “over-the-counter” switch.

•       Determine surrogate endpoint relevance, i.e. alternate indicators of efficacy.

  

•       Investigate impact of population genetic variability.

  

•       Evaluate special patient populations.

•       Support early “go/no-go” decisions.

  

•       Evaluate alternate protocols.

  

•       Assess strategic fit in franchise.

     

Our Strategic Consulting Services personnel are located throughout the United States, Europe and Australia. Most have Ph.D. degrees with post-doctoral training in medicine, clinical pharmacology, biostatistics, pharmacokinetics, mathematics, engineering, decision analysis or other relevant disciplines. Our senior consultants each have more than a decade of experience in drug disease modeling, trial design or strategic consulting. We also utilize a network of consultants with expertise in various specialized disciplines and therapeutic areas.

We believe that our continued growth is dependent upon continually refining our strategic consulting methodologies and introducing new technologies, while also expanding our activities at the portfolio level and into new therapeutic areas.

Reporting and Analysis Services

A complementary service to our Software Products and Strategic Consulting Services was launched in the first quarter of fiscal 2008. Reporting and Analysis Services addresses the full spectrum of client needs for modeling and simulation in regulatory reports such as those required in Section 5 of the Common Technical Document. These services meet growing customer demand for analysis and reporting of PK/PD data generated in clinical and preclinical studies supporting new drug approvals. These studies include toxicokinetic, single- and multiple-ascending dose, drug-drug interaction, renal and hepatically impaired, fed-fasted, bioequivalence/bioavailability, QT prolongation, and others.

Customers

Our software customers range in size from the largest pharmaceutical companies to small and medium-sized pharmaceutical and biotechnology organizations.

 

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Our Strategic Consulting Services customers range in size from the largest pharmaceutical companies to small pharmaceutical companies, and the focus of our work differs depending upon the size and maturity of the customer. With our smaller and medium-sized customers, we tend to engage in discrete projects often with challenging analytic and design problems, where modeling and simulation can be particularly valuable. This kind of work may or may not lead to subsequent engagements. By contrast, with our largest customers, we may have ongoing relationships which are more strategic in nature, and we focus on helping improve the process by which they develop drugs, broadening and deepening the application of modeling and simulation over time, with the intent of achieving systematic, lasting performance improvement.

Our Reporting and Analysis Services customers range in size from the largest pharmaceutical companies to small pharmaceutical and biotechnology companies. The focus of the work is independent of customer size.

During our fiscal year ended March 31, 2008, we provided products and services for which we recognized revenue from more than 1,000 customers. Our top two customers were Pfizer Inc., or Pfizer, and Daiichi Sankyo Inc, or Daiichi, in fiscal 2008 and Pfizer and Eli Lilly and Company, or Lilly in fiscal 2007 and 2006. In fiscal 2008, Pfizer, our largest customer, accounted for 10% of our total revenue, and Daiichi accounted for 7% of our total revenue. In fiscal 2007 and 2006, Pfizer accounted for 17% and 25% of our total revenue, respectively, and Lilly accounted for 11% and 17% of our total revenue, respectively. While we were successful in diversifying our customer base and reducing our dependency on our largest customers, we are still dependent on them for a substantial portion of our revenues. If we were to lose these customers, it would have a material adverse effect on our revenues and business. See “Item 1A—Risk Factors—Our revenue is concentrated in a few customers, and if we lose any of these customers our revenue may decrease substantially.”

Product Development

Within our software products segment, we employ engineers with expertise in software development, web-based applications, database systems, network architecture, and mathematical modeling, and scientists with expertise in clinical development, decision analysis, statistical modeling, clinical pharmacology, and drug development. Our product development personnel work closely with our Strategic Consulting and Reporting and Analysis scientists, and also with our client base, in designing and testing products to meet customer requirements.

Our research and development efforts are focused on improving and enhancing our existing products and services, as well as developing new products and services. Our research and development efforts take place principally at our office in Cary, North Carolina.

In fiscal 2004, we expanded investment in research and development to grow our ability to achieve potential breakthrough improvements in drug development productivity for our customers. The primary focus of this investment has been in software products that enable customers to adopt and implement our model-based drug development methodology. The introduction of DMX in fiscal 2004 represented one accomplishment in this area, enabling non-modelers in the drug development process to utilize those models in a systematic, integrated fashion to collaborate and make better decisions. In late 2005, we released WinNonlin Validation Suite, a product intended to speed the validation of WinNonlin installations. Many of our customers desire to operate WinNonlin within a validated workflow, and the Validation Suite automates part of the chore of validation. In 2005, we also released PKS Validation Suite, which automates many time-consuming tasks associated with the validation of PKS installations. Both WinNonlin and PKS Validation Suites make the process of deploying new versions of WinNonlin and PKS easier and faster, thus giving clients a faster path to benefits available in the most recent releases. In early 2007, we released IVIVC Toolkit for WinNonlin. IVIVC Toolkit for WinNonlin provides for special mathematical techniques for predicting the PK of new drug candidates in the human body from information gathered in vitro (outside the body), thus avoiding costly in-body testing. In early 2006, we began development of a productized version of our “PK Automation” framework (WinNonlin AutoPilot, released in June 2007), a software product incorporating functionality previously delivered as custom code. WinNonlin

 

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AutoPilot interoperates with WinNonlin, and automates the production of certain WinNonlin PK analyses routinely needed in the preparation of regulatory reports. We believe that WinNonlin AutoPilot can bring significant productivity improvements to companies facing an ongoing need for regulatory-quality clinical PK analysis. See “Item 1A—Risk Factors—We may lose existing customers or be unable to attract new customers if we do not keep pace with technological changes.”

Our research and development expenses were approximately $4.8 million, $4.3 million and $3.5 million, representing 17%, 17%, and 15% of total revenue in fiscal 2008, 2007 and 2006, respectively.

Sales and Marketing

Sales of our products and services are primarily generated in the United States and Europe through a direct field sales organization as well as an inside sales organization. Sales of our Strategic Consulting Services can range from discrete single projects, where modeling and simulation can be particularly valuable, to expansions of ongoing relationships at our larger clients, which are more strategic in nature. Sales of our Reporting and Analysis Services can range from analyses and reporting of individual preclinical or clinical trial datasets using noncompartmental methods to complex analyses of datasets from multiple trials using population methods. Reporting and Analysis Services sales can arise from either our outside or inside sales organizations. Our desktop software applications are primarily sold through our inside sales organization in the United States, Europe, and India, and through distributors in Japan and China. The decisions to purchase PKS or Autopilot software may involve several different customer departments, such as clinical pharmacology, ADME (Absorption, Distribution, Metabolism and Excretion), toxicology, biostatistics, regulatory and early clinical as well as information technology, or IT and procurement. PKS software sales involve a significant validation process and can demand a team of sales, marketing and IT support professionals during the sales process causing the sales cycle to be extended. DMX software sales require a team of Strategic Consulting Services consultants, sales and product management. A customer’s decision to purchase DMX may also involve several groups in research and development, such as PK/PD, modeling and simulation, clinical pharmacology, and biostatistics, as well as IT. A DMX purchaser would typically be a company whose decision process already incorporates modeling and simulation methodology.

Government Regulation

The pharmaceutical industry is regulated by a number of federal, state, local and international governmental entities. Although the FDA or comparable international agencies do not directly regulate the majority of our products and services, the use of certain of our analytical software products by our customers may be regulated. We currently provide assistance to our customers in achieving compliance with these regulations.

In addition, our Reporting and Analysis Services are subject to various regulatory requirements designed to ensure the quality and integrity of the data or products of these services. These regulations are governed primarily by Good Laboratory Practice, or GLP, and Good Clinical Practice, or GCP, guidelines mandated by the FDA. The standards of GLP and GCP are required by the FDA and by similar regulatory authorities around the world. GLP regulations contain the industry standard for the conduct of preclinical and laboratory testing, and require adherence to written, standardized procedures during the conduct of studies and the recording, reporting and retention of study data and records. GCP regulations contain the industry standard for the conduct of clinical research and development studies, and require rigorous attention to employee training; detailed, authorized documentation; equipment validation; careful tracking of changes and routine auditing of compliance.

Competition

Software Products. We compete based on a number of factors, including the functionality, reliability and ease of implementation and use of our software products. Our WinNonlin, WinNonMix, IVIVC Toolkit and PKS products compete with products produced by other companies. Our products perform certain mathematical

 

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operations that can in some cases be performed by general statistical software. Thus we face generalized, indirect competition from these products. Although we believe we currently do not have direct competitors for the entire functionality of our Trial Simulator product or our DMX product, other companies may directly compete with us with specialized, not general, products in the future. Competing tools for the simulation of specialized adaptive trial designs are emerging. Potential competitors may have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the pharmaceutical industry than we have. In addition, competitors may merge or form strategic alliances and be able to offer, or bring to market earlier, services that are superior to our own.

Strategic Consulting Services. We compete based on a number of factors, including cost, quality and effectiveness of our services and degree of complexity of the consulting offering. Our customers are primarily large pharmaceutical companies that have substantial research and development budgets, and these customers may internally develop the expertise that we provide. Other entities also provide modeling services, some of which are similar to those provided by our Strategic Consulting Services group.

Reporting and Analysis Services. We compete on the basis of quality and expertise of our analysis, the depth of our experience in the modeling techniques, and in faster, more reliable execution of the analysis and reporting through the use of our software tools. Our customers range from early stage companies with one or a few compounds in development and limited infrastructure to carry out analyses and reporting to large companies with extensive internal capabilities. In all cases we face competition from contract research organizations (CROs) which provide similar services to ours. Some CROs also operate bioanalytical labs and clinics, and can therefore offer a broader selection of services than we can.

Intellectual Property Rights

Technology In-Licensing

Although our products are based on our research and development, we license software from third parties when it is more efficient to incorporate pre-existing programs or routines, when there are novel technologies available by license that would improve our products, or when brand recognition of established products provides a marketing advantage. We incorporate such third-party software that we have rights to use under the terms of license agreements that require us to pay royalties to the licensor based upon either a percentage of the sales of products containing the licensed software or a fixed fee for each product shipped. Although all of the software we license for use in our products is replaceable with software from other vendors or our own development efforts, the loss of a license could delay the sales of certain of our products.

Intellectual Property

Our success is dependent in part upon our ability to develop and protect our proprietary technology and intellectual property rights. We rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, patent, copyright and trademark laws to accomplish these goals.

We license our software products pursuant to non-exclusive license agreements, which impose restrictions on customers’ ability to utilize the software. In addition, we seek to avoid disclosure of our trade secrets by restricting access to our source code, and requiring employees, customers and others with access to our proprietary information to execute confidentiality agreements with us. We also seek to protect our software, documentation and other written materials under trade secret and copyright laws.

We hold six U.S. patents with expirations dates between April 2021 and June 2024, and three U.S. patent applications pending. It is possible that the patents that we have applied for, if issued, or our potential future patents may be successfully challenged or that no patent will be issued from our patent applications. It is also possible that we may not develop proprietary products or technologies that are patentable, that any patent issued to us may not provide us with any competitive advantages, or that the patents of others will seriously harm our ability to do business.

 

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Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our product or to obtain and use information that we regard as proprietary. Accordingly, there can be no assurance that we will be able to protect our proprietary rights against unauthorized third party copying or use. Use by others of our proprietary rights could materially harm our business. Furthermore, policing the unauthorized use of our product is difficult and expensive litigation may be necessary in the future to enforce our intellectual property rights. See “Item 1A—Risk Factors—Our business depends on our intellectual property rights, and if we are unable to adequately protect them, our competitive position will suffer,” and “—If we become subject to infringement claims by third parties, we could incur unanticipated expense and be prevented from providing our products and services.”

Employees

As of March 31, 2008, we had a total of 113 employees—8 in software, training and deployment; 25 in Strategic Consulting Services; 11 in Reporting and Analysis Services; 20 in sales and marketing; 29 in research and development; and 20 in executive, general and administrative and information technology functions. None of our employees are represented by a collective bargaining agreement, nor have we experienced any work stoppage.

Available Information

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge through our website at http://www.pharsight.com as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission or SEC. Copies of our annual report will be made available, free of charge, upon written request to the Chief Financial Officer, c/o Pharsight Corporation, 321 E. Evelyn Ave., 3rd Floor, Mountain View, CA 94041-1530.

 

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ITEM 1A. RISK FACTORS

We operate in a rapidly changing economic and technological environment that presents numerous risks. Many of these risks are beyond our control and are driven by factors that we cannot predict. The following discussion, as well as our discussion above of critical accounting policies and estimates, highlights some of these risks. You should carefully consider the risks and uncertainties described below and the other information in this report before deciding whether to invest in shares of our common stock. If any of the following risks actually occur, our business, financial condition or operating results could be materially adversely affected. This could cause the trading price of our common stock to decline, and you may lose part or all of your investment.

Risks That Affect Our Future Operations

We may not be able to generate sufficient revenues to sustain profitability.

We commenced our operations in April 1995 and incurred net losses for every quarter until attaining profitability in the fourth quarter of fiscal 2004. While we have maintained annual profitability for four consecutive fiscal years, as of March 31, 2008, we had an accumulated deficit of approximately $72.6 million. We may incur losses again as we continue to develop our business. Our ability to sustain profitability is based on a number of assumptions, including some outside of our control, including the state of the overall economy and the demand for our products and services. If these assumptions do not prove to be accurate then we may not be able to generate sufficient revenues to sustain profitability. Furthermore, even if we do sustain profitability and positive operating cash flow, we may not be able to increase profitability or positive operating cash flow on a quarterly or annual basis. If our profitability does not meet the expectations of investors, the price of our common stock may decline.

We have a limited amount of capital resources and we may not be able to sustain or grow our business if we cannot sustain profitability or raise additional funds on a timely basis.

We believe we have adequate cash to sustain operations through the next 12 months, and we are managing the business to achieve positive cash flow utilizing existing assets. However, even if we sustain profitability, we may not be able to generate sufficient profits to grow our business. As a result, we may need to raise additional funds through public or private financings or other sources to fund our operations. We may not be able to obtain additional funds on commercially reasonable terms, or at all. Failure to raise capital when needed could harm our business. If we raise additional funds through the issuance of equity securities, these equity securities might have rights, preferences or privileges senior to our common stock and preferred stock. In addition, the necessity of raising additional funds could force us to incur debt on terms that could restrict our ability to make capital expenditures and incur additional indebtedness. If we proceed with one or more significant acquisitions in which the consideration includes cash, we could be required to use a substantial portion of our available cash to consummate any such acquisition. Acquisitions may result in the incurrence of debt, material one-time write-offs, or purchase accounting adjustments and restructuring charges. They may also result in recording goodwill and other intangible assets in our financial statements which may be subject to future impairment charges or ongoing amortization costs, thereby reducing future earnings. To the extent that we issue new stock or other rights to purchase stock or to generate additional cash, existing stockholders may be diluted and earnings per share may decrease.

The terms of our credit facilities contain covenants that limit our flexibility and prevent us from taking certain actions.

The terms governing our credit facilities with Silicon Valley Bank include a number of significant restrictive covenants. These covenants could adversely affect us by limiting our ability to plan for or react to market conditions, meet our capital needs and execute our business strategy. These covenants will, among other things, limit our ability to:

 

   

incur additional debt;

 

   

make certain investments;

 

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create liens; or

 

   

sell certain assets.

These covenants may significantly limit our operating and financial flexibility and limit our ability to respond to changes in our business or competitive activities. Our failure to comply with these covenants could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their scheduled due date. In addition, Silicon Valley Bank could foreclose on our assets.

Our quarterly operating results may fluctuate significantly and may not be predictive of future financial results.

Our quarterly operating results may fluctuate in the future, and may vary from investors’ expectations, depending on a number of factors, including:

 

   

Variances in demand for our products and services;

 

   

Timing of the introduction of new products or services and enhancements of existing products or services;

 

   

Our ability to complete fixed-price service contracts without committing additional unplanned resources;

 

   

Unanticipated changes in the capacity of our services organization;

 

   

Delays or deferrals of customer implementations of our software products;

 

   

Delays or deferrals of client drug development processes;

 

   

Changes in industry conditions affecting our customers, including industry consolidation; and

 

   

Our ability to realize operating efficiencies through restructuring or other actions.

As a result, quarterly comparisons may not indicate reliable trends of future performance.

We manage our expense levels in part based upon our expectations concerning future revenue, and these expense levels are relatively fixed in the short term. If we have lower revenue than expected, we may not be able to reduce our spending in the short term in response. Any shortfall in revenue would have a direct impact on our results of operations.

In the past we have taken actions intended to reduce our expenses on an annualized basis. Our cost reduction measures have left us with less excess capacity to deliver our products and services. If there is a significant increase in demand from what we estimate, it will take us longer to address this demand, which would limit our ability to grow our business and sustain profitability.

We may be required to defer recognition of software license revenue for a significant period of time after entering into an agreement, which could negatively impact our results of operations.

We may have to delay recognizing license revenue for a significant period of time for a variety of types of transactions, including:

 

   

transactions that include both currently deliverable software products and software products that are under development or contain other currently undeliverable elements;

 

   

transactions where the customer demands services that include significant modifications, customizations or complex interfaces that could delay product delivery or acceptance;

 

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transactions that involve non-standard acceptance criteria or identified product-related performance issues; and

 

   

transactions that include contingency-based payment terms or fees.

These factors and other specific accounting requirements for software revenue recognition require that we have very precise terms in our license agreements to allow us to recognize revenue when we initially deliver software or perform services. Although we have a standard form of license agreement that we believe meets the criteria for current revenue recognition on delivered elements, we negotiate and revise these terms and conditions in some transactions. Therefore, it is possible that from time to time we may license our software or provide service with terms and conditions that do not permit revenue recognition at the time of delivery or even as work on the project is completed. In fiscal 2008, software license revenue accounted for 50% of our total revenue. The majority of our large initial PKS software transactions include services pertaining to modification and customization of the core PKS software product, which may result in delayed revenue recognition for a significant period of time.

An increase in services revenue as a percentage of total revenue, or a decrease in software license revenue as a percentage of total revenue, may decrease our overall margins.

We realize lower margins on services revenue than on license revenue. In addition, we may contract with certain third parties to supplement the services we provide to customers, which generally yields lower gross margins than those margins generated by our deployment organization or internal scientific staff. As a result, if services revenue increases as a percentage of total revenue or if we increase our use of third parties to provide such services, our gross margins would be lower and our operating results may be adversely affected.

Because our sales and implementation cycles are long and unpredictable, our revenues are difficult to predict and may not meet our expectations or those of our investors.

The lengths of our sales and implementation cycles are difficult to predict and depend on a number of factors, including the type of product or services being provided, the nature and size of the potential customer and the extent of the commitment being made by the potential customer. Our sales cycle is unpredictable and may take six months or more. Our implementation cycle is also difficult to predict and can be longer than one year. Each of these can result in delayed revenues, increased selling expenses and difficulty in matching revenues with expenses, which may contribute to fluctuations in our results of operations. A key element of our strategy is to market our product and service offerings to large organizations. These organizations can have particularly lengthy decision-making processes and may require evaluation periods, which could extend the sales and implementation cycle. Moreover, we often must provide a significant level of education to our prospective customers regarding the use and benefit of our product and service offerings, which may cause additional delays during the evaluation and acceptance process. We therefore have difficulty forecasting the timing and recognition of revenues from sales of our product and service offerings.

Our revenue is concentrated in a few customers, and if we lose any of these customers our revenue may decrease substantially.

We receive a substantial majority of our revenue from a limited number of customers. For fiscal 2008, 2007 and 2006, sales to our top two customers accounted for approximately 17%, 28% and 42% of total revenue, respectively and sales to our top five customers accounted for approximately 29%, 43% and 52%. Our top two customers were Pfizer and Daiichi in fiscal 2008 as compared to Pfizer and Lily in fiscal 2007 and 2006. In fiscal 2008, Pfizer, our largest customer, accounted for approximately 10% of our total revenue, and Daiichi accounted for approximately 7% of our total revenue. In fiscal 2007, Pfizer accounted for approximately 17% of our total revenue and Lilly accounted for approximately 11% of our total revenue. In fiscal 2006, Pfizer accounted for approximately 25% and Lilly accounted for approximately 17% of our total revenue. We are dependent on a small number of customers for a substantial portion of our revenues, and if we were to lose these customers, it

 

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would have a material adverse effect on our revenues and business. We expect that a significant portion of our revenue will continue to depend on sales to a small number of customers. In addition, the worldwide pharmaceutical industry has undergone, and may in the future undergo, substantial consolidation, which may further reduce the number of our existing and potential customers. If we do not generate as much revenue from these major customers as we expect to, if revenue from such customers is delayed, or if we lose any of them as customers, our total revenue may be significantly reduced.

We may need to change our pricing models to compete successfully.

The markets in which we compete can put pressure on us to reduce our prices. If our competitors offer deep discounts on certain products in an effort to recapture or gain market share, we may then need to lower prices or offer other favorable terms in order to compete successfully. Any such changes would be likely to reduce margins and could adversely affect operating results. We have periodically changed our pricing model and any broadly based changes to our prices and pricing policies could cause service and license revenues to decline or be delayed as our sales force implements and our customers adjust to the new pricing policies. If we do not adapt our pricing models to reflect changes in customer use of our products, our revenues could decrease.

If we are unable to generate additional sales from existing customers and/or generate sales to new customers, we may not be able to realize sufficient revenues to sustain or increase our profitability.

Our success depends on our ability to develop our existing customer relationships and establish relationships with additional companies. If we lose any significant relationships with existing customers or fail to establish additional relationships, we may not be able to execute our business plan and our business will suffer. Developing customer relationships with pharmaceutical companies can be difficult for a number of reasons. These companies are often very large organizations with complex decision-making processes that are difficult to affect. In addition, because our products and services relate to the core technologies of these companies, these organizations are generally cautious about working with outside companies. Some potential customers may also resist working with us until our products and services have achieved more widespread market acceptance. Our existing customers could also reassess their commitment to us, not renew existing agreements or choose not to expand the scope of their relationship with us.

Our revenues and results of operations would be adversely affected if a customer cancels a contract for services, maintenance and support or software deployment with us.

Our customers can cancel many of our services or maintenance and support agreements upon prior notice. Additionally, due to the nature of our services and deployment engagements, customers sometimes delay projects because of timing of the clinical trials and the need for data and information that prevent us from proceeding with our projects. These delays and contract cancellations cannot be predicted with accuracy and we cannot assure you that we will be able to replace any delayed or canceled contracts with the customer or other customers. If we are unable to replace those contracts, our revenues and results of operations would be adversely affected.

We may lose existing customers or be unable to attract new customers if we do not develop new products and services or if our offerings do not keep pace with technological changes.

The successful growth of our business depends on our ability to develop new products and services and incorporate new capabilities, including the expansion of our product and services offerings to address a broader set of customer needs related to clinical development of drugs and thereby expand the number of our prospective users, on a timely basis. If we cannot adapt to changing technologies, emerging and evolving industry standards, new scientific developments and increasingly sophisticated customer needs, we may not achieve revenue growth and our products and services may become obsolete, and our business could suffer. We have suffered product delays in the past, resulting in lost product revenues. In addition, early releases of software often contain errors or defects. We cannot assure you that, despite our extensive testing, errors will not be found in our products before

 

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or after commercial release, which could result in product redevelopment costs and loss of, or delay in, market acceptance. Furthermore, a failure by us to introduce new products or services on schedule could harm our business prospects. Any delay or problems in the installation or implementation of new products or services may cause customers to forego purchases from us. We may need to accelerate product introductions and shorten product life cycles, which will require high levels of expenditures of research and development that could adversely affect our operating results. A failure by us to introduce new services on a timely and cost-effective basis to meet evolving customer requirements, or to integrate new services with existing services, could harm our business prospects.

If the security or confidentiality of our customers’ data is compromised or breached, we could be liable for damages and our reputation could be harmed.

As part of implementing our products and services, we inherently gain access to certain highly confidential proprietary customer information. It is critical that our facilities and infrastructure remain secure and are perceived by the marketplace to be secure. Despite our implementation of a number of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. We do not have insurance to cover us for losses incurred in many of these events. If we fail to meet our customers’ security expectations, we could be liable for damages and our reputation could suffer.

If we are unable to complete a project due to scientific limitations or otherwise meet our customers’ expectations, our reputation may be adversely affected and we may not be able to generate new business.

Because our projects may contain scientific risks, which are difficult to foresee, we cannot guarantee that we will always be able to complete them. Any failure to meet our customers’ expectations could harm our reputation and ability to generate new business. On a few occasions, we have encountered scientific limitations and been unable to complete a project. In each of these cases, we have been able to successfully renegotiate the terms of the project with the particular customer. We cannot assure you that we will be able to renegotiate our customer agreements if such circumstances occur in the future. Moreover, even if we complete a project, we may not meet our customers’ expectations regarding the quality of our products and services or the timeliness of our services.

Our future success depends on our ability to continue to retain and attract qualified employees.

We believe that our future success depends upon our ability to continue to train, retain, effectively manage and attract highly skilled technical, scientific, managerial, sales and marketing personnel. We currently have limited personnel and other resources to staff and complete consulting and software deployment projects. In addition, as we grow our business, we expect an increase in the number of complex projects and large deployments of our products and services, which require a significant amount of personnel for extended periods of time. In particular, there is a limited supply of modeling and simulation personnel worldwide, and competition for these personnel from numerous companies and academic institutions may limit our ability to hire these persons on commercially reasonable terms. From time to time, we experience difficulties in locating enough highly qualified candidates in desired geographic locations, or with required scientific or industry-specific expertise. Staffing projects and deploying our products and services will become more difficult as our operations and customers become more geographically diverse. If we are not able to adequately staff and complete our projects, we may lose customers and our reputation may be harmed. Any difficulties we may have in completing customer projects may impair our ability to grow our business.

If we lose key members of our management, scientific or development staff, or our scientific advisors, our reputation may be harmed and we may lose business.

We are highly dependent on the principal members of our management, scientific and development staff. Our reputation is also based in part on our association with key scientific advisors. The loss of any of these personnel might adversely impact our reputation in the market and harm our business. Failure to attract and retain

 

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key management, scientific and technical personnel could prevent us from achieving our strategy and developing our products and services. In addition, our management team has experienced significant personnel changes over the past years and may continue to experience changes in the future. If our management team continues to experience attrition, high turnover, or does not work effectively together, it could harm our business. Additionally, we do not currently hold key-man life insurance policies on our CEO, CTO or other key contributors. The demise of any of these individuals could adversely impact our business.

Our business depends on our intellectual property rights, and if we are unable to adequately protect them, our competitive position will suffer.

Our intellectual property is important to our competitive position. We protect our proprietary information and technology through a combination of patent, trademark, trade secret and copyright law, confidentiality agreements and technical measures. We cannot assure you that the steps we have taken will prevent misappropriation of our proprietary information and technology, nor can we guarantee that we will be successful in obtaining any patents or that the rights granted under such patents will provide a competitive advantage. Misappropriation of our intellectual property could harm our competitive position. We may also need to engage in litigation in the future to enforce or protect our intellectual property rights or to defend against claims of invalidity, and we may incur substantial costs as a result. In addition, the laws of some foreign countries provide less protection of intellectual property rights than the laws of the United States, Canada and Europe. As a result, we may have an increasingly difficult time adequately protecting our intellectual property rights as our sales in foreign countries grow.

If we become subject to infringement claims by third parties, we could incur unanticipated expense and be prevented from providing our products and services

We cannot assure you that infringement claims by third parties will not be asserted against us or, if asserted, will be unsuccessful. These claims, whether or not meritorious, could be expensive and divert management resources from operating our company. Furthermore, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could block our ability to provide products or services, unless we obtain a license to such technology. In addition, we cannot assure you that licenses for any intellectual property of third parties that might be required for our products or services will be available on commercially reasonable terms, or at all.

International sales of our product account for a significant portion of our revenue, which exposes us to risks inherent in international operations.

We market and sell our products and services in North America and internationally. International sales of our products and services as a percentage of our total revenue for fiscal 2008, 2007 and 2006 were approximately 28%, 34% and 24%, respectively. We have a total of 25 employees based outside the United States who deploy our software, perform consulting services and perform research in Canada, Europe and Australia. We cannot be certain that we have fully complied with all rules and regulations in every applicable jurisdiction outside of the United States with respect to our current and previous operations outside of the United States. The failure to comply with such rules and regulations could result in penalties, monetary or otherwise, against us. Our existing marketing efforts into international markets may require significant management attention and financial resources. We cannot be certain that our existing international operations will produce desired levels of revenue. We currently have limited experience in developing localized versions of our products and services and marketing and distributing our products internationally. Our international operations also expose us to the following general risks associated with international operations:

 

   

disruptions to commercial activities or damage to our facilities as a result of political unrest, war, terrorism, labor strikes and work stoppages;

 

   

difficulties and costs of staffing and managing foreign operations;

 

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the impact of recessions or inflation in economies outside the United States;

 

   

greater difficulty in accounts receivable collection and longer collection periods;

 

   

reduced protection for intellectual property rights in some countries;

 

   

potential adverse tax consequences, including higher tax rates generally in Europe;

 

   

tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers imposed by foreign countries;

 

   

unexpected changes in regulatory requirements of foreign countries, especially those with respect to software, pharmaceutical and biotechnology companies; and

 

   

fluctuations in the value of currencies.

To the extent that such disruptions and costs interfere with our commercial activities, our results of operations could be harmed.

Changes in government regulation could decrease the need for the products and services we provide.

Governmental agencies throughout the world, but particularly in the United States, highly regulate the drug development and approval process. A large part of our software and services business involves helping pharmaceutical and biotechnology companies through the regulatory drug approval process. Any relaxation in regulatory approval standards could eliminate or substantially reduce the need for our services, and, as a result, our business, results of operations and financial condition could be materially adversely affected. Potential regulatory changes under consideration in the United States and elsewhere include mandatory substitution of generic drugs for patented drugs, relaxation in the scope of regulatory requirements or the introduction of simplified drug approval procedures. These and other changes in regulation could have an impact on the business opportunities available to us.

Although we believe we currently have adequate internal control over financial reporting, we are required to assess our internal control over financial reporting on an annual basis, and any future adverse results from such assessment could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish a report by our management on our internal control over financial reporting. Such report will contain, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. In addition, we must comply with the auditor attestation requirements of Section 404 beginning in fiscal 2010.

Although we currently believe our internal control over financial reporting is effective, the effectiveness of our internal controls in future periods is subject to the risk that our controls may become inadequate. If we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to provide an attestation report regarding the effectiveness of our internal controls, or qualify such report or fail to provide such report in a timely manner), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.

 

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Risks Related To Our Industry

Our market may not develop as quickly as expected, and companies may enter our market, thereby increasing the amount of competition and impairing our business prospects.

Because our products and services are new and still evolving, there is significant uncertainty and risk as to the demand for, and market acceptance of, these products and services. As a result, we are not able to predict the size and growth rate of our market with any certainty. In addition, other companies, including potential strategic partners, may enter our market. Our existing customers may also elect to terminate our services and internally develop products and services similar to ours. If our market fails to develop, grows more slowly than expected, or becomes saturated with competitors, our business prospects will be impaired.

Government regulation of the pharmaceutical industry may restrict our operations or the operations of our customers and, therefore, adversely affect our business.

The pharmaceutical industry is regulated by a number of federal, state, local and international governmental entities. Although United States Food and Drug Administration or comparable international agencies do not directly regulate the majority our products and services, the use of some of our analytical software products by our customers may be regulated. We currently provide assistance to our customers in achieving compliance with these regulations. In addition, our Reporting and Analysis Services are subject to various regulatory requirements designed to ensure the quality and integrity of the data or products of these services. These regulations are governed primarily by good laboratory practice, or GLP, and good clinical practice, or GCP, guidelines mandated by the FDA. The regulatory agencies could enact new regulations or amend existing regulations with regard to these or other products that could restrict the use of our products or the business of our customers, which could harm our business.

Consolidation in the pharmaceutical industry could cause disruptions of our customer relationships, interfere with our ability to enter into new customer relationships and have a negative impact on our revenues

In recent years, the worldwide pharmaceutical industry has undergone substantial consolidation. If any of our customers consolidate with another business, they may delay or cancel projects, lay off personnel or reduce spending, any of which could cause our revenues to decrease. In addition, our ability to complete sales or implementation cycles may be impaired as these organizations undergo internal restructuring.

Reductions in the IT and/or research and development budgets of our customers may affect our sales.

Our customers include researchers at pharmaceutical and biotechnology companies, academic institutions and government and private laboratories. Fluctuations in the IT and research and development budgets of these researchers and their organizations could have a significant effect on the demand for our products. Research and development and IT budgets fluctuate due to changes in available resources, spending priorities, internal budgetary policies and the availability of grants from government agencies. Our business could be harmed by any significant decrease in research and development or IT expenditures by pharmaceutical and biotechnology companies, academic institutions or government and private laboratories.

Recent or continued withdrawals of drugs from the public market could affect pharmaceutical spending, reduce the demand for our products and have a negative impact on our revenues.

Recently, the pharmaceutical industry has experienced, and may continue to experience, forced withdrawal of certain drugs from the public market due to safety risks. Recent or future drug withdrawals could affect our ability to market and sell our products and services to companies faced with withdrawals. For example, withdrawals of drugs from the public market by our customers or potential customers may result in the reduction of current levels of spending on software solutions and strategic consulting services by these companies to minimize the impact of a potential decline in revenues. In addition, we may provide products or services to

 

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customers with drugs in the same class as the drugs withdrawn from the market. If the demand for drugs within the class of drugs faced with recent withdrawals decreases, we may experience a decrease in demand for our products or services in that class of drugs. A decrease in demand for our products, or a decrease in IT or research and development spending by pharmaceutical companies, could prevent us from increasing or sustaining our software and strategic consulting revenues and adversely affect our revenues and results of operations.

Risks Related to Our Stock

The public market for our common stock may be volatile.

The market price of our common stock has been, and we expect it to continue to be, highly volatile and to fluctuate significantly in response to various factors, including:

 

   

actual or anticipated variations in our quarterly operating results or those of our competitors;

 

   

announcements of technological innovations or new services or products by us or our competitors;

 

   

timeliness of our introductions of new products;

 

   

changes in management; and

 

   

changes in the conditions and trends in the pharmaceutical market.

For instance, on an as-adjusted basis to reflect the reverse stock split effected in November 2007, the trading price of our common stock closed as low as $4.41 and as high as $6.66 per share during fiscal 2008. We have experienced very low trading volume in our stock, and thus small purchases and sales can have a significant effect on our stock price. In addition, the stock markets have experienced extreme price and volume fluctuations, particularly in the past year, that have affected the market prices of equity securities of many technology companies. These fluctuations have often been unrelated or disproportionate to operating performance. These broad market factors may materially affect the trading price of our common stock. General economic, political and market conditions, such as recessions and interest rate fluctuations, may also have an adverse effect on the market price of our common stock.

Our principal stockholders will have a controlling influence over our business affairs and may make business decisions with which you disagree and which may adversely affect the value of your investment.

Our executive officers, directors, major stockholders and their affiliates beneficially own or control, indirectly or directly, a substantial number of shares of our common stock. As a result, if some of these persons or entities act together, they will have the ability to control matters submitted to our stockholders for approval, including the election and removal of directors, amendments to our certificate of incorporation and bylaws, and the approval of any business combination. These actions may be taken even if they are opposed by other stockholders. This concentration of ownership may also have the effect of delaying or preventing a change of control of our company or discouraging others from making tender offers for our shares, which could prevent our stockholders from receiving a premium for their shares.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable

ITEM 2. PROPERTIES

Our principal executive offices, totaling approximately 14,000 square feet, are located in Mountain View, California under a lease that expires in August 2010. We also lease approximately 18,000 square feet in Cary, North Carolina for a sales, development and training facility under a lease agreement that expires through March 2011. In April 2008, we entered into a three year operating lease agreement in Montreal, Canada for our Reporting and Analysis Services group. We believe that our existing facilities are adequate for our current needs and that additional space will be available as needed.

 

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ITEM 3. LEGAL PROCEEDINGS

From time to time, Pharsight may become involved in claims, legal proceedings, or state or federal government agency proceedings that arise in the ordinary course of its business. We are not currently a party to any material litigation and are currently not aware of any pending or threatened litigation that could have any material adverse effect upon our business, operating results or financial condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of Pharsight’s stockholders during the fourth quarter of our fiscal year ended March 31, 2008.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table provides information concerning our executive officers as of June 26, 2008:

 

Name

   Age   

Position

Shawn M. O’Connor

   49    President, Chief Executive Officer and Chairman

William Frederick

   45    Senior Vice President, Chief Financial Officer and Corporate Secretary

Daniel L. Weiner, PhD

   58    Senior Vice President and Chief Technology Officer

Mark Hovde

   51    Senior Vice President, Marketing

James D. Hayden

   40    Senior Vice President, Global Sales

John E. Murphy, DrPH

   60    Senior Vice President, Consulting Services

Shawn M. O’Connor, Pharsight’s President, Chief Executive Officer and Chairman since February 2003, joined Pharsight in September 2002 as its Senior Vice President and Chief Financial Officer. Mr. O’Connor has more than 20 years of experience in high technology executive management. Prior to joining Pharsight, Mr. O’Connor was the President and Chief Operating Officer of QRS Corporation, a leading provider of business-to-business e-commerce services to the retail industry, from 1995 to 2001. Prior to QRS, he served as Chief Financial Officer of Diasonics Ultrasound, Inc., a publicly held worldwide medical equipment manufacturer, from 1987 to 1994. Mr. O’Connor began his career with the accounting firm Peat Marwick, where he served as a CPA in both San Francisco and London. Mr. O’Connor holds a B.S. from the University of California, Berkeley, in Finance & Business Administration and is a graduate of the Executive Education Program at the Stanford Graduate School of Business.

William Frederick, joined Pharsight in April 2006. Prior to joining Pharsight, Mr. Fredrick was Vice President and Chief Financial Officer of Versata, Inc. from January 2004 to January 2005. Mr. Frederick joined Versata in December 2002 as Corporate Controller and was appointed as Vice President and Chief Financial Officer in January 2004. In February 2005, Mr. Frederick was also appointed as Versata’s interim Chief Executive Officer and President. From August 2000 through March 2002, Mr. Frederick served as Vice President, Finance at Clarent Corporation. From January 2000 through August 2000, Mr. Frederick was Corporate Controller at ACT Networks, Inc. a developer and manufacturer of broadband access equipment that was acquired by Clarent in August 2000. From May 1999 to November 1999, Mr. Frederick was the Chief Financial and Administrative Officer of IAM.com, Inc, a business-to-business web application company. From January 1998 to May 1999, Mr. Frederick was in the corporate finance department of The Disney Store division of The Walt Disney Company. Mr. Frederick holds a M.B.A degree from California State University at Long Beach and a bachelor’s degree in finance from California State University at Fullerton.

Daniel L. Weiner, Ph.D., rejoined Pharsight as Senior Vice President, Software Products in June 2004, and was recently promoted to Chief Technology Officer. Dr. Weiner worked as an independent pharmaceutical consultant before taking the position of Senior Vice President and Head of Global Clinical Development at

 

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IVAX Corporation from May 2003 to May 2004. From February 1998 until December 2002, Dr. Weiner held the position of Senior Vice President of Software Development with Pharsight Corporation. Dr. Weiner has served as an expert consultant to the FDA on pharmacokinetic modeling and bioequivalence assessment. Prior to his previous tenure with Pharsight as a Senior Vice President, Dr. Weiner held several management positions including Head, Biostatistics, Merrell Dow Pharmaceuticals; Vice President, Statistical Consultants, Inc.; Vice President, Syntex Development Research; and Senior Vice President and Principal Scientist, Quintiles. Dr. Weiner graduated from the University of Kentucky with a doctoral degree in Mathematical Statistics, with emphasis on compartmental modeling, as well as an M.S. in Statistics and a B.S. in Mathematics.

Mark Hovde, joined Pharsight in April 2005 as Senior Vice President, Marketing. Mr. Hovde has more than 15 years of experience in marketing and business development for pharmaceutical software, data, and services companies. Prior to joining Pharsight, from October 2003 to April 2005, Mr. Hovde was the President and founder of Hovde Associates, LLC, a management consulting firm specializing in counsel on pharmaceutical development. Prior to this, from September 2000 to October 2003, he was the Vice President, Sales and Business Development at Fast Track Systems, Inc., a developer of software focused on improving the protocol quality and the speed of the clinical trial process. From 1989 to August 2000, Mr. Hovde was also the co-founder of DataEdge, LLC, a developer of novel informatics that help reduce the time and cost of clinical trials. Mr. Hovde has authored several publications and presentations and holds a Bachelor of Science degree in Finance from the Wharton School of the University of Pennsylvania, where he was also named a Benjamin Franklin Scholar, and an MBA from Harvard Business School.

James D. Hayden, joined Pharsight in April 2005 as Senior Vice President, Global Sales. Mr. Hayden has 15 years of experience in sales, marketing and management within the life sciences industry. From May 1998 to April 2005, Mr. Hayden held various positions with Accelrys, Inc., a leading provider of software for computation, simulation, and the management and mining of scientific data used by biologists, chemists and materials scientists. From June 1991 to April 1998 he held various positions at Bio-Rad Laboratories, a developer of innovative tools and services for the clinical diagnostics and life sciences research markets including Product Support Manager and Senior Account Manager. Mr. Hayden began his career as an electrical engineer at Raytheon and holds an MBA from Rutgers University and a B.S. in Electrical Engineering from Boston University.

Dr. John E. Murphy, joined Pharsight in April 2008 as Senior Vice President, Consulting Services. Prior to joining Pharsight, from January 2005 to April 2008, Dr. Murphy was Principal and Executive Advisor at Booz Allen Hamilton, Inc. Before this, from September 2001 to January 2005, Dr. Murphy served as Vice President and Chief Information Officer at CuraGen Corporation, a publicly traded biopharmaceutical company. Prior to joining CuraGen, from July 1996 to April 2000, Dr. Murphy was founder and chief executive officer at Just Medicine Incorporated, a developer of regulatory-compliant clinical software for the management of real-time data collection and analysis. Dr. Murphy has also held a number of other senior leadership roles in medical device companies, life sciences software technology companies and healthcare delivery organizations, including Predict Incorporated, Community Health Computing and Mercy Hospital in Watertown, New York. He earned his masters and doctor of Public Health degrees from Columbia University.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is currently listed on the NASDAQ Capital Market under the symbol “PHST”. Our common stock first traded publicly on August 9, 2000, concurrent with the underwritten initial public offering of shares of our common stock, on the NASDAQ National Market and continued to be traded there until November 7, 2002. From November 8, 2002 to November 26, 2007, our common stock traded on the Over-The-Counter Bulletin Board system or OTCBB. On November 27, 2007, our common stock ceased to trade on the OTCBB and began trading on the NASDAQ Capital Market.

As of June 15, 2008, there were 9,465,218 of common stock outstanding that were held by 48 stockholders of record. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.

The table below sets forth the high and low sales prices for our common stock as reported on NASDAQ and the high and low bid information for our common stock as reported on the OTCBB, as applicable, for the periods indicated, all of which reflect the one for three reverse stock split effected on November 13, 2007:

 

     High     Low  
Fiscal year ended March 31, 2008     

Fourth Quarter

   $ 5.50     $ 3.76  

Third Quarter

     8.00       4.66  

Second Quarter

     6.75 *     4.50 **

First Quarter

     5.94 *     4.26 **
Fiscal year ended March 31, 2007     

Fourth Quarter

   $ 5.10 *   $ 3.75 **

Third Quarter

     5.85 *     3.96 **

Second Quarter

     4.50 *     3.15 **

First Quarter

     4.80 *     3.63 **

 

* This high bid information was reported on the “OTCBB”, on an as-adjusted basis to reflect the reverse stock split effected in November 2007.

 

** This low bid information was reported on the “OTCBB”, on an as-adjusted basis to reflect the reverse stock split effected in November 2007.

The over-the-counter quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.

We have never declared or paid any cash dividends on our common stock and do not anticipate paying such cash dividends on our common stock in the foreseeable future. We currently anticipate that we will retain all of our future earnings, if any, for use in the development and expansion of our business and for general corporate purposes. Any determination to pay dividends on our common stock in the future will be at the discretion of our board of directors and will depend upon our results of operation, financial condition and other factors as our board of directors, in its discretion, deems relevant. In addition, under the terms of some of our debt agreements, we are prohibited from paying dividends without the consent of the lender.

 

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Stock Performance Graph

The line graph below compares the cumulative total stockholder return on our common stock with the cumulative return of the NASDAQ Composite Index and the NASDAQ Biotechnology Index for the five years ended March 31, 2008. The graph and table assume that $100.00 was invested on March 31, 2003 (the last day of trading for the year ended March 31, 2003) in each of our common stock, the NASDAQ Composite Index, and the NASDAQ Biotechnology Index and that all dividends were reinvested. We have not paid or declared any cash dividends on our common stock. Stockholder returns over the period indicated should not be considered indicative of future stockholder returns.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN

Among Pharsight Corporation, The NASDAQ Composite Index

And The NASDAQ Biotechnology Index

LOGO

Notwithstanding any statement to the contrary in any of our previous or future filings with the SEC, the foregoing information relating to the price performance of our common stock shall not be deemed to be “filed” with the SEC or to be “soliciting material” under the Exchange Act, and it shall not be deemed to be incorporated by reference into any of our filings under the Securities Act or the Exchange Act, except to the extent we specifically incorporate it by reference into such filing.

 

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ITEM 6. SELECTED FINANCIAL DATA

You should read the following historical selected consolidated financial data in conjunction with the financial statements and related notes and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K. We have derived our consolidated balance sheet data as of March 31, 2008 and 2007 and consolidated statement of operations data for each of the years ended March 31, 2008, 2007 and 2006, from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We have derived our balance sheet data as of March 31, 2006, 2005 and 2004 and statement of operations for the years ended March 31, 2005 and 2004 from our audited consolidated financial statements not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of results to be expected for any future period.

 

     Years Ended March 31,  
     2008     2007     2006     2005     2004  
     (In thousands, except per share data)  

Consolidated Statement of Operations Data

          

Revenues

   $ 28,342     $ 25,092     $ 22,742     $ 22,593     $ 17,730  

Gross profit*

     18,612       17,361       15,043       14,832       9,937  

Total operating expenses*

     17,212       15,715       14,461       11,841       11,673  

Income (loss) from operations*

     1,400       1,646       582       2,991       (1,736 )

Net income (loss)*

     1,685       1,871       530       2,733       (1,997 )

Net income (loss) attributable to common stockholders

   $ (5,466 )   $ 1,125     $ (208 )   $ 2,123     $ (2,990 )

Net income (loss) per share attributable to common stockholders:

          

Basic

   $ (0.62 )   $ 0.17     $ (0.03 )   $ 0.33     $ (0.47 )

Diluted

   $ (0.62 )   $ 0.16     $ (0.03 )   $ 0.22     $ (0.47 )

Shares used to compute net income (loss) per share attributable to common stockholders:

          

Basic

     8,757       6,590       6,474       6,374       6,350  

Diluted

     8,757       7,187       6,474       9,503       6,350  
     As of March 31,  
   2008     2007     2006     2005     2004  
   (In thousands)  

Consolidated Balance Sheet Data

          

Cash, cash equivalents and short-term investments

   $ 17,099     $ 14,665     $ 10,832     $ 10,579     $ 10,027  

Total assets

     23,937       19,995       17,786       16,822       15,294  

Current portion of notes payable

     —         292       1,519       1,975       1,875  

Long-term obligations, net of current portion

     261       279       699       536       1,610  

Redeemable convertible preferred stock

     —         7,096       6,641       6,266       6,164  

Total stockholders’ equity (deficit)

   $ 9,841     $ (350 )   $ (2,659 )   $ (2,630 )   $ (4,915 )

 

* We adopted SFAS No. 123R on April 1, 2006 using the modified prospective transition method. The stock based compensation expense recognized under this method was approximately $1.3 million and $831,000 in fiscal 2008 and 2007, respectively.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section and other parts of this Form 10-K contain forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in “Part I—Item 1A—Risk Factors.” The following discussion should be read in conjunction with the financial statements and notes thereto set forth under “Item 8—Financial Statements and Supplementary Data.

Overview

Pharsight Corporation develops and markets software and provides strategic consulting services and reporting and analysis services that help pharmaceutical and biotechnology companies improve the efficiency of the drug development decision making process by reducing the costs and time requirements of their drug discovery, development, and commercialization efforts. Pharsight’s proprietary software products include Trial Simulator for clinical trial simulation and computer-aided trial design; WinNonlin and WinNonMix for the statistical analysis and mathematical modeling of PK/PD data; IVIVC Toolkit for WinNonlin for the development of in-vivo-in-vitro correlations and the management of related datasets and workflow; WinNonlin Validation Suite for streamlined on-site validation of WinNonlin; PKS, WinNonlin AutoPilot, PKS Reporter and PK Automation for the storage, management, analysis, and regulatory reporting of derived data and models in data repositories; PKS Validation Suite for streamlined on-site validation of PKS; and Drug Model Explorer for dynamic visualization and communication of model-based product profiles. Our software products and our services utilize expertise in the sciences of pharmacology, drug and disease modeling, biostatistics and strategic decision-making. Our service offerings use this expertise to interpret and improve the design of scientific experiments and clinical trials, and to optimize clinical trial design and portfolio decisions. By integrating scientific, clinical, and business decision criteria into a dynamic model-based methodology, we help our customers optimize the value of their drug development programs and portfolios from discovery to post-launch marketing.

We believe the use of our software and methodology is reaching the mainstream of the drug development process, as evidenced by the FDA’s call for modeling discussions in Phase IIa meetings with sponsors, the use of modeling and simulation by the FDA to support decisions on program designs or labeling in 25% of recent new drug application reviews, and the establishment of modeling and simulation groups in most of the top pharmaceutical and biotechnology companies. Although our methodology does not displace the use of human trials in drug development, we believe our software and our methodology renders human trials more efficient and relevant. The continued growth of our customer base, the increase in the number of contracts with our customers, and the increase in our average contract values over time have shown a trend that we believe demonstrates increased acceptance of our methodology and an increased demand for its use. We believe that these trends, in addition to increasing regulatory requirements from the FDA and the FDA’s emphasis on modeling and simulation found in the Critical Path Initiative and in our Cooperative Research and Development Agreement (CRADA) with the FDA announced in June 2006, demonstrate a potential for increased revenue growth resulting from increased demand for our current products and services, as well as long-term opportunities to expand the breadth and coverage of both our consulting services and software product offerings.

For reporting purposes, we operated in three business segments or groups during fiscal 2008: Software Products, Strategic Consulting Services, and Reporting and Analysis Services. Our Software Products segment consists of software products and software deployment and integration services that provide the analytical tools and conceptual framework to help clinical researchers optimize the decision-making and workflows required to perform, analyze, and report on the clinical tests needed to bring drugs to market. Our Strategic Consulting segment consists of consulting, training and process redesign conducted by our clinical and decision scientists in the application and implementation of our core decision methodology. Reporting and Analysis Services was launched in the first quarter of fiscal 2008 to address client needs for modeling and simulation in the production of reports submitted to regulatory authorities to gain marketing authorization. These services meet growing

 

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customer demands for analysis and reporting of pharmacokinetic/pharmacodynamic data generated in clinical and preclinical studies supporting new drug approvals. In the production of these analyses and reports, our Reporting and Analysis Services group often makes use of Pharsight software products. These segments were determined based on how management and our Chief Operating Decision Maker, or CODM, who is our Chief Executive Officer, view and evaluate our business.

Financial Highlights for Fiscal 2008

 

   

Our total revenue for fiscal 2008 was approximately $28.3 million, approximately a $3.3 million increase over fiscal 2007, primarily due to increases in both software license revenue and Reporting and Analysis Services revenue offset by a slight decrease in software services revenue and Strategic Consulting Services revenue.

 

   

Our revenue from the Software Products segment for fiscal 2008 was approximately $16.2 million compared with approximately $14.2 million for fiscal 2007. License, renewal and maintenance revenue for fiscal 2008 accounted for approximately $14.2 million, up from approximately $12.1 million for fiscal 2007. Software services revenue accounted for approximately $2.0 million for fiscal 2008, a decrease from approximately $2.2 million for fiscal 2007.

 

   

Our revenue from the Reporting and Analysis Services segment was approximately $1.5 million for fiscal 2008. Gross margin for this segment was 53% for the fourth quarter and 36% for fiscal 2008. The lower margin for the year compared to fourth quarter was due to start up costs at the beginning of the year.

Challenges and Risks

We achieved our first quarter of profitability in the fourth quarter of fiscal 2004. Fiscal 2008 marked our fourth consecutive fiscal year of annual profitability and positive annual net cash flow. Prior to that time we had incurred losses since inception. As of March 31, 2008, we had an accumulated deficit of approximately $72.6 million. To meet increased demand for our products and services, we may be required to invest further in our operations, technology and infrastructure, which may result in our inability to sustain profitability.

As of March 31, 2008, we had approximately $17.1 million in cash, cash equivalents and short-term investments and the limit on our line of credit was approximately $5 million. We believe that our current cash balances are sufficient to meet our working capital needs for the next twelve months. Our ability to generate positive net cash flow and sustain positive operating cash flow on a quarterly and annual basis is based on a number of factors, including some that are outside of our control, such as the state of the overall economy, the demand for our products and services and the length and lack of predictability of our sales cycle. In addition, if we proceed with one or more significant acquisitions in which the consideration includes cash, we could be required to use a substantial portion of our available cash to consummate any such acquisition. Acquisitions may result in the incurrence of debt, material one-time write-offs, or purchase accounting adjustments and restructuring charges. They may also result in recording goodwill and other intangible assets in our financial statements which may be subject to future impairment charges or ongoing amortization costs, thereby reducing future earnings. To the extent that we issue new stock or other rights to purchase stock or to generate additional cash, existing stockholders may be diluted and earnings per share may decrease.

While we expect that the overall long-term revenue trend in our software business will continue to increase in response to customer demand, software revenue in individual quarters may fluctuate significantly, based upon timing of completion of large software installations and related revenue recognition. Unanticipated delays in software project deployment schedules may have significant impact on the timing of revenue recognition and may have corresponding significant impact on our net income in that quarter. We have seen a trend develop where more of our projects have become fixed-fee or milestone based, as a result, the timing of completion on milestones may cause fluctuations in quarterly Strategic Consulting Services and Reporting and Analysis Services revenue.

 

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The worldwide pharmaceutical industry continues to undergo substantial consolidation, which may reduce the number of our existing and potential customers. The loss of one of our large customers could hurt our business and operating results.

Our Strategic Consulting Services customers range in size from the largest pharmaceutical companies to small biopharmaceutical companies, and the focus of our work differs depending upon the size and maturity of the customer. In our smaller and medium-sized customers, we tend to engage in discrete projects often with challenging analytic and design problems, where modeling and simulation can be particularly valuable. This kind of work may or may not lead to subsequent engagements. By contrast, at our largest customers, we tend to have ongoing relationships which are more strategic in nature, and we focus on helping improve the process by which they develop drugs, broadening and deepening the application of modeling and simulation over time, with the intent of achieving systematic, lasting performance improvement.

We established the Reporting and Analysis Services group in fiscal 2008. We currently do not have any history to validate the ongoing growth and success of this group.

Our customers may also expand their internal drug development organizations to include functions and individuals that might perform services similar to those performed by our Strategic Consulting Services group and Reporting and Analysis Services group. As a result, our consulting business could have difficulty sustaining its current levels of revenues, or increasing its revenues in the future. Unanticipated delays in consulting project schedules may have significant impact to the timing of revenue recognition and may have corresponding significant impact on our net income in that quarter.

The pharmaceutical industry in general has experienced, and may continue to experience, forced withdrawal of certain drugs from the public market due to unforeseen safety risks, more and more time-consuming safety and efficacy testing requirements in drug development, and patent expiries on significant portions of their marketed drugs. Our customers may, as a result, experience reductions in their current level of spending on software solutions and strategic consulting services. This could adversely affect our business and prevent us from increasing or sustaining our software and strategic consulting revenues.

Critical Accounting Policies and Estimates

We prepare our financial statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The primary critical accounting policies that currently affect our financial condition and results of operations are revenue recognition, allowance for doubtful accounts, valuation of stock-based compensation, and valuation of deferred tax assets, which impact revenue and operating expenses. We believe that these accounting policies are critical to fully understand and evaluate our reported financial results.

Revenue Recognition

Our revenues are derived from four primary sources: (1) initial and renewal fees for term-based and perpetual product licenses, and post-contract customer support (PCS or maintenance services), (2) services related to scientific and training consulting and software deployment, (3) Strategic Consulting Services and (4) Reporting and Analysis Services.

 

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Our revenue recognition policy is in accordance with Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), as amended. For each arrangement, we determine whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, collection is probable, and no significant post-delivery obligations remain unfulfilled. If any of these criteria are not met, we defer revenue recognition until such time as all of the criteria are met. We do not currently offer, have not offered in the past, and do not expect to offer in the future, extended payment term arrangements. If we do not consider collectability to be probable, we defer recognition of revenue until the fee is collected.

Software Product Segment

We enter into arrangements for term-based software licenses (initial and renewal fees) bundled with post-contract support services, or PCS, from which we receive solely license and renewal fees. We do not have vendor specific objective evidence, or VSOE, of fair value to allocate the fee to the separate elements for these arrangements. Therefore, we do not present PCS revenue separately in connection with these arrangements, and we do not believe other allocation methodologies, such as allocation based on relative costs, provide a meaningful and supportable allocation between license and PCS revenues. We recognize each of the initial and renewal license fees ratably over the one-year period or the remaining period of the license during which the PCS is expected to be provided as required by paragraph 12 of SOP 97-2. Revenues from bundled arrangements are recorded as license revenues in the statement of operations in the initial year and as renewal revenue in subsequent years.

We enter into arrangements consisting of perpetual licenses and PCS. Prior to the second quarter of fiscal 2008, we had not established VSOE of fair value to allocate the fee to the separate elements of the arrangement. We recognized revenue attributable to license and PCS ratably over the remaining period of the PCS term once the product was delivered. For financial statement presentation purposes, revenues from arrangements that included perpetual licenses were allocated among and recorded as license and maintenance revenue based upon management’s estimate of fair value and the Company’s price list. Renewals of related PCS were recorded as maintenance revenue for perpetual licenses and renewal revenue for term-based licenses. During the second quarter of fiscal 2008, we established VSOE of fair value of the separate elements of our enterprise software products. For perpetual license arrangements, we allocate revenue to delivered components, normally the license component of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to us. We determine the fair value of the undelivered elements based on our current price list and the historical evidence of the Company’s sales of these elements to third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

We enter into arrangements that consist of perpetual and term-based licenses, PCS and implementation/installation services. Prior to the second quarter of fiscal 2008, we had not established VSOE of fair value to allocate the fee to the separate elements of the arrangement. For arrangements involving a significant amount of services related to installation and implementation of our software products, we recognized revenue for the entire arrangement ratably over the remaining period of the PCS term once the implementation and installation services were completed and accepted by the customer. For financial statement presentation purposes, revenues from arrangements that included perpetual and term-based licenses were allocated among and recorded as license, maintenance, renewal and service revenue based upon management’s estimate of fair value and the Company’s price list. Renewals of related PCS were recorded as maintenance revenue for perpetual licenses and renewal revenue for term-based licenses. The implementation/installation services revenues were recorded as services revenue in the statement of operations. During the second quarter of fiscal 2008, we established VSOE of fair value of the separate elements of our enterprise software product arrangements. For perpetual license arrangements, we allocate revenue to delivered components, normally the license and installation components of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to us. We determine the fair value of the undelivered elements based on our current price list and the historical evidence of the Company’s sales of these elements to

 

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third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

We enter into arrangements consisting of optional scientific consulting services. The optional scientific consulting services meet the criteria of paragraph 65 of SOP 97-2 for separate accounting, as they are not essential to the functionality of the delivered software, are described and priced separately in the arrangement and are sold separately. We recognize fees from optional scientific consulting services (equal to the amounts set forth in the contracts) as revenue as these services are provided or upon their acceptance, as applicable.

For arrangements consisting solely of services, we recognize revenue as consulting services are performed. Arrangements for consulting services may be charged at daily rates for different levels of consultants plus out-of-pocket expenses, or may be charged as a fixed fee. For fixed fee contracts, with payments based on milestones or acceptance criteria, we recognize revenue using the proportional performance method—as such milestones are achieved, or if customer acceptance of the milestone’s completion is required, upon such customer acceptance, which approximates the level of services provided. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances, specification and testing requirement changes, and unforeseen changes in project scope.

We have two international distributors. There is no right of return or price protection for sales to the international distributors. Revenue on sales to these distributors is recognized ratably over the license term when the software is delivered to the distributors and other revenue recognition criteria are met.

Strategic Consulting Services and Reporting and Analysis Services Segments

We enter into arrangements for Strategic Consulting Services contracts and Reporting and Analysis Services contracts, which do not fall under the scope of SOP 97-2. Arrangements for these consulting services may be charged at daily rates and out-of-pocket expenses, or may be charged as a fixed fee. For fixed fee with payments based on milestones or acceptance criteria, we recognize revenue using the proportional performance method—as such milestones are achieved, or if customer acceptance is required, upon customer acceptance, which approximates the level of services provided. Management makes a number of estimates related to recognizing revenue for such contracts, as discussed above. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances, specification and testing requirement changes, and unforeseen changes in project scope.

Judgments Affecting Revenue Recognition

Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter. We recognize revenue in accordance with U.S. GAAP rules that have been prescribed for the software industry. The accounting rules related to revenue recognition are complex and are affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant judgments.

We do not record revenue on sales to customers whose ability to pay is in doubt at the time of sale. Rather, we recognize revenue from these customers as cash is collected. The determination of a customer’s ability to pay requires significant judgment. In this regard, management considers the international region of the customer and the financial viability of the customer in assessing a customer’s ability to pay.

We generally do not consider revenue arrangements with extended payment terms to be fixed or determinable and, accordingly, we do not generally recognize revenue on these arrangements until the customer payments become due. The determination of whether extended payment terms are fixed or determinable requires management to exercise significant judgment, including assessing such factors as the past payment history with

 

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the individual customer and evaluating the risk of concessions over an extended payment period. The determinations that we make can materially impact the timing of recognition of revenues. Our normal payment terms currently range from “net 30 days” to “net 60 days,” which are not considered by us to be extended payment terms.

The majority of our PKS software arrangements include software deployment services. Prior to the second quarter of fiscal 2008, we deferred revenue for software deployment services, along with the associated license revenue, until the services were completed. If there was significant uncertainty about the project completion or receipt of payment for the professional services, we deferred revenue until the uncertainty was sufficiently resolved. Beginning in the second quarter of fiscal 2008, for PKS perpetual licenses, we allocate revenue to delivered components, normally the license component of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to us. We determine the fair value of the undelivered elements based on our current price list and the historical evidence of the Company’s sales of these elements to third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts at an amount estimated to be sufficient to provide adequate protection against losses resulting from collecting less than the full payment on our currently outstanding receivables. We make judgments as to our ability to collect receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices and evaluation of historical trends of write-offs of accounts we deem uncollectible.

Stock-Based Compensation

On April 1, 2006, we adopted Statement of Financial Accounting Standards or SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS 123R, which requires the measurement and recognition of compensation expense in the statement of operations for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. In March 2005, the SEC issued SAB 107 relating to SFAS 123R. We applied the provisions of SAB 107 in our adoption of SFAS 123R. Using the modified prospective transition method of adopting SFAS 123R, we began recognizing compensation expense for stock-based awards granted or modified after March 31, 2006 and awards that were granted prior to the adoption of SFAS 123R but were still unvested at March 31, 2006. Under this method of implementation, no restatement of prior periods is required or has been made.

SFAS 123R requires us to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. We elected to calculate our compensation expense by applying the Black-Scholes valuation model and the value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statements of operations. Stock-based compensation expense recognized in our consolidated statements of operations for the years ended March 31, 2007 and 2008 included compensation expense for share-based payment awards granted prior to, but not yet vested as of March 31, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” or SFAS 123.

SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Accordingly, stock-based compensation expense recognized in the consolidated statements of operations for the years ended March 31, 2007 and 2008 has been reduced for estimated forfeitures. In our pro forma information required under SFAS 123 for the periods prior to fiscal 2007, we accounted for forfeitures as they occurred.

 

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Results of Operations

The following table sets forth, for the periods given, selected consolidated financial data by reportable segment as a percentage of our revenue and the percentage of period-over-period change. The table and the discussion below should be read in connection with the consolidated financial statements and the notes thereto which appear elsewhere in this report. All percentage calculations set forth in this section have been made using figures presented in the consolidated financial statements, and not from the rounded figures referred to in the text of this management discussion and analysis.

Revenue

 

    Year Ended
March 31,
    Percentage of Dollar
Change Year Over Year
    Percentage of Total Revenues
Year Ended March 31,
 
     2008   2007     2006     2008/2007     2007/2006     2008     2007     2006  
    (In thousands, except percentages)  

Total Revenues:

               

License, renewal and maintenance

  $ 14,215   $ 12,055     $ 10,769     18 %   12 %   50 %   48 %   47 %

Services

    14,127     13,037       11,973     8 %   9 %   50 %   52 %   53 %
                                           

Total revenues:

  $ 28,342   $ 25,092     $ 22,742     13 %   10 %   100 %   100 %   100 %
                                           

Software Products Segment Revenues:

               

License, renewal and maintenance

  $ 14,215   $ 12,055     $ 10,769     18 %   12 %   50 %   48 %   47 %

Services

    2,022     2,183       2,680     (7 )%   (19 )%   7 %   9 %   12 %
                                           

Total software products segment revenues:

  $ 16,237   $ 14,238     $ 13,449     14 %   6 %   57 %   57 %   59 %
                                           

Strategic Consulting Services Segment Revenues

  $ 10,568   $ 10,854     $ 9,293     (3 )%   17 %   37 %   43 %   41 %
                                           

Reporting and Analysis Services Segment Revenues

  $ 1,537     —   (1)     —   (1)   —   (1)   —   (1)   6 %   —   (1)   —   (1)
                       

 

(1)

Reporting and Analysis Services Segment was launched in fiscal 2008

Comparison of Year Ended March 31, 2008 and 2007 and Comparison of Year Ended March 31, 2007 and 2006

Year Ended March 31, 2008 and 2007

Total revenue for fiscal 2008 increased to approximately $28.3 million, compared to approximately $25.1 million for fiscal 2007. The increase was a result of a 14% increase in the Software Products segment revenue offset by a 3% decrease in the Strategic Consulting Services segment revenue, as well as approximately an additional $1.5 million in revenue derived from our Reporting and Analysis Services group launched at the beginning of fiscal 2008. In addition, we established VSOE for our enterprise software products during the second quarter of fiscal 2008 which had a positive impact on our revenue and we introduced WinNonlin AutoPilot in the first quarter of fiscal 2008.

 

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Software Products Segment Revenues

License, renewal and maintenance revenues

For fiscal 2008, desktop software products revenues increased to approximately $8.7 million from approximately $8.0 million in fiscal 2007. The increase is mainly attributable to a $989,000 increase in desktop software license renewal revenue as a result of continued high renewal rates, increased desktop product prices and increased commercial customer base offset by a $222,000 decrease in our initial desktop software product revenue. In addition, we increased our sales and marketing efforts and hired two additional people in the inside sales department during fiscal 2008 which we believe increased sales, contributing to the increase in total revenue.

PKS software revenues increased to approximately $3.6 million in fiscal 2008 from approximately $3.3 million in fiscal 2007. The increase in PKS software products revenues is mainly due to an increase of $548,000 in renewals and maintenance revenue as a result of a larger customer base and due to existing customers buying additional licenses.

DMX software revenues were $911,000 in fiscal 2008 compared to $795,000 in fiscal 2007. The increase is due to three additional customers purchasing DMX licenses during fiscal 2008.

WinNonlin AutoPilot, or Autopilot was introduced in the first quarter of fiscal 2008. The revenue generated from sales of Autopilot was $977,000 in fiscal 2008.

Services revenues. Software services revenues were approximately $2.0 million in fiscal 2008 compared to approximately $2.2 million in fiscal 2007. The decrease in software services revenue was primarily due to decreased customized services associated with PKS installation, deployment and automation projects.

Strategic Consulting Services Segment Revenues

Strategic Consulting Services segment revenues were approximately $10.6 million in fiscal 2008 compared to approximately $10.9 million in fiscal 2007. The Strategic Consulting Services segment continued to diversify its customer portfolio. For fiscal 2008, 51% of SCS revenue came from our top 5 customers, compared with 75% the prior year; however, the 3% reduction in SCS revenue is due to a decline in revenue from two of our top customers, Pfizer and Lilly. Revenue received from these two customers decreased by 56% in fiscal 2008 as compared to fiscal 2007. Revenue received from customers other than our top five increased by 89% in fiscal 2008 as compared to fiscal 2007.

Reporting and Analysis Services Segment Revenues

Reporting and Analysis Services segment was launched in the first quarter of fiscal 2008 and the total revenue generated was approximately $1.5 million in fiscal 2008. This segment has shown continued growth quarter over quarter including an 86% growth in the fourth quarter compared to the third quarter of fiscal 2008. Gross margin for the fourth quarter and fiscal 2008 was 53% and 36% respectively. The lower margin for the year as compared to fourth quarter was due to start-up costs incurred earlier in the year.

Year Ended March 31, 2007 and 2006

Total revenue for fiscal 2007 increased to approximately $25.1 million, compared to approximately $22.7 million for fiscal 2006. The increase was a result of a 6% increase in the Software Products segment revenue and a 17% increase in the Strategic Consulting Services segment revenue.

 

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Software Products Segment Revenues

License, renewal and maintenance revenues

For fiscal 2007, desktop software products revenues increased to approximately $8.0 million from approximately $6.8 million in fiscal 2006. The increase is mainly attributable to a $508,000 increase in our initial desktop software product revenue as we were able to successfully execute on growth initiatives and increase sales of our desktop software products and a $685,000 increase in desktop software license renewal revenue due to a continued increase in our installed base and our license renewal rate remained high at approximately 95%.

PKS software revenues increased to approximately $3.3 million in fiscal 2007 from approximately $2.2 million in fiscal 2006. The increase in revenue is primarily due to the growth of our customer base and increase of sales of professional services and annual maintenance contracts. We completed 5 new installation projects in fiscal 2007 as well as expansion and renewal of licenses to 19 customers.

DMX software revenues were $795,000 in fiscal 2007 compared to approximately $1.8 million in fiscal 2006. The decrease is mainly attributable to the completion of smaller DMX development projects in fiscal 2007, compared to fiscal 2006 when one large DMX development project was completed.

Services revenues. Software services revenues were approximately $2.2 million in fiscal 2007 compared to approximately $2.7 million in fiscal 2006. The decrease in software services revenue was primarily due to decreased customized services associated with PKS installation, deployment and automation projects.

Strategic Consulting Services Segment Revenues

Strategic Consulting Services segment revenues were approximately $10.9 million in fiscal 2007 compared to approximately $9.3 million in fiscal 2006. The increase was primarily attributable to expansion in our customer base.

Cost of Revenues

 

    Year Ended
March 31,
    Percentage of Dollar
Change Year Over Year
    Percentage of Total Revenues
Year Ended March 31,
 
     2008   2007     2006     2008/2007     2007/2006     2008     2007     2006  
    (In thousands, except percentages)  

Cost of Revenues:

               

License, renewal and maintenance

  $ 251   $ 287     $ 295     (13 )%   (3 )%   1 %   1 %   1 %

Services

    9,479     7,444       7,404     27 %   1 %   33 %   30 %   33 %
                                           

Total cost of revenues:

  $ 9,730   $ 7,731     $ 7,699     26 %   0 %   34 %   31 %   34 %
                                           

Cost of Software Products Segment Revenues:

               

License, renewal and maintenance

  $ 251   $ 287     $ 295     (13 )%   (3 )%   1 %   1 %   1 %

Services

    1,629     1,097       1,495     48 %   (27 )%   6 %   5 %   7 %
                                           

Total software products:

  $ 1,880   $ 1,384     $ 1,790     36 %   (23 )%   7 %   6 %   8 %
                                           

Cost of Strategic Consulting Services Segment Revenues

  $ 6,859   $ 6,347     $ 5,909     8 %   7 %   24 %   25 %   26 %
                                           

Cost of Reporting and Analysis Services Segment Revenues

  $ 991     —   (1)     —   (1)   —   (1)   —   (1)   3 %   —   (1)   —   (1)
                       

 

(1)

Reporting and Analysis Services Segment was launched in fiscal 2008

 

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Year Ended March 31, 2008 and 2007

Total Cost of Revenues

Total cost of revenues was approximately $9.7 million in fiscal 2008 compared to approximately $7.7 million in fiscal 2007. Cost of revenue is comprised mainly of payroll and payroll related expenses plus royalty expenses and shipping costs. The increase in total cost of revenue is primarily associated with increased payroll and consulting related expenses associated with higher department headcount in fiscal 2008 and the additional costs associated with Reporting and Analysis Services group launched in the first quarter of fiscal 2008. Also included is the allocation of stock-based compensation expense of $233,000 in fiscal 2008, compared to $168,000 in fiscal 2007.

Cost of Software Products Segment Revenues

Cost of license, renewal and maintenance revenues. Cost of license, renewal and maintenance revenues primarily consists of royalty expense for third-party software included in our products, and cost of materials for both initial products and product updates provided for in our annual license agreements.

Cost of license, renewal and maintenance revenues was $251,000 for fiscal 2008 compared to $287,000 in fiscal 2007. The decrease in cost of license, renewal and maintenance revenues in fiscal 2008 in absolute dollars is primarily due to decreased royalty expense and product update materials costs.

Cost of services revenues. Cost of services revenues consists of payroll and related costs, travel expenses, and facilities and overhead costs associated with our deployment services group.

Cost of services revenue was approximately $1.6 million for fiscal 2008 compared to approximately $1.1 million in fiscal 2007. The increase is primarily due to higher costs related to an increase in headcount from fiscal 2007 to 2008 and payroll related costs associated with training services, deployment and automation projects. We added two additional employees to meet the increased demand for training and to maintain the needs in our deployment services group.

Cost of Strategic Consulting Services Segment Revenues

Cost of services for our Strategic Consulting Services segment consists of payroll and payroll related costs, travel expenses, facilities and overhead costs associated with our strategic consulting personnel.

Cost of services for our Strategic Consulting Services segment was approximately $6.9 million for fiscal 2008 compared to approximately $6.3 million in fiscal 2007. The increase was primarily due to higher payroll and consultant related expenses due to the impact of foreign exchange rates and increased headcount as we continue to build for growth in the segment and costs associated with the support of sales and marketing efforts. On average for fiscal 2008 the Strategic Consulting Services segment had two additional employees compared to prior year.

Cost of Reporting and Analysis Services Segment Revenues

Cost of services for our Reporting and Analysis Services segment consists of payroll and payroll related costs, travel expenses, facilities and overhead costs associated with our reporting and analysis personnel. Cost of services for our Reporting and Analysis Services segment was $991,000 for fiscal 2008. We increased headcount for this segment by 11 persons during fiscal 2008 to compensate for the increase in our service capacity demand.

 

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Year Ended March 31, 2007 and 2006

Total Cost of Revenues

Total cost of revenues remained relatively constant at approximately $7.7 million for fiscal 2007 and fiscal 2006. Also included in cost of revenues in fiscal 2007 is $168,000 of stock-based compensation expense related to the adoption of SFAS 123R. Cost of software revenue decreased by $406,000 in fiscal 2007, offset by an increase of $439,000 in cost of Strategic Consulting Services revenue.

Cost of Software Products Segment Revenues

Cost of license, renewal and maintenance revenues. Cost of license, renewal and maintenance revenues was $287,000 for fiscal 2007 compared to $295,000 in fiscal 2006. The decrease in cost of license, renewal and maintenance revenues in fiscal 2007 in absolute dollars is primarily due to decreased cost of materials, offset by increase of payroll related expenses.

Cost of services revenues. Cost of services revenue was approximately $1.1 million for fiscal 2007 compared to approximately $1.5 million in fiscal 2006. The decrease in cost of services revenues is due to reduction of department headcount as we only had one automation project in fiscal 2007, compared to two automation projects completed in fiscal 2006.

Cost of Strategic Consulting Services Segment Revenues

Cost of services for our Strategic Consulting Services segment was approximately $6.3 million for fiscal 2007 compared to approximately $5.9 million in fiscal 2006. The adoption of SFAS 123R in fiscal year 2007 resulted in an expense of $148,000 stock based compensation. Additionally, employee and allocation related expenses increased by $481,000 over the prior year due to an increase in department headcount and payroll related expenses.

Operating Expenses

 

     Year Ended
March 31,
   Percentage of Dollar
Change Year Over
Year
    Percentage of Total
Revenues

Year Ended
March 31,
 
      2008    2007    2006    2008/2007     2007/2006     2008     2007     2006  
     (In thousands, except percentages)  

Total revenues

   $ 28,342    $ 25,092    $ 22,742    13 %   10 %      
                               

Research and development expense:

                   

Total research and development

   $ 4,787    $ 4,295    $ 3,497    11 %   23 %   17 %   17 %   15 %
                                           

Sales and marketing expense:

                   

Total sales and marketing

   $ 6,924    $ 6,330    $ 5,638    9 %   12 %   24 %   25 %   25 %
                                           

General and administrative expense:

                   

Total general and administrative

   $ 5,501    $ 5,090    $ 5,326    8 %   (4 )%   19 %   20 %   23 %
                                           

Year Ended March 31, 2008 and 2007

Research and Development

Research and development expenses consist mainly of payroll, payroll related expenses and consulting expenses.

 

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Research and development expenses were approximately $4.8 million in fiscal 2008 compared to approximately $4.3 million in fiscal 2007. The percentage of total revenue of research and development expenses remains relatively constant at 17% for fiscal 2008 and 2007. The increase in research and development expenses for fiscal 2008 in absolute dollars compared to fiscal 2007 was primarily due to an increase in payroll and payroll related costs associated with the launch of various product releases, such as Autopilot, and an increase in payroll and related expenses as a result of higher department headcount partially offset by lower consulting expense. We increased headcount by eleven employees in fiscal 2008 to address increased research and development efforts associated with future product releases. During fiscal 2008, we decreased the use of consultants as we focused on increasing permanent employees.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel costs, including salaries, commissions for sales, corporate marketing and travel related costs.

Sales and marketing expenses were approximately $6.9 million in fiscal 2008 compared to approximately $6.3 million in fiscal 2007. The increase in sales and marketing expenses for fiscal 2008, compared to fiscal 2007 was primarily due to an increase in payroll related expenses due to higher department headcount, an increase in travel costs associated with our growth and an increase in stock compensation expenses. We added two employees to our inside sales department during fiscal 2008 and hired a sales director for the European region in the fourth quarter of fiscal 2007

General and Administrative

General and administrative expenses consist primarily of personnel costs of executive officers and support personnel, facilities, investor relations, insurance, legal and accounting and auditing fees.

General and administrative expenses were approximately $5.5 million in fiscal 2008 compared to approximately $5.1 million in fiscal 2007. The increase in general and administrative expense in absolute dollars and as a percentage of revenue in fiscal 2008 as compared to fiscal 2007 was primarily a result of an increase in payroll and payroll related expenses due to increased department headcount and an increase in legal fees, mainly associated with re-listing on the NASDAQ Capital Market.

Year Ended March 31, 2007 and 2006

Research and Development

Research and development expenses were approximately $4.3 million in fiscal 2007 compared to approximately $3.5 million in fiscal 2006. The increase in research and development expenses in absolute dollars, for fiscal 2007 compared to fiscal 2006 was primarily due to an increase in third-party consulting expense of approximately $382,000 in fiscal 2007 as well as an increase of $117,000 in payroll related expenses and an increase of $189,000 in reallocation expenses of employees from other departments. The increase in third party consulting expenses and headcount is due to the company’s focus on delivering new products to the market, such as IVIVC and Autopilot.

Sales and Marketing

Sales and marketing expenses were approximately $6.3 million in fiscal 2007 compared to approximately $5.6 million in fiscal 2006. The increase in sales and marketing expense in absolute dollars in fiscal 2007 compared to fiscal 2006 was primarily the result of an increase in payroll-related expenses. In addition, there was an increase of $200,000 in sales commission resulting from increased revenue and an increase in marketing expenses related to sales conferences associated with our increased marketing efforts. Stock based compensation expense as a result of the adoption of SFAS 123R in fiscal 2007 was $315,000.

 

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General and Administrative

General and administrative expenses were approximately $5.1 million in fiscal 2007 compared to approximately $5.3 million in fiscal 2006. The decrease related to a $223,000 decrease in audit and tax fees, a $179,000 decrease in investor relations costs and a $110,000 decrease in consulting fees. These decreases were partially offset by $270,000 in stock based compensation expense as a result of the adoption of SFAS 123R in fiscal 2007 and a $190,000 increase in bonus and payroll related costs.

In addition, we evaluated the impact of the adoption of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, or SAB 108, issued by the SEC, which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. Based on SAB 108, we recorded a cumulative effect adjustment of $256,000 related to the accounting for accrued expenses. We over-accrued on recurring professional services fees included in general and administrative expenses. The error arose as a result of accrual of such services ratably over the year rather than as the service was rendered. Under the rollover method of evaluating misstatements, the effect of the methodology used did not result in a material misstatement of the financial statements.

We evaluated the impact of correcting all misstatements, including both carryover and reversing effects of prior years misstatements on the current year financial statements. We determined that the effect of the errors on all prior financial statement filings were immaterial, but would be considered material to the financial statements under the methodology prescribed by SAB 108. Therefore, the Company recorded a cumulative effect adjustment to the applicable carrying values of liabilities for these previous errors as of April 1, 2006, with an offsetting adjustment to retained earnings. The amount recorded was a debit of $256,000 to accrued expenses with the offsetting credit of $256,000 to retained earnings. The error was discovered during the three months ended December 2006 and the adjustment was recorded at that time. The understatement of expense was not considered material for any other reported period and those results were therefore not restated.

Other Income (Expense)

Other income, net of expense, was $430,000 in fiscal 2008 compared to $372,000 in fiscal 2007. The increase was mainly due to an increase in franchise taxes as a result of the reverse stock split and an increase in interest income as a result of higher cash balances offset by a decrease in interest expense as a result of the debt payoff.

Other income, net of expense, was $372,000 in fiscal 2007 compared to $16,000 in fiscal 2006. We started to purchase short term investments in fiscal 2007. The increase in other income in fiscal 2007 was due to higher interest rates on our short term investments.

Provision for Income Taxes

 

     Years ended
     2008    2007    2006

Provision for income taxes

   $ 145    $ 147    $ 68

Provision for income taxes for fiscal 2008 was $145,000 as compared to $147,000 and $68,000 in fiscal 2007 and fiscal 2006, respectively which were attributable to federal and state alternative minimum taxes, other state taxes and foreign income tax. The amounts provided were at rates less than the combined U.S. federal and state statutory rates due to the utilization of federal and state net operating loss carryforwards. As of March 31, 2008, we had federal and state net operating loss carryforwards of approximately $52.9 million and $49.1 million respectively, which begin to expire in the years fiscal 2013 through 2027, if not utilized. We have recorded a valuation allowance against the entire net operating loss carry-forwards and other deferred tax assets because of

 

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the uncertainty that we will be able to realize the benefit of the net operating loss carry-forwards before they expire. We have federal and state research and development tax credit carry-forwards of approximately $1.4 million and $746,000, respectively. The federal research and development credits begin to expire in fiscal 2011 through 2027, and the state credits can be carried forward indefinitely.

Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards and credit carryforwards may be impaired or limited in certain circumstances. Events which may restrict utilization of a company's net operating loss and credit carryforwards include, but are not limited to, certain ownership change limitations as defined in Internal Revenue Code Section 382 and similar state provisions. As a result of these ownership changes, our ability to utilize carryforwards may be restricted to an annual limitation. This annual limitation could result in the expiration of net operating loss carryforwards and credit carryforwards before utilization.

Reverse Stock Split

In October 2007, our Board of Directors approved a one-for-three reverse split of our common stock, following approval by our stockholders on August 8, 2007. The reverse stock split was effected on November 13, 2007. As a result, our issued and outstanding common stock was reduced from approximately 28.2 million shares to approximately 9.4 million shares. The par value of our common stock was not affected by the reverse stock split and remains at $0.001 per share. All per share amounts and outstanding shares, including all common stock equivalents (stock options, warrants, preferred stocks, other equity incentive awards and equity compensation plans) have been restated in the Consolidated Financial Statements, Notes to the Consolidated Financial Statements and this Item 7 for all periods presented to reflect the reverse stock split.

Off-Balance Sheet Arrangements

As of March 31, 2008, we did not have any off-balance sheet arrangements.

Liquidity and Capital Resources

From our inception through the initial public offering of our common stock, we funded operations through the private sale of preferred stock, with net proceeds of approximately $38 million, limited borrowings and equipment leases. In August 2000, we completed our initial public offering of 3,000,000 shares of common stock, at a price of $10.00 per share, all of which were issued and sold by us for net proceeds of approximately $26.4 million, net of underwriting discounts and commissions of approximately $2.1 million and expenses of approximately $1.5 million. We paid approximately $6.1 million to holders of our Series C preferred stock at the closing of the offering as required by the terms of the Series C preferred stock. After this payment, our net proceeds were approximately $20.3 million. In June and September of fiscal 2002, we completed a private placement of preferred stock, raising additional net proceeds of approximately $7.2 million. On June 27, 2007, all of the holders of preferred stock elected to convert all of their shares of preferred stock into shares of common stock.

 

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Summarized cash, working capital and cash flow information is as follows (dollars in thousands):

 

     Years Ended March 31,     Percentage of
Dollar Change
Year Over
Year
 
     2008     2007     2008/2007  

Cash and cash equivalents

   $ 10,757     $ 7,829     37 %
                  

Short term investments

   $ 6,342     $ 6,836     (7 )%
                  

Working capital

   $ 8,469     $ 5,305     60 %
                  

Cash flows provided by operating activities

   $ 3,557     $ 5,969     (40 )%
                  

Cash flows used in investing activities

   $ (338 )   $ (7,260 )   (95 )%
                  

Cash flows used in financing activities

   $ (214 )   $ (1,658 )   (87 )%
                  

Cash, Cash Equivalents and Short-term Investments. As of March 31, 2008, our cash and cash equivalents consisted primarily of demand deposits and money market funds. Our short-term investments consisted primarily of corporate securities, commercial paper, agency bonds and asset-backed securities with an original maturity at the time of purchase of over three months. The increase in our cash and cash equivalents during fiscal 2008 as compared to fiscal 2007 was attributable to income generated during the period, partially offset by an increase of approximately $1.6 million in account receivable driven by the timing of the revenue generated and cash collections. Our current working capital, defined as current assets less current liabilities, increased to approximately $8.5 million primarily due to an increase in cash and cash equivalents. We believe that our existing cash balances will be sufficient to meet our working capital requirements for at least the next 12 months. However, if we proceed with one or more significant acquisitions in which the consideration includes cash, we could be required to use a substantial portion of our available cash to consummate any such acquisition. Acquisitions may result in the incurrence of debt, material one-time write-offs, or purchase accounting adjustments and restructuring charges. They may also result in recording goodwill and other intangible assets in our financial statements which may be subject to future impairment charges or ongoing amortization costs, thereby reducing future earnings. To the extent that we issue new stock or other rights to purchase stock or to generate additional cash, existing stockholders may be diluted and earnings per share may decrease.

Cash Flows Provided by Operating Activities. Cash provided by operating activities was approximately $3.6 million in fiscal 2008, primarily due to a net income of approximately $1.7 million, a decrease in deferred revenue, accrued compensation and accounts payable of approximately $1.3 million, an increase of non-cash items such as stock-based compensation expense, depreciation and amortization and loss on disposal of assets of approximately $2.2 million offset by an increase in accounts receivable of approximately $1.6 million driven by the timing of the revenue generated and cash collections during the period. Our accounts receivable and deferred revenue balances fluctuate from period to period and are primarily dependent on the timing of the closure of our license agreements, the related invoicing and payment provisions and collections.

Cash Flows Used for Investing Activities. Cash used in investing activities in fiscal 2008 was approximately $338,000 compared to approximately $7.3 million for fiscal 2007. Cash used in investing activities during fiscal 2008 was primarily related to the purchases and sales of short-term investments and miscellaneous asset purchases of capital equipment necessary for our ongoing operations. Cash used in investing activities decreased in fiscal 2008 compared to fiscal 2007 primarily due to a $10.8 million increase in proceeds from sales of short term investments.

Cash Flows Used for Financing Activities. Cash used in financing activities in fiscal 2008 was approximately $214,000 compared to approximately $1.7 million for fiscal 2007. Cash used in financing activities during fiscal 2008 was primarily the result of a $392,000 payment against our outstanding loan

 

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facilities with Silicon Valley Bank and a $73,000 payment of dividends to our preferred stockholders, offset by the receipt of $251,000 in proceeds from sales of common stock.

Credit Facilities and Loans. We have a credit facility with Silicon Valley Bank (the “Bank”), providing for up to approximately $5 million in borrowings, secured by eligible accounts receivable. On June 21, 2007, we entered into the Seventh Amendment to the Loan and Security Agreement (the “Seventh Amendment” ) with the Bank. The Seventh Amendment amends in part Section 2.1 of the Loan and Security Agreement to decrease the Quick Ratio from at least 2.00 to 1.00 to at least 1.75 to 1.00 and amends Section 2.2 of the Loan and Security Agreement by increasing the “Committed Revolving Line” from approximately $3 million to approximately $5 million. If our modified quick ratio is equal to 1.75:1 or greater, the Bank may include foreign accounts receivable to determine eligible receivables. However, if the modified quick ratio is less than 1.75:1, all or a portion of foreign accounts may be excluded from eligible account receivables. There was no outstanding borrowing under this facility at March 31, 2008. In June 2008, we received a commitment letter from the Bank agreeing to extend the Committed Revolving Line for two additional years while maintaining the same conditions as the Seventh Amendment.

We had a secured term loan payable over 48 months, with monthly payments that commenced in July 2002. The balance was paid off as of June 30, 2006. In February 2005, we secured an additional term loan for the purchase of a new financial system, which was added to the existing term loan. The $300,000 additional term loan was payable over 36 months. In addition, we secured an equipment credit facility through June 2006 for up to $600,000. Each advance was payable over 36 months. On August 9, 2007, we paid off the remaining balances for both loans.

Preferred Stock Financing. On June 26, 2002 and September 11, 2002, we completed a private placement of 604,887 Units (each a “Unit,” and, collectively, the “Units”) for an aggregate purchase price of approximately $7.5 million to certain investors. The sale and issuance of the Units were made pursuant to a Preferred Stock and Warrant Purchase Agreement (the “Purchase Agreement”) and closed in two phases. The first phase was completed on June 26, 2002, pursuant to which we sold an aggregate of 253,973 Units for an aggregate purchase price of approximately $3.15 million. The second phase was completed on September 11, 2002, pursuant to which we sold an aggregate of 350,914 Units for an aggregate purchase price of approximately $4.35 million. Each Unit consisted of one share of our Series A redeemable convertible preferred stock (the “Series A Preferred”) and a warrant to purchase one share of common stock (each, a “Warrant” and, collectively, the “Warrants”).

On June 27, 2007, all of the holders of our preferred stock elected to convert all of their shares of preferred stock into shares of common stock. Each share of preferred stock was convertible into four shares of common stock. As a result of such conversion, our outstanding shares of common stock increased by 2,685,628 shares and we recorded a approximately $7.0 million deemed dividend which represented the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the Company to the holders of the convertible preferred stock over (2) the fair value of securities issuable pursuant to the shareholders in the calculation of earning per shares.

As of March 31, 2008, the total number of shares underlying the outstanding warrants was 694,438. The exercise prices ranged from $0.75 per share to $21.60 per share. The warrants issued in connection with the 2002 private investment were originally exercisable for a period of five years from issuance. The expiration date of the warrants is extended by one day for each day that a registration statement covering the resale of the shares of common stock issuable upon exercise of the warrants is not effective or otherwise suspended. Our registration statement covering the resale of the common stock issuable upon exercise of the warrants has not been effective since November 2002. If not exercised after the extended expiration date, the right to purchase the common stock will terminate. The warrants contain a cashless exercise feature. The common stock issuable upon exercise of the warrants is entitled to the benefits and is subject to the terms of a registration right agreement.

Contractual Commitments. As of March 31, 2008, we have operating leases for our facilities that expire at various times through fiscal years 2010 and 2011. These arrangements allow us to obtain the use of facilities

 

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without purchasing them. If we were to acquire these assets, we would be required to obtain financing and record a liability related to the financing of these assets or we would need to utilize upfront cash flow to purchase them. During the year ended March 31, 2008, we recorded rent expense of $410,000.

The following is a summary of our contractual commitments associated with our lease obligations as of March 31, 2008 (in thousands):

 

     Payments Due by Period

Contractual Obligations

   Total    Less Than 1
Year
   1-3 Years    3-5 Years    More Than 5
Years

Operating leases

   $ 1,384    $ 534    $ 850    $ —      $ —  
                                  

Total commitments

   $ 1,384    $ 534    $ 850    $ —      $ —  
                                  

Short Term and Long Term Liquidity. We believe that the combination of our cash, cash equivalents and short-term investments, and currently anticipated cash flow from operations should be adequate to sustain operations through the next twelve months. We are managing the business to achieve positive cash flow utilizing existing assets. Although operating expenses have increased, which is consistent with our growth over the past several fiscal years, we generated positive annual operating cash flow for fiscal 2008, fiscal 2007 and 2006. However, there is no assurance that we can continue to maintain positive cash flow quarterly or annually, and we have experienced negative operating cash flow in some quarters due to timing of normal payments during the quarter. We are committed to the successful execution of our operating plan and we will take continued actions as necessary to ensure our cash resources are sufficient to fund our working capital requirements at least for the next twelve months.

Our long-term liquidity and capital requirements will depend on numerous factors including our future revenues and expenses, growth or contraction of operations and general economic pressures. We may not be able to maintain our current market share, or continue to expand our business, without investing in our operations, technology, or product and service offerings. As a result, we may need to raise additional funds or secure additional credit facilities through public or private financings or other sources to fund our operations. We may not be able to obtain additional funds on commercially reasonable terms, or at all. The necessity of raising additional funds could require us to incur debt on terms that could restrict our ability to make capital expenditures and incur additional indebtedness.

Impact of Inflation

The effects of inflation and changing prices on our operations were not significant during the periods presented.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

We had cash, cash equivalents and short-term investments totaling approximately $17.1 million at March 31, 2008. These amounts were invested primarily in money market funds and instruments, corporate securities, commercial paper, agency bonds, asset-backed securities and other securities with strong credit ratings. The cash, cash equivalents and short-term investments are held for working capital purposes. We do not enter into investments for trading or speculative purposes.

Our fixed-income portfolio is subject to interest rate risk. Fluctuations in the value of our investment securities caused by a change in interest rates (gains or losses on the carrying value) are recorded in other comprehensive income, and are realized only if we sell the underlying securities. We manage our exposure to interest rate risk by investing primarily in short-term securities. However, our efforts do not provide complete assurance that we will be protected from interest rate fluctuations. We do not believe that a sharp rise in interest rates would have a significant impact on the fair value of our investment portfolio.

Generally, our sales are made in U.S. dollars and as a result, we do not consider that our financial results and cash flows could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We have not entered into any derivative instrument transactions to manage foreign currency risks. Based on our overall foreign currency rate exposure at March 31, 2008, we do not believe that a hypothetical 10% change in foreign currency rates would materially adversely affect our financial position or results of operations.

 

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Supplementary Data

The following tables set forth unaudited quarterly supplementary data for each of the years in the two-year period ended March 31, 2008.

 

     Quarter Ended
     June 30     September 30    December 31    March 31
     (In thousands, except per share amounts)

FISCAL 2008

          

Revenues

   $ 6,050     $ 7,329    $ 7,373    $ 7,590

Cost of revenues

     2,303       2,408      2,635      2,384

Gross profit

     3,747       4,921      4,738      5,206

Income (loss) from operations

     (478 )     828      439      611

Net income (loss) attributable to common stockholders

     (7,534 )*     915      532      621

Net income (loss) per common share attributable to common stockholders, basic

   $ (1.11 )*   $ 0.10    $ 0.06    $ 0.07

Net income (loss) per common share attributable to common stockholders, diluted

   $ (1.11 )*   $ 0.09    $ 0.05    $ 0.06

FISCAL 2007

          

Revenues

   $ 5,428     $ 6,284    $ 6,121    $ 7,259

Cost of revenues

     1,756       1,817      1,871      2,287

Gross profit

     3,672       4,467      4,250      4,972

Income (loss) from operations

     (334 )     714      417      849

Net income (loss) attributable to common stockholders

     (422 )     534      300      713

Net income (loss) per common share attributable to common stockholders, basic

   $ (0.06 )   $ 0.08    $ 0.05    $ 0.11

Net income (loss) per common share attributable to common stockholders, diluted

   $ (0.06 )   $ 0.07    $ 0.04    $ 0.09

 

* Insignificant adjustments have been made to previously reported amounts on Form 10-Q filed on August 13, 2007

Note: The earnings per share for Q1 and Q2 in both fiscal 2008 and 2007 has been adjusted to reflect our one for three reverse stock split in November 2007.

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Management’s Report On Internal Control Over Financial Reporting

   48

Report of Grant Thornton LLP, Independent Registered Public Accounting Firm

   49

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

   50

Consolidated Balance Sheets

   51

Consolidated Statements of Operations

   52

Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

   53

Consolidated Statements of Cash Flows

   54

Notes to the Consolidated Financial Statements

   55

 

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Management’s Report On Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934, as amended). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

The Company’s management has used the criteria established in the “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), to evaluate the effectiveness of Pharsight’s internal control over financial reporting. Management has selected the COSO framework for its evaluation as it is a control framework recognized by the Securities and Exchange Commission and the Public Company Accounting Oversight Board, that is free from bias, permits reasonably consistent qualitative and quantitative measurement of Pharsight’s internal controls, is sufficiently complete so that relevant controls are not omitted, and is relevant to an evaluation of internal controls over financial reporting.

Based on our assessment, management has concluded that our internal control over financial reporting, based on criteria established in “Internal Control-Integrated Framework” issued by COSO was effective as of March 31, 2008.

This annual report does not include an attestation report of Pharsight’s independent registered public accounting firm regarding internal control over financial reporting. Pharsight’s internal control over financial reporting was not subject to attestation by the Pharsight’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit Pharsight to provide only management’s report in this annual report.

Date: June 26, 2008

 

/s/    SHAWN M. O’CONNOR        

Shawn M. O’Connor, Chief Executive Officer

/s/    WILLIAM FREDERICK        

William Frederick, Chief Financial Officer

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Pharsight Corporation and subsidiaries

We have audited the accompanying consolidated balance sheets of Pharsight Corporation and its subsidiaries (“the Company”) as of March 31, 2008 and 2007, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders’ equity (deficit) and cash flows for each of the two years in the period ended March 31, 2008. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Schedule II. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pharsight Corporation and subsidiaries as of March 31, 2008 and 2007, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, effective April 1, 2006, the Company adopted the provisions of the Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, applying the modified prospective method.

/s/ GRANT THORNTON LLP

San Jose, CA

June 26, 2008

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Pharsight Corporation

We have audited the accompanying consolidated statements of operations, redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows of Pharsight Corporation for the year ended March 31, 2006. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Pharsight Corporation for the year ended March 31, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

San Jose, California

May 5, 2006

 

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PHARSIGHT CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

    March 31,  
    2008     2007  
ASSETS    

Current assets:

   

Cash and cash equivalents

  $ 10,757     $ 7,829  

Short term investments

    6,342       6,836  

Accounts receivable, net of allowance for doubtful accounts of $20 at March 31, 2008 and 2007

    4,664       3,087  

Prepaids and other current assets

    541       523  
               

Total current assets

    22,304       18,275  

Property and equipment, net

    1,581       1,674  

Other assets

    52       46  
               

Total assets

  $ 23,937     $ 19,995  
               
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)    

Current liabilities:

   

Accounts payable

  $ 930     $ 769  

Accrued expenses

    537       570  

Accrued compensation

    3,469       3,050  

Deferred revenue

    8,899       8,289  

Current portion of notes payable

    —         292  
               

Total current liabilities

    13,835       12,970  

Deferred revenue, long term portion

    156       —    

Notes payable, less current portion

    —         100  

Other long term liabilities

    105       179  

Commitments and contingencies (Note 6 )

   

Redeemable convertible preferred stock, $0.001 par value:

   

Authorized shares—3,200,000 (2,000,000 designated as Series A and 1,200,000 designated as Series B) at March 31, 2008 and 2007

   

Issued and outstanding shares—none and 665,358 at March 31, 2008 and 2007, respectively (none and 604,887 designated as Series A at March 31, 2008 and 2007, none and 60,471 designated as Series B at March 31, 2008 and 2007, respectively)

    —         7,096  

Stockholders’ equity (deficit):

   

Preferred stock, $0.001 par value:

   

Authorized shares—1,800,000 at March 31, 2008 and 2007

   

Issued and outstanding shares—none at March 31, 2008 and 2007

   

Common stock, $0.001 par value:

   

Authorized shares—120,000,000 at March 31, 2008 and 2007

   

Issued and outstanding shares—9,431,507 and 6,673,384 at March 31, 2008 and 2007, respectively

    9       6  

Additional paid-in capital

    82,616       74,041  

Accumulated other comprehensive loss

    (141 )     (69 )

Accumulated deficit

    (72,643 )     (74,328 )
               

Total stockholders’ equity (deficit)

    9,841       (350 )
               

Total liabilities, redeemable convertible preferred stock, and stockholders’ equity (deficit)

  $ 23,937     $ 19,995  
               

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

 

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PHARSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

     Years Ended March 31,  
     2008     2007     2006  

Revenues:

      

License

   $ 5,738     $ 5,402     $ 4,864  

Renewal

     7,214       5,652       4,928  

Maintenance

     1,263       1,001       977  

Services

     14,127       13,037       11,973  
                        

Total revenues

     28,342       25,092       22,742  

Costs of revenues

      

License, renewal and maintenance

     251       287       295  

Services

     9,479       7,444       7,404  
                        

Total costs of revenues

     9,730       7,731       7,699  
                        

Gross profit

     18,612       17,361       15,043  

Operating expenses:

      

Research and development

     4,787       4,295       3,497  

Sales and marketing

     6,924       6,330       5,638  

General and administrative

     5,501       5,090       5,326  
                        

Total operating expenses

     17,212       15,715       14,461  
                        

Income from operations

     1,400       1,646       582  

Other income (expense):

      

Interest income

     662       603       255  

Interest expense

     (13 )     (127 )     (167 )

Other expense

     (219 )     (104 )     (72 )
                        

Total other income

     430       372       16  
                        

Income before income taxes

     1,830       2,018       598  

Provision for income taxes

     (145 )     (147 )     (68 )
                        

Net income

     1,685       1,871       530  

Preferred stock dividends

     (158 )     (746 )     (738 )

Deemed dividend from stock conversion

     (6,993 )     —         —    
                        

Net income (loss) attributable to common stockholders

   $ (5,466 )   $ 1,125     $ (208 )
                        

Earnings per share attributable to common stockholders:

      

Basic

   $ (0.62 )   $ 0.17     $ (0.03 )
                        

Diluted

   $ (0.62 )   $ 0.16     $ (0.03 )
                        

Shares used to compute earnings per share attributable to common stockholders:

      

Basic

     8,757       6,590       6,474  
                        

Diluted

     8,757       7,187       6,474  
                        

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

 

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PHARSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK

AND STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands)

 

    Redeemable
Convertible
Preferred Stock
    Common Stock   Additional
Paid-In
Capital (1)
    Accumulated
Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Total  
    Shares (1)     Amount     Shares (1)   Amount (1)        

Balance at March 31, 2005

  623     $ 6,266     6,444   $ 6   $ 74,373     $ (24 )   $ (76,985 )   $ (2,630 )
                                                       

Issuance of common stock under employee benefit plans, net of repurchases

  —         —       87     —       168       —         —         168  

Issuance of Series B redeemable convertible preferred stock

  18       375     —       —       (375 )     —         —         (375 )

Accrued dividends on Series A redeemable convertible preferred stock

  —         —       —       —       (363 )     —         —         (363 )

Comprehensive income:

                 

Foreign currency translation gain

  —         —       —       —       —         11       —         11  

Net income

  —         —       —       —       —         —         530       530  
                       

Total comprehensive income

                    541  
                                                       

Balance at March 31, 2006

  641     $ 6,641     6,531   $ 6   $ 73,803     $ (13 )   $ (76,455 )   $ (2,659 )
                                                       

Issuance of common stock under employee benefit plans, net of repurchases

  —         —       142     —       153       —         —         153  

Issuance of Series B redeemable convertible preferred stock

  24       455     —       —       (455 )     —         —         (455 )

Accrued dividends on Series A redeemable convertible preferred stock

  —         —       —       —       (291 )     —         —         (291 )

Stock-based compensation expense

  —         —       —       —       831       —         —         831  

Cumulative effect of accounting change

  —         —       —       —       —         —         256       256  

Comprehensive income:

                 

Foreign currency translation loss

  —         —       —       —       —         (57 )     —         (57 )

Net unrealized gain on investments

  —         —       —       —       —         1       —         1  

Net income

  —         —       —       —       —         —         1,871       1,871  
                       

Total comprehensive income

                    1,815  
                                                       

Balance at March 31, 2007

  665     $ 7,096     6,673   $ 6   $ 74,041     $ (69 )   $ (74,328 )   $ (350 )
                                                       

Issuance of common stock under employee benefit plans, net of repurchases

  —         —       73     —       251       —         —         251  

Issuance of Series B redeemable convertible preferred stock

  6       134     —       —       (134 )     —         —         (134 )

Accrued dividends on Series A redeemable convertible preferred stock

  —         —       —       —       (24 )     —         —         (24 )

Stock-based compensation expense

  —         —       —       —       1,255       —         —         1,255  

Conversion of preferred stock

  (671 )     (7,230 )   2,686     3     7,227       —           7,230  

Comprehensive income:

                 

Foreign currency translation loss

  —         —       —       —       —         (76 )     —         (76 )

Net unrealized gain on investments

  —         —       —       —       —         4       —         4  

Net income

  —         —       —       —       —         —         1,685       1,685  
                       

Total comprehensive income

                    1,613  
                                                       

Balance at March 31, 2008

  —       $ —       9,432   $ 9   $ 82,616     $ (141 )   $ (72,643 )   $ 9,841  
                                                       

 

(1)

To reflect the one for three reverse stock split in November 2007. All share amounts have been retroactively adjusted and reclassifications have been made to prior period common stock, additional paid in capital and preferred stock to conform to the current period presentation for all periods presented.

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

 

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PHARSIGHT CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Years Ended March 31,  
     2008     2007     2006  

Cash Flows From Operating Activities:

      

Net income

   $ 1,685     $ 1,871     $ 530  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     923       775       561  

Loss on disposal of assets

     6       —         —    

Stock-based compensation expenses

     1,255       831       —    

Accumulated effect of accounting change

     —         256       —    

Changes in operating assets and liabilities:

      

Accounts receivable, net

     (1,577 )     1,498       224  

Prepaids and other current assets

     (24 )     (225 )     486  

Accounts payable

     161       (25 )     (68 )

Accrued expenses and other long term liabilities

     (57 )     (539 )     535  

Accrued compensation

     419       898       271  

Deferred revenue

     766       629       355  
                        

Net cash provided by operating activities

     3,557       5,969       2,894  
                        

Cash Flows From Investing Activities:

      

Purchases of property and equipment

     (837 )     (424 )     (1,982 )

Proceeds from sale of short-term investments

     12,651       1,850       —    

Purchases of short-term investments

     (12,152 )     (8,686 )     —    
                        

Net cash used in investing activities

     (338 )     (7,260 )     (1,982 )
                        

Cash Flows From Financing Activities:

      

Proceeds from issuance of notes payable

     —         —         600  

Principal payments on notes payable

     (392 )     (1,519 )     (1,075 )

Proceeds from the issuance of common stock

     251       152       169  

Dividends paid to preferred stockholders

     (73 )     (291 )     (363 )
                        

Net cash used in financing activities

     (214 )     (1,658 )     (669 )
                        

Effect of exchange rate changes on cash and cash equivalents

     (77 )     (54 )     10  
                        

Net increase (decrease) in cash and cash equivalents

     2,928       (3,003 )     253  

Cash and cash equivalents at the beginning of the year

     7,829       10,832       10,579  
                        

Cash and cash equivalents at the end of the year

   $ 10,757     $ 7,829     $ 10,832  
                        

Supplemental disclosures of non cash activities

      

Issuance of dividend to preferred stockholders in form of Series B Preferred Stock

   $ 134     $ 455     $ 375  
                        

Accrued preferred stock dividend

   $ —       $ 48     $ 48  
                        

Supplemental disclosure of cash flow information

      

Cash paid for interest

   $ 13     $ 131     $ 167  
                        

Cash paid for income taxes

   $ 190     $ 57     $ 146  
                        

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

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

Pharsight Corporation (“Pharsight” or the “Company”) develops and markets software and provides strategic consulting services that help pharmaceutical and biotechnology companies improve the efficiency of the drug development decision making process, by reducing the costs and time requirements of their drug development and commercialization efforts. Pharsight’s products include proprietary software for clinical trial simulation and computer-aided trial design, for the statistical analysis and mathematical modeling of data, for the development of in-vivo-in-vitro correlations and the management of related datasets and workflow, for streamlined on-site validation of certain of our products, for the storage, management, and regulatory reporting of derived data and models in data repositories, and for dynamic visualization and communication of model-based product profiles. The Company’s software products and services utilize expertise in the sciences of pharmacology, drug and disease modeling, human genetics, biostatistics and strategic decision-making. Pharsight Corporation was incorporated in California in April 1995 and reincorporated in Delaware in June 2000.

Beginning in fiscal 2008, Pharsight started to operate in three operating segments, which are also its reportable segments: Software Products, Strategic Consulting Services and Reporting and Analysis Services. These segments were determined based on how management and the Company’s Chief Operating Decision Maker (“CODM”), who is the Company’s chief executive officer, view and evaluate the business.

2. Summary of Significant Accounting Policies

Basis of Presentation

Pharsight Corporation and its wholly owned subsidiaries prepare their financial statements in accordance with accounting principles generally accepted in the United States of America or U.S. GAAP.

Consolidation

The consolidated financial statements include the accounts of Pharsight and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

Reclassifications

Certain reclassifications, not affecting net income, have been made to prior period information to conform to the current period presentation format.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires Pharsight to make certain estimates, judgments and assumptions. The Company believes that the estimates, judgments and assumptions upon which they rely are reasonable based upon information available to them at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, the Company’s financial statements will be affected.

Reverse Stock Split

On October 18, 2007, the Company’s Board of Directors approved a one-for-three reverse split of its common stock, following approval by the Company’s stockholders on August 8, 2007. The reverse stock split was effective at 5:00 pm on November 13, 2007. As a result, the Company’s issued and outstanding common

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

stock was reduced from approximately 28.2 million shares to approximately 9.4 million shares. The par value of the common stock was not affected by the reverse stock split and remains at $0.001 per share. All per share amounts and outstanding shares, including all common stock equivalents (stock options, warrants, preferred stocks, other equity incentive awards and equity compensation plans) have been retroactively adjusted in the Consolidated Financial Statements and in the Notes to the Consolidated Financial Statements for all periods presented to reflect the reverse stock split.

Cash, Cash Equivalents and Investments

Cash equivalents consist of highly liquid investments with original maturities from the date of purchase of three months or less. Investments with an original maturity at the time of purchase of over three months are classified as short-term investments regardless of maturity date as all investments are classified as available-for-sale and can be readily liquidated to meet current operational needs. Available-for sale securities are stated at fair value using the specific identification method, with the unrealized gains and losses, net of tax, reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity. The amortized cost of available-for-sale securities is adjusted for amortization of premiums and accretion of discounts to maturity and the amortization is included in interest income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest income.

Fair Value of Financial Instruments

The carrying values of Pharsight’s cash and cash equivalents, investments, accounts receivable and payable, and accrued liabilities approximate their fair values due to their short-term nature. The fair values of notes payable are estimated based on current interest rates available to Pharsight for debt instruments with similar terms, degrees of risk, and remaining maturities. The carrying values of these obligations approximate their respective fair values.

Foreign Currency Translation

The functional currency of the Company’s foreign subsidiaries is the local currency. The financial statements of these subsidiaries are translated to U.S. dollars using period-end exchange rates for assets and liabilities, and average exchange rates for revenues, costs and expenses. The effects of these translation adjustments are reported as a separate component of accumulated other comprehensive income (loss) in stockholders' equity. Transaction gains and losses that arise from exchange rate changes denominated in other than the local currency are included in other income (expense) in the accompanying consolidated statements of operations.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts at an amount estimated to be sufficient to provide adequate protection against losses resulting from collecting less than the full payment on our currently outstanding receivables. The Company makes judgments as to its ability to collect receivables and provide allowances for the applicable portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. In determining its allowances, the Company analyzes its historical collection experience and current economic trends. The allowance for doubtful accounts at March 31, 2008 and March 31, 2007 was $20,000.

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of three to five years. Property under capital leases is amortized over the lesser of the useful lives of the assets or the lease term. Amortization expense related to these assets is included in depreciation expense.

SFAS No. 143, Accounting for Asset Retirement Obligations and Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of SFAS 143, requires the recognition of a liability for the fair value of a legally required conditional asset retirement obligation when incurred, if the liability’s fair value can be reasonably estimated. Management reviewed the Company’s facility lease and concluded that the cost, if any, of potential physical reinstatement obligation is not reasonably determinable, and as such, no asset retirement obligation was recorded in the financial statements for the years presented.

Maintenance and repairs are charged directly to expense as incurred, whereas improvements and renewals are generally capitalized in their respective property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized in the results of operations.

Internal Use Software

Pharsight accounts for internal use software costs, in accordance with Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). In accordance with SOP 98-1, Pharsight capitalizes costs to develop software for internal use when preliminary development efforts are successfully completed and management has authorized and committed project funding and it is probable that the project will be completed and the software will be used as intended. Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed. Costs incurred for upgrades and enhancements that are probable to result in additional functionality are also capitalized. All capitalized costs are included in property, plant and equipment and are amortized to expense over their expected useful lives.

Impairment of Long-Lived Assets

In accordance with FASB Statement of Financial Accounting Standard (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company evaluates the recoverability of all long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of an asset, an impairment loss is recognized. The loss is measured as the amount by which the carrying amount of the asset exceeds its fair value calculated using the present value of estimated net future cash flows. The Company did not recognize any impairment charge in fiscal 2008, 2007 or 2006.

Income Taxes

Pharsight accounts for income taxes under the liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Revenue Recognition

The Company’s revenues are derived from four primary sources: (1) initial and renewal fees for term-based and perpetual product licenses, and post-contract customer support (PCS or maintenance services), (2) services related to scientific and training consulting and software deployment, (3) Strategic Consulting Services and (4) Reporting and Analysis Services.

The Company’s revenue recognition policy is in accordance with Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), as amended. For each arrangement, the Company determines whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, collection is probable, and no significant post-delivery obligations remain unfulfilled. If any of these criteria are not met, the Company defers revenue recognition until such time as all of the criteria are met. The Company does not currently offer, has not offered in the past, and does not expect to offer in the future, extended payment term arrangements. If the Company does not consider collectability to be probable, the Company defers recognition of revenue until the fee is collected.

Software Product Segment

The Company enters into arrangements for term-based software licenses (initial and renewal fees) bundled with post-contract support services, or PCS, from which the Company receives solely license and renewal fees. The Company does not have vendor specific objective evidence, or VSOE of fair value to allocate the fee to the separate elements for these arrangements. Therefore, the Company does not present PCS revenue separately in connection with these arrangements, and it does not believe other allocation methodologies, such as allocation based on relative costs, provide a meaningful and supportable allocation between license and PCS revenues. The Company recognizes each of the initial and renewal license fees ratably over the one-year period or the remaining period of the license during which the PCS is expected to be provided as required by paragraph 12 of SOP 97-2. Revenues from bundled arrangements are recorded as license revenues in the statement of operations in the initial year and as renewal revenue in subsequent years.

The Company enters into arrangements consisting of perpetual licenses and PCS. Prior to the second quarter of fiscal 2008, the Company had not established VSOE of fair value to allocate the fee to the separate elements of the arrangement. The Company recognized revenue attributable to license and PCS ratably over the remaining period of the PCS term once the product was delivered. For financial statement presentation purposes, revenues from arrangements that included perpetual licenses were allocated among and recorded as license and maintenance revenue based upon management’s estimate of fair value and the Company’s price list. Renewals of related PCS were recorded as maintenance revenue for perpetual licenses and renewal revenue for term-based licenses. During the second quarter of fiscal 2008, the Company established VSOE of fair value of the separate elements of its enterprise software products. For perpetual license arrangements, it allocates revenue to delivered components, normally the license component of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to the Company. The Company determines the fair value of the undelivered elements based on its current price list and the historical evidence of the Company’s sales of these elements to third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

The Company enters into arrangements that consist of perpetual and term-based licenses, PCS and implementation/installation services. Prior to the second quarter of fiscal 2008, the Company had not established VSOE of fair value to allocate the fee to the separate elements of the arrangement. For arrangements involving a significant amount of services related to installation and implementation of its software products, the Company

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

recognized revenue for the entire arrangement ratably over the remaining period of the PCS term once the implementation and installation services were completed and accepted by the customer. For financial statement presentation purposes, revenues from arrangements that included perpetual and term-based licenses were allocated among and recorded as license, maintenance, renewal and service revenue based upon management’s estimate of fair value and the Company’s price list. Renewals of related PCS were recorded as maintenance revenue for perpetual licenses and renewal revenue for term-based licenses. The implementation/installation services revenues were recorded as services revenue in the statement of operations. During the second quarter of fiscal 2008, the Company established VSOE of fair value of the separate elements of its enterprise software product arrangements. For perpetual license arrangements, the Company allocates revenue to delivered components, normally the license and installation components of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to the Company. The Company determines the fair value of the undelivered elements based on its current price list and the historical evidence of the Company’s sales of these elements to third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

The Company enters into arrangements consisting of optional scientific consulting services. The optional scientific consulting services meet the criteria of paragraph 65 of SOP 97-2 for separate accounting, as they are not essential to the functionality of the delivered software, are described and priced separately in the arrangement and are sold separately. The Company recognizes fees from optional scientific consulting services (equal to the amounts set forth in the contracts) as revenue as these services are provided or upon their acceptance, as applicable.

For arrangements consisting solely of services, the Company recognizes revenue as consulting services are performed. Arrangements for consulting services may be charged at daily rates for different levels of consultants and out-of-pocket expenses, or may be charged as a fixed fee. For fixed fee contracts, with payments based on milestones or acceptance criteria, the Company recognizes revenue using the proportional performance method—as such milestones are achieved, or if customer acceptance of the milestone’s completion is required, upon such customer acceptance, which approximates the level of services provided. A number of internal and external factors can affect the Company’s estimates, including labor rates, utilization and efficiency variances, specification and testing requirement changes, and unforeseen changes in project scope.

The Company has two international distributors. There is no right of return or price protection for sales to the international distributors. Revenue on sales to these distributors is recognized ratably over the license term when the software is delivered to the distributors and other revenue recognition criteria are met.

Strategic Consulting Services and Reporting and Analysis Services Segments

The Company enters into arrangements for Strategic Consulting Services contracts and Reporting and Analysis Services contracts, which do not fall under the scope of SOP 97-2. Arrangements for these consulting services may be charged at daily rates plus out-of-pocket expenses, or may be charged as a fixed fee. For fixed fee with payments based on milestones or acceptance criteria, the Company recognizes revenue using the proportional performance method—as such milestones are achieved, or if customer acceptance is required, upon customer acceptance, which approximates the level of services provided. Management makes a number of estimates related to recognizing revenue for such contracts, as discussed above. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances, specification and testing requirement changes, and unforeseen changes in project scope.

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Judgments Affecting Revenue Recognition

Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause the Company’s operating results to vary significantly from quarter to quarter. The Company recognizes revenue in accordance with U.S. GAAP rules that have been prescribed for the software industry. The accounting rules related to revenue recognition are complex and are affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant judgments.

The Company does not record revenue on sales to customers whose ability to pay is in doubt at the time of sale. Rather, it recognizes revenue from these customers as cash is collected. The determination of a customer’s ability to pay requires significant judgment. In this regard, management considers the international region of the customer and the financial viability of the customer in assessing a customer’s ability to pay.

The Company generally does not consider revenue arrangements with extended payment terms to be fixed or determinable and, accordingly, it does not generally recognize revenue on these arrangements until the customer payments become due. The determination of whether extended payment terms are fixed or determinable requires management to exercise significant judgment, including assessing such factors as the past payment history with the individual customer and evaluating the risk of concessions over an extended payment period. The determinations that the Company makes can materially impact the timing of recognition of revenues. The Company’s normal payment terms currently range from “net 30 days” to “net 60 days,” which are not considered by the Company to be extended payment terms.

The majority of our PKS software arrangements include software deployment services. Prior to the second quarter of fiscal 2008, the Company deferred revenue for software deployment services, along with the associated license revenue, until the services were completed. If there was significant uncertainty about the project completion or receipt of payment for the professional services, it deferred revenue until the uncertainty was sufficiently resolved. Starting from the second quarter of fiscal 2008, for PKS perpetual licenses, the Company allocates revenue to delivered components, normally the license component of the arrangement, using the residual method, based on VSOE of fair value of the undelivered elements (generally the maintenance services components), which is specific to the Company. It determines the fair value of the undelivered elements based on its current price list and the historical evidence of the Company’s sales of these elements to third parties. The revenue attributable to the delivered components is recognized once the implementation and installation services are completed and accepted by the customer and the revenue attributable to the undelivered components is recognized ratably over the period until the services are completed.

Deferred Revenue

Deferred revenue is comprised of deferred license fees (initial and renewal) and maintenance and support, which are recognized ratably over the one-year period of the license. In applying its revenue recognition policy the Company must determine which portions of its revenue are recognized in the current period and which portions must be deferred. For some of its enterprise software license contracts that required customer acceptance of installation, it will defer the revenue until such criteria is met. In addition, deferred revenue includes services and training revenue, which will be recognized as services are performed. Deferred revenue also includes deferred license and service fees for arrangements that include significant implementation services, which have not yet been completed.

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The principal components of deferred revenue at March 31, 2008 and 2007 were as follows (in thousands):

 

     2008    2007

License fees

   $ 2,104    $ 2,800

Renewals

     5,332      4,298

Training

     70      40

Maintenance

     1,073      650

Services

     476      501
             

Total deferred revenue

   $ 9,055    $ 8,289
             

Short-term deferred revenue

   $ 8,899    $ 8,289

Long-term deferred revenue

     156      —  
             

Total deferred revenue

   $ 9,055    $ 8,289
             

Shipping Costs

Shipping and handling costs are included under cost of license and renewal for all periods presented. These costs were insignificant in all periods presented.

Research and Development

Pharsight capitalizes eligible computer software development costs, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” (“SFAS 86”). SFAS 86 specifies that costs incurred internally in creating a computer software product should be charged to expense when incurred as research and development until technological feasibility has been established for the product. Once technological feasibility is established, all software costs should be capitalized until the product is available for general release to customers. Judgment is required in determining when the technological feasibility of a product is established and Pharsight has defined technological feasibility as completion of a working model. As of March 31, 2008 and 2007, there were no such internal capitalizable costs. Accordingly, Pharsight has charged all such internal costs to research and development expenses in the accompanying consolidated statements of operations.

Advertising

Pharsight expenses the cost of advertising as incurred. These costs were insignificant in all periods presented.

Earnings per Share

Basic earnings per share attributable to common stock is computed by dividing net income or loss attributable to common stockholders for the period by the weighted-average number of shares of vested common stock (i.e. not subject to a right of repurchase) outstanding during the period.

Diluted earnings per share attributable to common stockholders is computed by dividing net income or loss attributable to common stockholders for the period by the weighted-average number of shares of vested common stock outstanding and, where dilutive, weighted average number of shares of unvested common stock outstanding. Diluted earnings per share attributable to common stockholders also gives effect, as applicable, to the potential dilutive effect of outstanding stock options and warrants to purchase common stock using the treasury stock method, and convertible preferred stock using the as-if-converted method, as of the beginning of the period presented or the original issuance date, if later.

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

On June 27, 2007, the Company converted 604,887 shares of Series A Convertible Preferred Stock and 66,518 shares of Series B Convertible Preferred Stock into common stock as a result of the election to convert all such shares into common stock by our preferred stockholders. The total number of restricted unregistered shares of common stock issued as a result of this conversion was 2,685,628.

On November 13, 2007, a one-for-three reverse stock split became effective. The Company’s common stock began to trade on the OTC Bulletin Board on a split adjusted basis on November 14, 2007, under a new trading symbol “PHRS.OB”.

The trading symbol changed to “PHST” after the Company started to trade on the NASDAQ Capital Market on November 27, 2007. Accordingly, the calculations of basic and diluted net income (loss) per share have been adjusted to reflect this change as follows (in thousands, except per share data):

 

     Years Ended March 31,  
     2008     2007     2006  

Net income

   $ 1,685     $ 1,871     $ 530  

Preferred stock dividend

     (158 )     (746 )     (738 )

Deemed dividend from stock conversion

     (6,993 )     —         —    
                        

Net income (loss) attributable to common stockholders for basic computation

   $ (5,466 )   $ 1,125     $ (208 )
                        

Dilutive effect of preferred stock dividends

     —         —         —    
                        

Net income (loss) attributable to common stockholders after assumed conversions for diluted computation

   $ (5,466 )   $ 1,125     $ (208 )
                        

Weighted-average common shares used to compute net income (loss) per share attributable to common stockholders for basic computation

     8,757       6,590       6,474  
                        

Dilutive effect of:

      

Stock options and stock-based awards

     —   (1)     597       —   (1)
                        

Dilutive weighted-average common shares outstanding

     8,757       7,187       6,474  
                        

Net income (loss) per share attributable to common stockholders

      

Basic

   $ (0.62 )   $ 0.17     $ (0.03 )
                        

Diluted

   $ (0.62 )   $ 0.16     $ (0.03 )
                        

 

(1)

Dilutive potential weighted-average common shares are excluded from the calculation of diluted net loss per share.

The potential weighted-average common shares that are excluded from the calculation of diluted net loss per share as their effect is anti-dilutive are as follows (in thousands):

 

     March 31,
     2008    2007    2006

Stock Options

   408    —      676

Warrants

   233    —      228

Employee Stock Purchase Plan

   6    —      2

 

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PHARSIGHT CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Outstanding options and warrants with an exercise price greater than the average market price of common stock that have a dilutive effect under the treasury stock method are as follows (in thousands):

 

     March 31,
     2008    2007    2006

Stock Options

   1,211    1,087    218

Warrants

   52    52    52

Stock-Based Compensation

The Company has adopted several stock plans that provide equity instruments to our employees and non-employee directors. Our plans include incentive and non-statutory stock options and restricted stock awards. Stock options generally vest ratably over a four-year period on the anniversary date of the grant, and expire ten years after the grant date. The Company also has employee stock purchase plans that allow qualified employees to purchase Company shares at 85% of the fair market value on specified dates.

Prior to April 1, 2006, the Company accounted for stock-based employee compensation plans under the measurement and recognition provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). It generally recorded no stock-based compensation expenses during periods prior to April 1, 2006 as all stock-based grants had exercise prices equal to the fair market value of its common stock on the date of grant. The Company also recorded no compensation expense in connection with its employee stock purchase plans as they qualified as non-compensatory plans following the guidance provided by APB 25. In accordance with SFAS 123 and SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company disclosed its net income or loss and net income or loss per share for the years ended March 31, 2006 as if it had applied the fair value based method in measuring compensation expense for its stock-based compensation programs. Under SFAS 123, it elected to calculate its compensation expense by applying the Black-Scholes valuation model, applying the graded vesting expense attribution method and recognizing forfeited awards in the period that they occurred.

On April 1, 2006, the Company adopted Statement of Financial Accounting Standards or SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS 123R, which requires the measurement and recognition of compensation expense in the statement of operations for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 or SAB 107, relating to SFAS 123R. The Company applied the provisions of SAB 107 in its adoption of SFAS 123R. Using the modified prospective transition method of adopting SFAS 123R, the Company began recognizing compensation expense for stock-based awards granted or modified after March 31, 2006 and awards that were granted prior to the adoption of SFAS 123R but were still unvested at March 31, 2006. Under this method of implementation, no restatement of prior periods is required or has been made.

SFAS 123R requires the Company to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The Company elected to calculate its compensation expense by applying the Black-Scholes valuation model and the assumptions shown below. It estimates the expected term of options granted based on the history of grants, exercises and post-vesting cancellations in its option database. Contractual term expirations have not been significant. The Company estimates the volatility of its common stock at the date of grant based on historical prices of its common stock to complete the calculation of expected volatility, consistent with SFAS 123R and SAB 107. Prior to the adoption of SFAS 123R, it relied exclusively on the

 

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historical prices of its common stock in the calculation of expected volatility. The Company bases the risk-free interest rate that it uses in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with remaining terms equivalent to the expected term of its option grants. The Company has never paid any cash dividends on its common stock and it does not anticipate paying any cash dividends in the foreseeable future. Consequently, it uses an expected dividend yield of zero in the Black-Scholes option valuation model. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. For options granted before April 1, 2006, the Company estimated the fair value using the multiple option approach and is amortizing the fair value on a graded vesting basis. For options granted on or after April 1, 2006, the Company estimates the fair value using a single option approach and amortizes the fair value on a straight-line basis. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Accordingly, stock-based compensation expense recognized in the consolidated statements of operations for the years ended March 31, 2007 and 2008 has been reduced for estimated forfeitures. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2007, the Company accounted for forfeitures as they occurred. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s statements of operations. The Company may elect to use different assumptions under the Black-Scholes option valuation model in the future if its current experience indicates that a different measure is preferable, which could materially affect its net income or loss and net income or loss per share.

As required by FAS 148, the following table illustrates the effect on net loss per share if the Company had accounted for its stock option and stock purchase plans under the fair value method of accounting during fiscal 2006 (in thousands, except per share amounts):

 

     Years Ended
March 31,
 
     2006  

Net loss attributable to common stockholders, as reported

   $ (208 )

Add back:

  

Stock-based employee compensation included in reported net loss

     —    

Less:

  

Total stock-based employee compensation expense determined under the fair value method for all awards

     (927 )
        

Pro forma net loss attributable to common stockholders

   $ (1,135 )
        

Basic net income loss per share attributable to common stockholders

  

As reported

   $ (0.03 )
        

Pro forma

   $ (0.18 )
        

Diluted net loss per share attributable to common stockholders

  

As reported

   $ (0.03 )
        

Pro forma

   $ (0.18 )
        

Valuation Assumptions for Stock Options and ESPP

The Company estimates the fair value of its options using the Black-Scholes option value model, which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions, including the expected

 

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stock price volatility. The Company’s employee stock options have characteristics significantly different than those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimates.

The fair value of options granted and the option component of the employee purchase plan shares were estimated at the date of grant, assuming no expected dividends, and with the following weighted average assumptions:

 

     ESPP
March 31,
    Options
March 31,
 
     2008     2007     2006     2008     2007     2006  

Expected life (years)

   0.50     0.49     0.49     4.64     2.69     3.14  

Expected stock price volatility

   54.92 %   59.14 %   90.3 %   159.5 %   119.9 %   200.8 %

Risk-free interest rate

   4.09 %   5.07 %   4.11 %   4.72 %   5.01 %   3.81 %

Stock Options

The following is a summary of stock option activity during the year ended March 31, 2008:

 

     Numbers of
Options
Outstanding

(in thousands)
    Weighted
Average
Exercise
Price Per
Share
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value

as of 3/31/08
(in thousands)

Balance at March 31, 2005

   1,336     $ 3.33    7.80   

Options granted

   369       4.71      

Options exercised

   (73 )     4.89      

Options canceled/forfeited

   (170 )     4.77      
              

Balance at March 31, 2006

   1,462     $ 3.60    7.41   

Options granted

   524       4.11      

Options exercised

   (124 )     1.08      

Options canceled/forfeited

   (207 )     3.78      
              

Balance at March 31, 2007

   1,655     $ 3.93    7.09   

Options granted

   460       5.32      

Options exercised

   (41 )     2.04      

Options canceled/forfeited

   (80 )     5.58      
              

Balance at March 31, 2008

   1,994     $ 4.23    6.96    $ 2,980
                        

Options vested and expected to vest at March 31, 2008

   1,740     $ 4.15    6.73    $ 2,833
                        

Options exercisable at March 31, 2008

   1,221     $ 3.84    5.92    $ 2,588
                        

The weighted average remaining amortization period was 2.34 years as of March 31, 2008. The Company had 1,221,067 exercisable options and the unamortized stock compensation was approximately $2.1 million as of March 31, 2008. Cash received from exercise of stock options in fiscal 2008, 2007 and 2006 were $83,400, $135,000, and $111,000, respectively. The total intrinsic value of options exercised in fiscal 2008, 2007 and 2006 were $132,500, $397,600, and $244,200, respectively.

 

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The below table summarizes the stock-based expenses recorded during the year ended March 31, 2008 and 2007 (in thousands):

 

     Year Ended
March 31,
     2008    2007

Cost of revenues

   $ 233    $ 168

Research and development

     126      78

Sales and marketing

     501      315

General and administrative

     395      270
             

Total

   $ 1,255    $ 831
             

See Note 9. Stock-Based Benefit Plans for additional information.

Comprehensive Income

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS 130”), requires Pharsight to display comprehensive income and its components as part of the financial statements. Comprehensive income includes certain changes in equity that are excluded from net income. Pharsight’s comprehensive income consists of net income adjusted for the effect of foreign currency translation gains or losses and unrealized gains or losses on investments.

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Financial Accounting Standards Board Statement No. 109, or FAS 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 in the first quarter of fiscal 2008 which did not have a material effect on its consolidated financial position and results of operations.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements ” (“SAB 108”), which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. Specifically, SAB 108 articulates the SEC’s position that registrants should quantify the effects of prior period errors using both a balance sheet approach (“iron curtain method”) and an income statement approach (“rollover method”) and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective as of the end of the Company’s 2007 fiscal year, allowing a one-time transitional cumulative effect adjustment to beginning retained earnings as of April 1, 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108.

The Company evaluated the impact of the adoption of SAB 108 and recorded a cumulative effect adjustment of $256,000 related to the accounting for accrued expenses. The Company was over-accrued on recurring professional services fees included in general and administrative expenses. The error arose as a result

 

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of accrual of such services ratably over the year rather than as the service was rendered. Under the rollover method of evaluating misstatements, the effect of the methodology used by the Company did not result in a material misstatement of the financial statements.

The Company evaluated the impact of correcting all misstatements, including both carryover and reversing effects of prior years misstatements on the current year financial statements. The Company determined that the effect of the errors on all prior financial statement filings were immaterial, but would be considered material to the financial statements under the methodology prescribed by SAB 108. Therefore, the Company recorded a cumulative effect adjustment to the applicable carrying values of liabilities for these previous errors as of April 1, 2006, with an offsetting adjustment to retained earnings. The amount recorded was a debit of $256,000 to accrued expenses with the offsetting credit of $256,000 to retained earnings. The error was discovered during the three months ended December 2006 and the adjustment was recorded at that time. The understatement of expense was not considered material for any other reported period and those results were therefore not restated.

In September 2006, the FASB issued Statement No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies only to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate the adoption of this statement to have a material effect on its consolidated financial position and results of operations.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate the adoption of this statement to have a material effect on its consolidated financial position and results of operations.

In December 2007, the FASB issued FASB Statements No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). Effective for fiscal years beginning after December 15, 2008, the standards will improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. SFAS 141R requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 160 provides guidance for accounting and reporting of noncontrolling interests in consolidated financial statements. The adoption of this statement will not impact the Company’s consolidated financial position and results of operations, since it applies to future acquisitions.

In March, 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently assessing the impact of SFAS 161 on its consolidated financial position and results of operations.

 

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3. Financial Statement Detail

Investments

The amortized cost, unrealized gains and losses and fair value of available-for-sale securities using the specific identification method are as follows (in thousands):

 

     Available-For-Sale
     Amortized
Cost
   Gross
Unrealized

Gains
   Gross
Unrealized

Losses
   Fair
Value

March 31, 2008:

           

Asset-backed securities

   $ 348    $ 3    $ —      $ 351

Agency bonds

     965      4      —        969

Corporate securities

     3,187      4      6      3,185

Commercial paper

     1,837      —        —        1,837
                           

Total

   $ 6,337    $ 11    $ 6    $ 6,342
                           

March 31, 2007:

           

Asset-backed securities

   $ 1,048    $ —      $ —      $ 1,048

Agency bonds

     400      —        —        400

Corporate securities

     3,939      1      —        3,940

Commercial paper and certificates of deposit

     1,448      —        —        1,448
                           

Total

   $ 6,835    $ 1    $ —      $ 6,836
                           

The gross realized gains on sales of available-for-sale securities were $7,000 and none for fiscal 2008 and 2007, respectively. There were no gross realized losses on sales of available-for-sale securities during fiscal 2008 and fiscal 2007. The net adjustment to unrealized holding gains and losses on available-for-sale securities included as a separate component of shareholders’ equity totaled $4,000 and $1,000 for fiscal 2008 and 2007, respectively. There were no investments in fiscal 2006.

The amortized cost and fair value of available-for-sale securities by contractual maturity are as follows (in thousands):

 

     Amortized
Cost
   Fair
Value

March 31, 2008:

     

Due in one year or less

   $ 6,337    $ 6,342

Due after one year

     —        —  
             

Total

   $ 6,337    $ 6,342
             

 

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Property and Equipment

Property and equipment are stated at cost and consist of the following (in thousands):

 

     March 31,  
     2008     2007  

Furniture and fixtures

   $ 359     $ 339  

Computers and equipment

     3,272       7,187  

Leasehold improvements

     729       709  
                
     4,360       8,235  

Accumulated depreciation and amortization

     (2,779 )     (6,561 )
                
   $ 1,581     $ 1,674  
                

Depreciation and amortization expense was $923,000, $775,000 and $561,000 for fiscal 2008, 2007 and 2006, respectively.

Accrued Compensation

Accrued Compensation consists of the following (in thousands):

 

     March 31,
     2008    2007

Accrued vacation

   $ 1,024    $ 740

Accrued commissions

     203      162

Accrued bonus

     1,748      1,622

Accrued payroll taxes

     451      445

Other accrued compensation

     43      81
             
   $ 3,469    $ 3,050
             

4. Concentrations of Credit Risk

Financial instruments that potentially subject Pharsight to concentrations of credit risk consist primarily of cash and cash equivalents, and trade receivables. Pharsight generally invests its excess cash in money market funds, commercial paper, corporate notes and obligations issued by or fully collateralized by the U.S. government or federal agencies. Pharsight places its investments with high-credit quality counterparties and, by policy, limits the amount of credit exposure to any one counterparty.

Pharsight sells its products and services primarily to major pharmaceutical and biotechnology companies. Pharsight evaluates its customers’ financial condition when necessary and routinely receives a deposit for services contracts at the time of sale. Pharsight generally requires no collateral from its customers. To date, Pharsight has not experienced any significant losses with respect to these balances and there were no significant bad debt write-offs during fiscal 2008 and 2007. During fiscal 2006, the Company wrote off $37,000 against the allowance for doubtful accounts.

The Company receives the majority of its revenue from a limited number of customers. For fiscal 2008, 2007 and 2006, sales to our top two customers accounted for approximately 17%, 28% and 42% of total revenue, respectively and sales to our top five customers accounted for approximately 29%, 43% and 52%. In fiscal 2008,

 

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Pfizer, our largest customer, accounted for approximately 10% of our total revenue and Daiichi accounted for approximately 7% of our total revenue. In fiscal 2007, Pfizer, accounted for approximately 17% of our total revenue and Lilly accounted for approximately 11% of our total revenue. In fiscal 2006, Pfizer accounted for approximately 25% of our total revenue and Lilly accounted for approximately 17% of our total revenue.

Three customers comprised 33% of accounts receivable at March 31, 2008. Three customers comprised 43% of accounts receivable at March 31, 2007.

5. Debt

The Company has a credit facility with Silicon Valley Bank (the “Bank”), providing for up to $5 million in borrowings, secured by eligible accounts receivable. On June 21, 2007, we entered into the Seventh Amendment to the Loan and Security Agreement (the “Seventh Amendment “) with the Bank. The Seventh Amendment amends in part Section 2.1 of the Loan and Security Agreement to decrease the Quick Ratio from at least 2.00 to 1.00 to at least 1.75 to 1.00 and amends Section 2.2 of the Loan and Security Agreement by increasing the “Committed Revolving Line” from $3 million to $5 million. If our modified quick ratio is equal to 1.75:1 or greater, the Bank may include foreign accounts receivable to determine eligible receivables. However, if the modified quick ratio is less than 1.75:1, all or a portion of foreign accounts may be excluded from eligible account receivables. There was no outstanding borrowing under this facility as of March 31, 2008. See Note 14. Subsequent Events for additional information on the amendment.

The Company had a secured term loan payable over 48 months, with monthly payments that commenced in July 2002. The balance was paid off as of June 30, 2006. In February 2005, the Company secured an additional term loan for the purchase of a new financial system, which was added to the existing term loan. The $300,000 additional term loan was payable over 36 months. In addition, we secured an equipment credit facility through June 2006 for up to $600,000. Each advance was payable over 36 months. On August 9, 2007, we paid off the remaining balances for both loans.

6. Commitments and Contingencies

Operating Leases

Pharsight leases its office facilities under noncancelable operating leases expiring through 2011. Certain of the Company’s operating leases include free rent periods and/or escalation clauses. The Company records rent expense on a straight-line basis. Minimum annual rental commitments at March 31, 2008 are as follows (in thousands):

 

     March 31,

2009

   $ 534

2010

     485

2011

     365
      

Total minimum payments

   $ 1,384
      

Rent expense was $410,000, $351,000 and $513,000 for the years ended March 31, 2008, 2007, and 2006, respectively.

Contingencies

From time to time and in the ordinary course of business, the Company may be subject to various claims, charges, and litigation. In the opinion of management, final judgments from such pending claims, charges, and litigation, if any, against the Company, would not have a material adverse effect on the Company’s financial position, result of operations, or cash flows.

 

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Guarantees

From time to time, the Company enters into certain types of contracts that contingently require it to indemnify parties against third party claims. These obligations relate to certain agreements with the Company’s officers, directors and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship. Other obligations relate to certain commercial agreements with its customers, under which the Company may be required to indemnify such parties against liabilities and damages arising out of claims of patent, copyright, trademark or trade secret infringement by its software. The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not had to make any payments for these obligations, and no liabilities have been recorded for these obligations on the Company’s balance sheets as of March 31, 2008 and 2007.

7. Preferred Stock

As of March 31, 2008 Pharsight is authorized to issue up to 5,000,000 shares of preferred stock. The Board of Directors designated 2,000,000 shares as Series A preferred stock and 1,200,000 shares as Series B preferred stock. The Board of Directors may determine the rights and preferences of the remaining 1,800,000 shares of preferred stock, subject to limitations provided pursuant to the terms of the Series A and Series B preferred stock.

Series A Redeemable Convertible Preferred Stock and Common Stock Warrants

On June 26, 2002 and September 11, 2002, the Company completed a private placement of 604,887 Units (each a “Unit,” and, collectively, the “Units”) for an aggregate purchase price of approximately $7.5 million to certain investors. The sale and issuance of the Units were made pursuant to a Preferred Stock and Warrant Purchase Agreement (the “Purchase Agreement”) and closed in two phases. The first phase was completed on June 26, 2002, pursuant to which the Company sold an aggregate of 253,973 Units for an aggregate purchase price of approximately $3.15 million. The second phase was completed on September 11, 2002, pursuant to which the Company sold an aggregate of 350,914 Units for an aggregate purchase price of approximately $4.35 million. Each Unit consists of one share of the Company’s Series A redeemable convertible preferred stock (the “Series A Preferred”) and a warrant to purchase one share of common stock (each a “Warrant,” and, collectively, the “Warrants”).

On June 27, 2007, all of the holders of preferred stock elected to convert all of their shares of preferred stock into shares of common stock. Each share of preferred stock was convertible into four shares of common stock. As a result of conversion, our outstanding shares of common stock increased by 2,685,628 shares and we recorded approximately a $7.0 million deemed dividend which represented the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the Company to the holders of the convertible preferred stock over (2) the fair value of securities issuable to the stockholders in the calculation of earning per share.

Dividends

The holders of the Series A Preferred were entitled to receive cumulative dividends in preference to any dividend on the common stock, payable quarterly at the rate of 8% per annum, either in cash or in shares of Series B redeemable convertible preferred stock (the “Series B Preferred” and, together with the Series A Preferred, the “Preferred Stock”) at the election of the holder. The Series B Preferred has identical rights, preferences and privileges as the Series A Preferred, except that the Series B Preferred was not entitled to the dividend payment right. The Company issued dividends of 6,047, 24,188 and 18,141 shares of Series B Preferred Stock to Series A holders during fiscal 2008, 2007 and 2006, respectively.

 

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Warrants

The Warrants are generally exercisable for a period of five years from the date of issuance at a per share price equal to $1.15, subject to proportional adjustments for stock splits, stock dividends, recapitalizations and the like. The expiration date of the warrants is extended by one day for each day that a registration statement covering the resale of the shares of common stock issuable upon exercise of the warrants is not effective or otherwise suspended. If not exercised after expiration date, the right to purchase the common stock will terminate. The Warrants contain a cashless exercise feature. The common stock issuable upon exercise of the Warrants are entitled to the benefits and subject to the terms of the Registration Rights described above. The earliest maturity date as of March 31, 2008 is September 27, 2011.

Summary of Certain Preferred Stock and Warrant Accounting

Due to the nature of the redemption features of the Series A Preferred, the Company had excluded the Series A Preferred from stockholders’ equity in its financial statements.

The amount representing the Series A Preferred with total gross proceeds of approximately $7.5 million was discounted by a total of approximately $2.1 million, including approximately $1.3 million representing the value assigned to the Warrants, $585,000 representing the related beneficial conversion feature of the Series A Preferred, and $268,000 representing issuance costs. The amounts allocated in determining the discount were computed on a relative fair value basis. After reducing the proceeds by the value of the Warrants, the remaining proceeds were used to compute a discounted conversion price in accordance with EITF 00-27, “Application of EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios to Certain Convertible Instruments.” The discounted conversion price for each of the two closings was compared to the fair market value of the Company’s common stock on June 26, 2002 (the date of issuance of the Series A Preferred) and September 6, 2002 (the date of the stockholder vote approving the second closing) that resulted in a total beneficial conversion feature of $585,000, which represents the difference between the fair market value of its common stock and the deemed conversion price.

The net discounted value for the Series A Preferred of approximately $5.6 million was recorded as a long-term liability as of March 31, 2003 with the corresponding aggregate value of the Warrants and the beneficial conversion feature of approximately $1.9 million (approximately $1.3 million plus $585,000) recorded as additional-paid-in-capital within equity.

Deemed dividends were recorded by the Company for the year ended March 31, 2008 totaling approximately $7.0 million which represented the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the Company to the holders of the convertible preferred stock over (2) the fair value of securities issuable to the stockholders in the calculation of earning per share. There were no deemed dividends recorded by the Company for the year ended March 31, 2007, 2006 and 2005. Deemed dividends were recorded by the Company for the year ended March 31, 2004 totaling approximately $339,000, representing accretion of the discount resulting from the value of the beneficial conversion feature. The aggregate deemed dividends recorded were charged against additional-paid-in-capital and included in the calculation of net loss applicable to common stockholders.

Dividends on the Preferred Stock, calculated at the rate of 8% per annum, were $158,000, $746,000 and 738,000 for the years ended March 31, 2008, 2007 and 2006. The dividends were charged against additional-paid-in-capital and included in the calculation of net loss applicable to common stockholders.

During the three months ended June 30, 2003, the Company recorded a $96,000 deemed dividend, for a cumulative amount of $342,000 in total deemed dividends for the Series A Preferred. During the three months

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

ended September 30, 2003, the Company recorded a $243,000 deemed dividend, representing the balance of the $585,000 beneficial conversion feature of the Series A Preferred. The increase in the deemed dividend in the second quarter of fiscal 2004 reflected an adjustment to recognize the remaining amount of the $585,000 beneficial conversion feature. The adjustment for the beneficial conversion feature was initiated by the Company’s reevaluation of the various complex rules surrounding the accounting for the Series A Preferred and the related interpretations under EITF 00-27 for redeemable preferred stock. The amounts of deemed dividends related to the beneficial conversion feature that should have been originally recorded were $484,000 and $101,000 for the three months ended June 30, 2002 and September 30, 2002, respectively. No other amounts representing deemed dividends should have been recorded in other periods. The Company does not believe that the $96,000 and $243,000 amounts recorded as deemed dividends in the three months ended June 30, 2003 and September 30, 2003, respectively, and the $339,000 total amount recorded as deemed dividends in the year ended March 31, 2004, are material to the periods in which they should have been recorded.

The Company recognized the $268,000 of issuance costs when the Series A Preferred were redeemed and will recognize the remaining $1.6 million value of the warrants when and if it becomes probable the warrants will be exercised

Series B Redeemable Convertible Preferred Stock

The following table depicts activities for Series B Preferred Stock for three years ended March 31, 2008:

 

     Number of shares
of Series B
 

Balance at March 31, 2005

   18,142  

Preferred Series B issued September 1, 2005

   6,047  

Preferred Series B issued December 1, 2005

   6,047  

Preferred Series B issued March 1, 2006

   6,047  
      

Balance at March 31, 2006

   36,283  

Preferred Series B issued June 1, 2006

   6,047  

Preferred Series B issued September 1, 2006

   6,047  

Preferred Series B issued December 1, 2006

   6,047  

Preferred Series B issued March 1, 2007

   6,047  
      

Balance at March 31, 2007

   60,471  

Preferred Series B issued June 1, 2007

   6,047  

Conversion June 27, 2007

   (66,518 )
      

Balance at March 31, 2008

   —    
      

The Series B Preferred had identical rights, preferences and privileges as the Series A Preferred, except that the Series B Preferred was not entitled to the dividend payment right. Due to the nature of the redemption features of the Series B Preferred, the Company had excluded the Series B Preferred from stockholders’ equity in its financial statements.

The amount of the Series B Preferred dividend was determined based on the estimated per share fair value of the Series B Preferred Stock. To record the fair value of the Series B Preferred Stock, the Company performed a valuation based on its 5-day average stock price leading up to and including the Valuation Date. Various factors including, but not limited to, deemed time to liquidity and form of dividend payment were considered in the valuation of the Series B Preferred.

 

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8. Common Stock

Pharsight is authorized to issue up to 120,000,000 shares of common stock. At March 31, 2008, common stock was reserved for future issuance as follows (in thousands):

 

Warrants outstanding

   694

Stock option plans

   2,975

Employee stock purchase plans

   272
    
   3,941
    

Warrants

No warrants have been granted during fiscal 2008, 2007 and 2006. The number of warrants outstanding was 694,248, 695,176, and 696,758 for fiscal 2008, 2007 and 2006, respectively. The warrants expiration dates range from May 2008 to August 2010.

9. Stock-Based Benefit Plans

Stock Option Plans

In May 2000 the stockholders approved, and in April 2001 the Board of Directors adopted, the 2000 Equity Incentive Plan (“Incentive Plan”). The Incentive Plan became effective upon Pharsight’s initial public offering in August 2000. The Incentive Plan provides for the granting of stock awards, including incentive stock options, nonstatutory stock options, stock bonuses and rights to acquire restricted stock, to Pharsight’s employees and consultants. In addition, the Incentive Plan provides for non-discretionary grants of nonstatutory stock options to Pharsight’s non-employee directors.

Under the Incentive Plan, the Board of Directors determines the term of each award and the award price. In the case of incentive stock options, the exercise price may not be less than the fair market value on the date of grant, while nonstatutory options and restricted stock awards have exercise prices of not less than 85% of fair market value on the date of grant. Stock bonuses may be granted with a zero exercise price in consideration of past services rendered. In general, stock options vest over a four-year period, 25% on the first anniversary of the grant and ratably on a monthly basis thereafter.

Non-employee directors are eligible to receive nonstatutory stock options with an exercise price equal to fair market value on the date of grant under the Incentive Plan. Each newly appointed director of Pharsight who is (i) not an employee of Pharsight, (ii) is not acting in the capacity of a consultant to Pharsight, and (iii) cannot exercise, individually or in affiliation with any entity or group of entities that exercises voting control over more than 20% of Pharsight’s voting stock (an “Independent Director”), receives a one-time grant of options to purchase 33,333 shares of common stock under the Incentive Plan, which vest monthly over a two-year period and have a maximum term of 10 years (the “Initial Grant”). A director, who was not independent when appointed who later becomes an Independent Director, will receive the Initial Grant at that time. In addition, each eligible director is also granted an option to purchase 3,333 shares of common stock on the day after each Annual Meeting of Stockholders, which vests in full on the first anniversary of the date of grant and has a maximum term of 10 years.

Pharsight has reserved 2,852,535 shares for grant under the Incentive Plan as of March 31, 2008. In 2003, the Board of Directors reduced the number of shares available for grant under the Incentive Plan to comply with certain provisions of the California Code of Regulations. Each January 1, the number of shares reserved will

 

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increase automatically by the least of (i) 5% of the total number of common shares outstanding on that date, (ii) 2,000,000 shares, (iii) such fewer number of shares as determined by the Board of Directors, or (iv) so long as Pharsight is subject to certain provisions of the California Code of Regulations, such fewer number of shares such that the Incentive Plan will be in compliance with such provisions. On January 1, 2008, January 1, 2007 and January 1, 2006, the number of shares reserved for issuance under the Incentive Plan increased by 470,471, 234,941, and 261,877 shares, respectively.

In April 2001, the Board of Directors approved the UK Company Share Option Plan (“UK Plan”). The UK Plan became effective upon approval of its terms by the Inland Revenue of the United Kingdom (“Inland Revenue”). The UK Plan provides for the granting of stock options to Eligible Employees (as defined in the UK Plan). Pharsight has reserved 66,666 shares for grant under the UK Plan.

Under the UK Plan, the Board of Directors determines the term of each award and the award price (subject to the approval of Inland Revenue). The exercise price of all options may not be less than the fair market value on the date of the grant. In general, stock options vest over a four-year period, 25% on the first anniversary of the grant and ratably on a monthly basis.

Under the UK Plan, any option granted to an eligible employee shall be limited and take effect so that, immediately following such grant, the aggregate market value of all the shares which he or she may acquire upon the exercise in full of all unexercised options then held by him under the UK Plan and any share option plan (other than a savings-related share option plan) approved by the Inland Revenue under Schedule 9 and adopted by the Company or any Associated Company (as defined in the Plan) of the Company, shall not exceed 30,000 English Pounds.

See Note 2 for a summary of Pharsight’s stock option activity and related information for the three fiscal years ended March 31, 2008.

At March 31, 2008, 2007, and 2006, there were 980,930, 897,914, and 982,313 shares available for future option grants, respectively.

The following table summarizes information about stock options outstanding and exercisable at March 31, 2007 (in thousands, except per share amounts):

 

          Options Outstanding    Options Exercisable

Range of Exercise Prices
         per Share

   Number
Outstanding
   Weighted
Average
Remaining
Contractual
Life (years)
   Weighted
Average
Exercise
Price
per Share
   Number
Exercisable
   Weighted
Average
Exercise
Price
per Share

$ 0.18 - $0.18

   249,998    5.07    $ 0.18    249,998    $ 0.18

$ 0.57 - $2.76

   243,965    5.39      2.11    237,464      2.10

$ 3.00 - $3.90

   40,996    7.09      3.33    38,516      3.34

$ 4.05 - $4.05

   349,114    8.06      4.05    160,713      4.05

$ 4.20 - $4.41

   218,889    6.79      4.39    158,825      4.39

$ 4.44 - $4.89

   240,589    7.11      4.65    169,087      4.68

$ 5.01 - $5.04

   54,165    6.88      5.01    39,581      5.01

$ 5.25 - $5.25

   341,810    9.12      5.25    0      0.00

$ 5.31 - $7.65

   204,984    6.85      5.80    117,058      5.89

$11.25 - $30.00

   49,825    2.15      19.85    49,825      19.85
                  

$ 0.18 - $30.00

   1,994,335    6.96    $ 4.23    1,221,067    $ 3.84
                  

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

As of March 31, 2007, the number of excisable stock options was 950,380 and weighted average excise price per share was $3.78. As of March 31, 2006, the number of excisable stock options was 858,763 and weighted average excise price per share were $3.45.

Employee Stock Purchase Plan

In April 2000 the Board of Directors adopted, and in May 2000 the stockholders approved, the 2000 Employee Stock Purchase Plan (“Purchase Plan”). The Purchase Plan became effective upon Pharsight’s initial public offering in August 2000.

Pharsight has reserved 186,977 shares for issuance under the Purchase Plan as of March 31, 2008. In 2003, the Board of Directors reduced the number of shares available for grant under the Purchase Plan to comply with certain provisions of the California Code of Regulations. Each January 1, the number of shares reserved will be increased automatically by the least of (i) 1.5% of the number of shares of common stock outstanding on that date, (ii) 600,000 shares, (iii) a fewer number as determined by the Board of Directors, or (iv) so long as Pharsight is subject to certain provisions of the California Code of Regulations, such fewer number of shares such that the Incentive Plan will be in compliance with such provisions. On January 1, 2007, the number of shares reserved for issuance under the Purchase Plan did not increase.

Eligible employees may purchase common stock through payroll deductions by electing to have up to 20% of their compensation withheld. Each participant is granted an option to purchase common stock on the first day of each six-month offering period and this option is automatically exercised on the last day of the offering period. The purchase price for the common stock under the Purchase Plan is 85% of the lesser of the fair market value of the common stock on the first day and the last day of the offering period. Offering periods begin on February 1 and August 1 of each year. Shares of common stock issued under the Purchase Plan totaled 30,586, 15,280 and 14,639 in fiscal 2008, fiscal 2007 and fiscal 2006, respectively.

In April 2001, the Board of Directors adopted the 2001 UK Employee Stock Purchase Plan (“UK Purchase Plan”). The UK Purchase Plan became effective immediately. Pharsight has reserved 84,571shares for issuance under the UK Purchase Plan. Each January 1, the number of shares reserved will be increased automatically by the lesser of 1.5% of the number of shares of common stock outstanding on that date, 130,000 shares or a fewer number as determined by the Board of Directors. On January 1, 2008, 2007 and 2006, the number of shares reserved for issuance under the UK Purchase Plan did not increase.

Eligible employees may purchase common stock through payroll deductions by electing to have up to 20% of their compensation withheld. Each participant is granted an option to purchase common stock on the first day of each six-month offering period and this option is automatically exercised on the last day of the offering period. The purchase price for the common stock under the UK Purchase Plan is 85% of the lesser of the fair market value of the common stock on the first day and the last day of the offering period. Offering periods begin on February 1 and August 1 of each year. Shares of common stock issued under the Purchase Plan totaled 329, 1,224 and 541 in fiscal 2008, 2007 and fiscal 2006, respectively.

The weighted average grant date fair value of stock option grants, as calculated using the Black-Scholes model, was as follows:

 

     ESPP
Years Ended March 31,
   Options
Years Ended March 31,
     2008    2007    2006    2008    2007    2006

Weighted average fair value

   $ 1.53    $ 1.26    $ 2.16    $ 4.77    $ 2.91    $ 4.41

 

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10. Income Taxes

The components of income before income taxes are as follows (in thousands):

 

      Years Ended March 31,
      2008    2007    2006

United States

   $ 1,416    $ 1,785    $ 375

Foreign

     414      233      223
                    

Income before income taxes

   $ 1,830    $ 2,018    $ 598
                    

Foreign income before income taxes reflects the allocation of revenue in locations where formal transfer pricing agreements are in place between the company and its foreign subsidiaries. The allocated revenue is eliminated for consolidated financial reporting purposes.

Significant components of provision for income taxes are as follows (in thousands):

 

     Years Ended March 31,
     2008    2007    2006

Current:

        

Federal

   $ 49    $ 53    $ —  

State

     30      34      9

Foreign

     66      60      59
                    
   $ 145    $ 147    $ 68
                    

Deferred:

        

Federal

   $ —      $ —      $ —  

State

     —        —        —  

Foreign

     —        —        —  
                    
   $ —      $ —      $ —  
                    

Total

   $ 145    $ 147    $ 68
                    

The difference between the provision for income taxes and the amount computed by applying the federal statutory income tax rate of 34% to income before income taxes is as follows (in thousands):

 

     Years Ended March 31,  
     2008     2007     2006  

Tax expense (benefit) at U.S. statutory rate

   $ 622     $ 686     $ 220  

State taxes, net of federal expense

     21       23       9  

Stock based compensation

     426       283       —    

Change in valuation allowance

     (918 )     (861 )     (190 )

Other

     (6 )     16       29  
                        
   $ 145     $ 147     $ 68  
                        

 

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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows (in thousands):

 

     March 31,  
     2008     2007  

Deferred tax assets:

    

Net operating loss carryforwards

   $ 18,742     $ 7,961  

Research and development tax credits

     2,118       907  

Capitalized research and development

     262       273  

Amortization of intangible assets

     283       334  

Other

     417       328  
                

Total deferred tax assets

     21,822       9,803  

Valuation allowance

     (21,822 )     (9,803 )
                

Net deferred tax assets

   $ —       $ —    
                

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Management evaluates on a periodic basis the recoverability of deferred tax assets and the need for a valuation allowance based on all available positive and negative evidence. As a result of this review, the net deferred tax assets have been fully offset by a valuation allowance at March 31, 2008. At such time management determines it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced. The valuation allowance for deferred tax assets increased by approximately $12.0 million in fiscal 2008 from fiscal 2007 and decreased by approximately $920,000 in fiscal 2007 from fiscal 2006.

Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards and credit carryforwards may be impaired or limited in certain circumstances. Events which may restrict utilization of a company's net operating loss and credit carryforwards include, but are not limited to, certain ownership change limitations as defined in IRC Section 382 and similar state provisions. This annual limitation could result in the expiration of net operating loss carryforwards and credit carryforwards before utilization.

As of March 31, 2008, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $52.9 million and $49.1 million respectively, which begin to expire in the fiscal 2013 through 2027.

We have federal and state research and development tax credit carry-forwards of approximately $1.4 million and $746,000, respectively. The federal research and development credits begin to expire in fiscal 2011 through 2027, and the state credits can be carried forward indefinitely.

Utilization of the Company’s net operating loss and credits may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss and credits before utilization.

11. Segment Information

Segment information is presented in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). This standard is based on a management approach, which requires segmentation based upon the Company’s internal organization and reporting of revenue and operating income based upon internal accounting methods. The Company’s financial reporting systems present various data for management to run the business, including internal profit and loss statements prepared on a basis not

 

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consistent with U.S. GAAP. Assets and liabilities are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment and it is impracticable for the Company to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.

The Company’s Chief Operating Decision Maker (“CODM”), as defined by SFAS No. 131, is its chief executive officer. The CODM allocates resources to and assesses the performance of each operating segment using information about their revenue and gross profit. The Company’s segments are designed to promote better alignment of strategic objectives between development, sales, marketing and services organizations; provide for more timely and rational allocation of development, sales and marketing resources within businesses; and for long-term planning efforts on key objectives and initiatives. The segments are used to allocate resources internally and provide a framework to determine management responsibility.

The Company’s Software Products segment consists of software products and software deployment and integration services that provide the analytical tools and conceptual framework to help clinical researchers optimize the decision-making required to perform the clinical testing needed to bring drugs to market. By applying mathematical modeling and simulation to all available information regarding the compound being tested, researchers can clarify and quantify which trial and treatment design factors will influence the success of clinical trials.

The Company’s Strategic Consulting Services segment consists of consulting, training and process redesign conducted by its clinical and decision scientists in the application and implementation of its core decision methodology. The Company’s methodology enables customers to identify which uncertainties are greatest and matter most, and then to design development programs, trial sequences, and individual trials in such a way that those trials systematically reduce the identified uncertainties, in the most rapid and cost-effective manner possible.

The Company’s Reporting and Analysis Services segment was launched in the first quarter of fiscal 2008. It addresses the full spectrum of client needs for modeling and simulation in regulatory reports such as those required in Section 5 of the Common Technical Document. These services meet growing customer demands for analysis and reporting of PK/PD data generated in clinical and preclinical studies supporting new drug approvals. These studies include toxicokinetic, single- and multiple-ascending dose, drug-drug interaction, renal and hepatically impaired, fed-fasted, bioequivalence/bioavailability, QT prolongation, and others.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Summarized financial information on the Company’s reportable segments is shown in the following table (in thousands):

 

     Year Ended March 31, 2008
     Software
Products
   Strategic
Consulting
Services
   Reporting and
Analysis
Services
   Total

Revenues:

           

License, renewal and maintenance

   $ 14,215    $ —      $ —      $ 14,215

Services

     2,022      10,568      1,537      14,127
                           

Total revenues

   $ 16,237    $ 10,568    $ 1,537    $ 28,342
                           

Gross profit

   $ 14,357    $ 3,708    $ 547    $ 18,612

 

     Year Ended March 31, 2007
     Software
Products
   Strategic
Consulting
Services