S-1/A 1 a2200192zs-1a.htm S-1/A

Use these links to rapidly review the document
Table of contents
Index to financial statements

Table of Contents

As filed with the United States Securities and Exchange Commission on January 20, 2011

Registration No. 333-168176

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

AMENDMENT NO. 6
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

EPOCRATES, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  7375
(Primary Standard Industrial
Classification Code Number)
  94-3326769
(I.R.S. Employer
Identification No.)



1100 Park Place, Suite 300
San Mateo, California 94403
(650) 227-1700
(Address, including zip code, and telephone number, including area code, of registrant's principal executive offices)

ROSEMARY A. CRANE
PRESIDENT AND CHIEF EXECUTIVE OFFICER
EPOCRATES, INC.
1100 PARK PLACE, SUITE 300
SAN MATEO, CALIFORNIA 94403
(650) 227-1700
(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:

Matthew B. Hemington, Esq.
Sally A. Kay, Esq.
Cooley
LLP
3175 Hanover Street
Palo Alto, California 94304
(650) 843-5000

 

Alan F. Denenberg, Esq.
Davis Polk & Wardwell LLP
1600 El Camino Real
Menlo Park, California 94025
(650) 752-2000



                  Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

                  If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. o

                  If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

                  If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

                  If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. o

                  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer o   Non-accelerated filer ý
(Do not check if a
smaller reporting company)
  Smaller reporting company o

CALCULATION OF REGISTRATION FEE

               
 
Title of Each Class of Securities to be Registered
  Amount to be
Registered(1)

  Proposed
Maximum
Offering
Price Per
Share(2)

  Proposed
Maximum
Aggregate
Offering
Price

  Amount of
Registration
Fee(3)

 

Common Stock, $0.001 par value

  6,164,000   $15.00   $92,460,000.00   $7,374.61

 

(1)
Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(o) of the Securities Act of 1933, as amended. Includes shares that the underwriters have the option to purchase to cover over-allotments.
(2)
Anticipated to be between $13.00 and $15.00 per share.
(3)
A registration fee of $2,947.50 was previously paid with the filing of the registration statement filed on April 17, 2008 (333-150291). Pursuant to Rule 457(p), $2,947.50 of the previously paid registration fee is offset against the registration fee otherwise due for this registration statement. The registrant paid an additional $2,400.00 in connection with the initial filing of this registration statement. The registrant paid an additional $2,027.11 in connection with the filing of this Amendment No. 6 to Form S-1.

                  The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.


Table of Contents

The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we are not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

Subject to completion, dated January 20, 2011

Prospectus

5,360,000 shares

LOGO

Epocrates, Inc.

Common stock

This is an initial public offering of common stock by Epocrates, Inc. We are selling 3,574,285 shares of common stock. The selling stockholders identified in this prospectus are selling an additional 1,785,715 shares of common stock. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders. The estimated initial public offering price is between $13.00 and $15.00 per share.

We have been approved to list our common stock on The NASDAQ Global Market under the symbol "EPOC."

   

    Per share     Total  
   

Initial public offering price

  $     $    

Underwriting discounts and commissions

 
$
 
$
 

Proceeds to us, before expenses

 
$
 
$
 

Proceeds to the selling stockholders, before expenses

 
$
 
$
 
   

We have granted the underwriters an option for a period of 30 days to purchase from us up to 804,000 additional shares of common stock at the initial public offering price, less the underwriting discounts and commissions.

Investing in our common stock involves a high degree of risk. See "Risk factors" beginning on page 12.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock on or about            , 2011.

J.P.Morgan   Piper Jaffray



William Blair & Company   JMP Securities

                        , 2011


Table of Contents




Table of contents



We have not authorized anyone to provide any information other than contained or incorporated by reference in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We take no responsibility for, and can provide no assurances as to the reliability of, any other information that others may give you. We are not making an offer of these securities in any jurisdiction where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus.

No action is being taken in any jurisdiction outside the United States to permit a public offering of our common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction.

Until                        , 2011 (25 days after the date of this prospectus), all dealers that buy, sell or trade our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

i


Table of Contents


Prospectus summary

Our business

Epocrates is a leading provider of mobile drug reference tools to healthcare professionals and interactive services to the healthcare industry. Most commonly used on mobile devices at the point of care, our products help healthcare professionals make more informed prescribing decisions, enhance patient safety and improve practice productivity. Our user network consists of over one million healthcare professionals, including over 300,000, or over 45% of, U.S. physicians. We offer our products on all major U.S. mobile platforms including Apple® (iPhone®, iPod touch® and iPad™), Android™, BlackBerry®, Palm® and Windows® Mobile devices. To date, we have worked with all of the top 20 global pharmaceutical companies by sales and over 350 individual pharmaceutical brands to engage with healthcare professionals through our interactive services.

Our proprietary drug content is the most frequently used mobile reference product and provides healthcare professionals with convenient access to information they need at the point of care. Healthcare professionals are able to access information such as dosing, drug/drug interactions, pricing and insurance coverage for thousands of brand, generic and over-the-counter drugs. Physicians trust Epocrates for accurate content and innovative offerings and use our products more than any other mobile drug reference tool. Our strong brand has enabled us to build a large and active network of users, which enhances our ability to market our interactive services.

Through our interactive services, we provide the healthcare industry, primarily pharmaceutical companies, access to our user network to deliver targeted information and conduct market research in a cost-effective manner. Our services include DocAlert® clinical messages that deliver product news and alerts to healthcare professionals. Our Virtual Representative Services, including drug detailing, sampling, patient literature delivery and the ability to contact drug manufacturers, are designed to supplement and replicate the activities of pharmaceutical sales representatives.

We generate revenue by providing healthcare companies with interactive services to communicate with our network of users and through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals. In 2009, we recognized total net revenue of $93.7 million, compared to $83.3 million for 2008. Total net revenues were $73.7 million for the nine months ended September 30, 2010 compared to $66.2 million for the nine months ended September 30, 2009. Our income before taxes for the year ended December 31, 2009 was $14.4 million, compared to a $13.9 million for the year ended December 31, 2008. Our income before taxes for the nine months ended September 30, 2010 was $3.3 million compared to $8.2 million for the nine months ended September 30, 2009.

Market opportunity

Physicians

Physicians are seeking ways to address growing administrative complexities, increasing reimbursement pressures and a constantly changing regulatory environment. As a result, physicians are increasingly adopting technology solutions that enable them to respond to these challenges and improve practice efficiencies and patient care. Physicians are also overburdened with information and challenged with keeping current on medical developments and news. Therefore, physicians need access to relevant and reliable clinical information at the point of care to help reduce medical errors and make informed prescribing decisions. We believe these trends and the quality of our products and services will continue to strengthen our user network.

1


Table of Contents

Pharmaceutical companies

Pharmaceutical companies are seeking to improve the quality and frequency of their interactions with physicians and other healthcare professionals. Pharmaceutical companies are facing patent expirations and fewer new drug approvals, which result in reduced revenues and profit. Additionally, pharmaceutical sales representatives have restricted access to, and limited time with, busy physicians. As a result, many pharmaceutical companies are changing the traditional sales model and reducing the size of their sales forces.

In 2008, pharmaceutical companies spent over $12.8 billion on professional promotional activities including detailing, journal advertisements and ePromotion, according to SDI's 2009 Promotional Audits. An increasing proportion of this annual pharmaceutical promotional spend may be redirected from traditional promotion, such as sales representatives and print medium, to electronic channels. We believe the effectiveness of our interactive services and size of our network will enable us to capture a greater portion of this spend.

Electronic health records

The Health Information Technology for Economic and Clinical Health Act, or HITECH Act, passed as part of the American Recovery and Reinvestment Act of 2009, was intended to fund and incentivize the adoption of Electronic Health Records, or EHR, by physicians. By 2016, $19.2 billion of government subsidies for EHR implementation are expected to be distributed.

EHR systems have had limited adoption by physicians due to the required information technology resource investment, usability concerns and potential workflow disruption. While EHR adoption is increasing, as of 2009, solo and small group practices had the lowest rate of adoption. Solo and small group practices are seeking a cost-effective, easy to implement and remotely-hosted product.

Our solutions

Physicians

Physicians and other healthcare professionals often refer to Epocrates numerous times throughout the day for quick access to drug and clinical information. We provide healthcare professionals with access to current drug information, specifically edited and formatted for use at the point of care. Our in-house team of pharmacists and physicians proactively collect, analyze and distribute relevant drug information that physicians utilize to make more informed clinical decisions. Our drug reference tool is available on all major U.S. mobile platforms in order to provide physicians with flexibility in their choice of mobile device.

Physicians report that the use of our proprietary drug reference tool reduces the likelihood of adverse drug events, improves patient safety and saves time. More than 50% of physician users reported avoiding one or more medical errors every week, according to a survey conducted by Epocrates of over 2,800 physician users in 2010. Additionally, over 40% of respondents reported saving more than 20 minutes per day.

Pharmaceutical companies

We provide access to physicians segmented by medical specialty and other characteristics, allowing for more targeted communications. Our established trust with physicians and knowledge of their information preferences increase their receptiveness to communications from pharmaceutical companies delivered through our services. Our interactive services enable pharmaceutical companies to increase

2


Table of Contents


the effectiveness of interactions with physicians. For example, we believe communication to physicians through our DocAlert messaging service creates significant return on investment for pharmaceutical companies in the form of increased prescription volume and accurate message recall. Our demonstrated return on investment generates repeat and expanded business from our pharmaceutical clients.

Electronic health records

We are developing an affordable, easy-to-use EHR product that will serve the needs of solo and small group practices and will allow users to qualify for subsidies under the HITECH Act. We believe our experience developing information technology tools used by physicians at the point of care provides us the insight and experience to deliver a product that physicians will find easy to learn and use.

Our strengths

We believe that we have the following key competitive strengths:

Recognized and trusted brand with healthcare professionals

Our brand is recognized and endorsed among healthcare professionals as a trusted and accurate source of drug and clinical information. Epocrates is the preferred mobile provider to facilitate communication between physicians and pharmaceutical companies, according to SDI's Mobile and Social Media Study conducted in 2009. We believe our trusted brand has contributed significantly to the growth of our network and our revenues.

Large and active network

Our large and active user network is a valuable asset for our business. We currently have over one million active healthcare professional users, including over 45% of U.S. physicians. Epocrates products are widely used by general and specialty physicians and we have extensive geographic reach with users in all 50 states. Across these demographics, Epocrates has become an integral part of the daily clinical workflow of users in our network, resulting in frequent use of our products and services. For these reasons, we believe the breadth and loyalty of our user network are not easily replicated.

Proprietary drug reference tools

Our proprietary drug content is developed and continually updated by a team of physicians and pharmacists who work to ensure accuracy and relevance. This team also works to provide objective and reliable information to our network. We believe the quality, relevance and ease of use of our content drive our ability to attract and retain users.

Powerful business model

Our user network is primarily composed of healthcare professionals who access our free drug reference content. A smaller percentage of our users purchase one or more of our premium drug and clinical reference tools. Regardless of whether a healthcare professional pays for a subscription or uses our free version, our network provides a base for generating multiple revenue streams from healthcare industry clients. By providing our clients, primarily pharmaceutical companies, with opportunities to engage with our network of physicians, we monetize our network while incurring limited incremental expenses. In addition, we believe our revenue generating services enhance the product offerings to our users with additional free content that they may elect to download.

3


Table of Contents

Proven technology architecture

Our mobile products are not dependent on continuous access to the Internet, and therefore are fast and accessible to our users. Our infrastructure is designed to seamlessly control and deploy robust content to a large number of users in a customizable way, allowing for simple and efficient downloads and updates of our clinical information. We believe these attributes are a significant advantage in supporting our network.

Extensive industry relationships

We have developed relationships with key participants in the healthcare industry. Our large client base provides us with diversification across the healthcare industry, including pharmaceutical companies, market research companies and healthcare payors. We also collaborate with other important healthcare organizations, including medical schools and associations and government agencies.

Experienced management team

Our management team includes experienced healthcare, pharmaceutical and information technology industry executives with operational experience, a thorough understanding of the marketplace and extensive relationships with pharmaceutical companies and other existing and potential clients.

Our strategy

Our strategy is to strengthen our leadership position as a provider of proprietary drug reference and other point of care tools to healthcare professionals. Helping physicians and other healthcare professionals improve patient care, reduce medical errors and save time is central to the success of our business. By expanding our interactive service offerings, we will provide pharmaceutical companies additional opportunities to more effectively engage with our user network. Key elements of our strategy include:

Strengthen and maintain our network

We believe that our focus on the needs of healthcare professionals is the foundation of our success and is critical to the growth of our business. We intend to meet healthcare professionals' evolving needs by continuing to invest significant clinical, development and marketing resources in our products. We plan to strengthen our network by continuing to deliver innovative products for healthcare professionals that easily integrate into their workflow.

Further integrate our products into physicians' office workflow

We are an established part of the workflow of many physicians and are working to become further integrated into their daily practices. We plan to develop applications and products that further enhance practice productivity and efficiency and allow physicians to more conveniently access patient medical data. A key element of our strategy is to leverage our deep understanding of physicians' needs, workflow and preferences to create an innovative EHR solution that will further integrate our products into our users' daily practices.

Develop our solutions for new technology platforms

Our strategy is to make our products available to healthcare professionals on the mobile device of their choice. As the leading developer of mobile drug and clinical reference tools, we are well positioned to take advantage of the new hardware and software entering the market. Our drug reference was the first

4


Table of Contents


medical application available on the iPhone platform and is also available on the iPad. In addition, we launched the Epocrates drug reference product on the Google Android and Palm webOS operating systems in February 2010.

Expand our pharmaceutical offerings

Pharmaceutical companies are embracing new and innovative means to reach physicians in a more efficient and cost-effective manner. The increased adoption of information technology solutions has created a substantial opportunity for healthcare companies to leverage mobile devices and the Internet to reach physicians, including those in our network. We will continue to expand our offerings and promote our electronic services as a highly-trusted and targeted channel to reach healthcare professionals.

Corporate information

We were incorporated in California in August 1998 as nCircle Communications, Inc. In September 1999, we changed our name to ePocrates, Inc., and in May 2006, we reincorporated in Delaware and changed our name to Epocrates, Inc. We have offices located at 1100 Park Place, Suite 300, San Mateo, California 94403, and 50 Millstone Road, Building 400, Suite 100, East Windsor, New Jersey 08520. Our telephone number is (650) 227-1700. Our website address is www.epocrates.com. The information contained in, or that can be accessed through, our website is not part of this prospectus. Unless the context indicates otherwise, as used in this prospectus, the terms "Epocrates," "we," "us" and "our" refer to Epocrates, Inc. We use DocAlert®, Epocrates®, Epocrates Honors®, Epocrates ID®, Epocrates Lab™, Epocrates MedTools®, Epocrates Rx®, Epocrates Rx Pro®, Epocrates Dx®, Epocrates QuickSurvey®, Epocrates QuickRecruit®, Epocrates MedInsight®, EssentialPoints® and MedCafe® as trademarks in the United States and other countries. All other trademarks and trade names mentioned in this prospectus are the property of their respective owners.

5


Table of Contents


The offering

Common stock offered by us     3,574,285 shares

Common stock offered by the selling stockholders

 

  1,785,715 shares

Over-allotment option

 

     804,000 shares

Common stock to be outstanding after the offering

 

22,282,384 shares

Use of proceeds

 

We plan to use the net proceeds of this offering to pay aggregate cumulative dividends to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010 (and accruing at a rate of approximately $237,000 per month)) and the remainder for general corporate purposes, including working capital, research and development, sales and marketing and capital expenditures. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products and technologies. We will not receive any of the proceeds from the sale of shares by the selling stockholders.

Risk factors

 

See the section of this prospectus entitled "Risk factors" and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.

Proposed NASDAQ Global Market symbol

 

EPOC

The number of shares of our common stock to be outstanding immediately after this offering is based on 18,708,099 shares outstanding as of September 30, 2010, on an as-converted basis, and excludes:

5,598,246 shares of common stock issuable upon the exercise of outstanding options under our 2008 Equity Incentive Plan as of September 30, 2010, with a weighted average exercise price of $8.45 per share;

58,950 shares of common stock issuable upon the vesting of restricted stock units under our 2008 Equity Incentive Plan as of September 30, 2010;

1,309,992 shares of common stock reserved and available for future issuance under our 2008 Equity Incentive Plan as of September 30, 2010; and

16,540 shares of common stock, on an as-converted basis, issuable upon the exercise of an outstanding warrant to purchase Series B preferred stock with an exercise price of $5.71 per share, which will automatically convert into a warrant to purchase shares of our common stock upon the completion of this offering.

6


Table of Contents

Except as otherwise indicated, all information in this prospectus assumes:

a one-for-0.786 reverse stock split of our common stock to be effected prior to the effectiveness of this offering;

the conversion of all outstanding shares of our preferred stock into 11,089,201 shares of common stock upon the closing of this offering;

the payment of aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010) with a portion of the net proceeds of this offering;

the filing of our amended and restated certificate of incorporation immediately prior to the closing of this offering; and

no exercise of the underwriters' over-allotment option.

7


Table of Contents


Summary financial data

The following tables summarize our historical financial data. The statements of operations for the years ended December 31, 2007, 2008 and 2009 are derived from our audited financial statements included elsewhere in this prospectus. The statements of operations data for the nine months ended September 30, 2009 and 2010 and the balance sheet data as of September 30, 2010 are derived from our unaudited financial statements included elsewhere in this prospectus. The unaudited financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of our management, reflect all adjustments necessary for the fair presentation of the financial information set forth in those statements. Our historical results are not necessarily indicative of our operating results or financial condition to be expected in the future. You should read this data together with the financial statements and related notes included elsewhere in this prospectus and the information under the section of this prospectus entitled "Management's discussion and analysis of financial condition and results of operations."

Statements of operations data

 
  Years Ended December 31,   Nine Months Ended
September 30,
 
 
  2007   2008   2009   2009   2010  
 
  (in thousands, except per share data)
 

Total revenues, net

  $ 65,611   $ 83,345   $ 93,654   $ 66,248   $ 73,703  

Total cost of revenues(1)

    22,805     24,786     29,452     21,945     23,330  
                       

Gross profit

    42,806     58,559     64,202     44,303     50,373  

Operating expenses:(1)

                               
 

Sales and marketing

    16,887     18,167     22,704     16,306     22,011  
 

Research and development

    10,519     12,430     14,663     10,555     14,512  
 

General and administrative

    11,983     14,888     11,587     8,630     11,249  
 

Change in fair value of contingent consideration

                    885  
                       

Total operating expenses

    39,389     45,485     48,954     35,491     48,657  
                       

Income from operations

    3,417     13,074     15,248     8,812     1,716  

Interest and other income (expense), net

    1,196     870     (801 )   (606 )   1,550  
                       

Income before income taxes

    4,613     13,944     14,447     8,206     3,266  

Benefit (provision) for income taxes

    21,126     (6,510 )   (6,788 )   (4,050 )   (2,142 )
                       

Net income

    25,739     7,434     7,659     4,156     1,124  

Less: accretion of Series B mandatorily redeemable preferred stock dividends

    3,747     3,523     3,523     2,643     2,643  

Less: allocation of net income to participating preferred stockholders

    14,965     2,290     2,433     887      
                       

Net income (loss) available to common stockholders—basic

  $ 7,027   $ 1,621   $ 1,703   $ 626   $ (1,519 )

Undistributed earnings re-allocated to common stockholders

    1,447     219     205     76      
                       

Net income (loss) available to common stockholders—diluted

  $ 8,474   $ 1,840   $ 1,908   $ 702   $ (1,519 )
                       

Net income (loss) per common share—basic

  $ 1.18   $ 0.21   $ 0.22   $ 0.08   $ (0.20 )
                       

Net income (loss) per common share—diluted

  $ 1.06   $ 0.19   $ 0.20   $ 0.07   $ (0.20 )
                       

                               

8


Table of Contents

 
  Years Ended December 31,   Nine Months Ended
September 30,
 
 
  2007   2008   2009   2009   2010  
 
  (in thousands, except per share data)
 

Weighted average shares used in computing net loss per common share—basic

    5,967     7,847     7,758     7,816     7,517  

Weighted average shares used in computing net loss per common share—diluted

    7,966     9,852     9,491     9,599     7,517  

Pro forma net income per share—basic (unaudited)(2)

              $ 0.36         $ 0.05  
                             

Pro forma net income per share—diluted (unaudited)(2)

              $ 0.34         $ 0.05  
                             

Pro forma weighted average common shares outstanding—basic

                20,990           20,922  
                             

Pro forma weighted average common shares outstanding—diluted

                22,730           22,551  
                             


                               

(1)              Includes stock-based compensation in the following amounts:

 

Cost of revenues

 
$

178
 
$

158
 
$

213
 
$

155
 
$

218
 

Sales and marketing

    1,127     676     1,221     953     1,320  

Research and development

    747     511     899     595     1,237  

General and administrative

    1,135     2,275     2,201     1,620     1,929  
(2)
See Note 2 to our audited financial statements for an explanation of the method used to calculate pro forma basic and diluted net income per share of common stock.

Balance sheet data

 
  As of September 30, 2010  
 
  Actual   Pro Forma
As Adjusted(1)(2)
 
 
  (in thousands)
 

Cash, cash equivalents, and short-term investments

  $ 70,178   $ 87,150  

Working capital

    35,585     52,557  

Total assets

    122,240     137,796  

Deferred revenue

    55,615     55,615  

Other long-term obligations

    18,261     18,165  

Mandatorily redeemable convertible preferred stock

    72,632      

Accumulated deficit

    (44,715 )   (44,715 )

Total stockholders' equity (deficit)

    (34,962 )   53,322  

(1)
The pro forma as adjusted summary balance sheet data as of September 30, 2010 gives effect to the conversion of all outstanding shares of our preferred stock into an aggregate of 11,089,201 shares of common stock upon the closing of this offering and the payment of aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010) and gives further effect to the sale of 3,574,285 shares of our common stock at an assumed initial public offering price of $14.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, after deducting underwriting discounts and estimated offering expenses payable by us.

(2)
A $1.00 increase (decrease) in the assumed initial public offering price of $14.00 per share would increase (decrease) cash, cash equivalents and short-term investments and total assets, and decrease (increase) stockholders' deficit by $3.3 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and estimated offering expenses payable by us.

9


Table of Contents

Other financial data

 
  Years Ended December 31,   Nine Months Ended September 30,  
 
  2007   2008   2009   2009   2010  
 
  (unaudited)
(in thousands)

 

Adjusted EBITDA(1)

  $ 8,225   $ 18,484   $ 21,816   $ 13,648   $ 9,879  

Net cash provided by operating activities

    23,366     16,822     17,018     11,452     9,789  

Capital expenditures

    (6,309 )   (2,860 )   (2,613 )   (1,823 )   (3,086 )

(1)
Adjusted EBITDA is an unaudited number and represents net income (loss) before interest income, interest expense, other income (expense), net, benefit (provision) for income taxes, depreciation and amortization, building rent recorded as interest expense, stock-based compensation and the change in the fair value of contingent consideration.

Adjusted EBITDA is not a measure of liquidity calculated in accordance with U.S. generally accepted accounting principles, or GAAP, and should be viewed as a supplement to—not a substitute for—our results of operations presented on the basis of GAAP. Adjusted EBITDA does not purport to represent cash flow provided by, or used in, operating activities as defined by GAAP. Our statement of cash flows presents our cash flow activity in accordance with GAAP. Furthermore, adjusted EBITDA is not necessarily comparable to similarly-titled measures reported by other companies.

We believe adjusted EBITDA is used by and is useful to investors and other users of our financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across companies and across periods. We believe that:

EBITDA is widely used by investors to measure a company's operating performance without regard to such items as interest expense, taxes, depreciation and amortization, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired; and

investors commonly adjust EBITDA information to eliminate the effect of stock-based compensation expenses and other charges, which can vary widely from company to company and impair comparability.

Our management uses adjusted EBITDA:

as a measure of operating performance to assist in comparing performance from period to period on a consistent basis;

as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations;

in communications with the board of directors, stockholders, analysts and investors concerning our financial performance; and

as a significant performance measurement included in our bonus plan.

10


Table of Contents

The table below sets forth a reconciliation of net income (loss) to adjusted EBITDA:

 
  Years Ended December 31,   Nine Months Ended September 30,  
 
  2007   2008   2009   2009   2010  
 
  (unaudited)
(in thousands)

 

Net income

  $ 25,739   $ 7,434   $ 7,659   $ 4,156   $ 1,124  

Interest income

    (1,714 )   (1,180 )   (127 )   (109 )   (73 )

Interest expense

    285     855     855     641     214  

Building rent recorded as interest expense

    (285 )   (855 )   (855 )   (641 )   (214 )

Other income (expense), net

    233     (545 )   73     74     (2 )

Provision (benefit) for income taxes

    (21,126 )   6,510     6,788     4,050     2,142  

Depreciation and amortization

    1,906     2,645     2,889     2,154     2,240  

Amortization of purchased intangibles

                    548  

Stock-based compensation

    3,187     3,620     4,534     3,323     4,704  

Change in fair value of contingent consideration

                    885  

Gain on sale-leaseback of building

                    (1,689 )
                       

Adjusted EBITDA

    8,225     18,484     21,816     13,648     9,879  
                       

11


Table of Contents


Risk factors

Investing in our common stock involves a high degree of risk. This section describes circumstances or events that could have a negative effect on our business. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. If any of the following risks occur, our business, financial condition or results of operations could be materially and adversely affected. In these circumstances, the market price of our common stock could decline and you may lose some or all of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business and operations.

Risks related to our business

If we are unable to retain our existing users and attract new users, especially physician users, our revenue will decline and our business will suffer.

A necessary condition to our long-term success is our ability to retain our existing users and attract new users, especially physician users in specialties of interest to our healthcare clients, to our interactive services and drug and clinical reference tools. If we are unable to do so, our revenue could decline materially.

Most of our users use only our free drug reference product and may stop using the products at anytime without loss. Most of the paid subscriptions to our premium drug and clinical reference products have a term of one year and our users have no obligation to renew their subscriptions when such subscriptions expire. Under certain circumstances, our users may cancel their subscriptions prior to expiration or simply stop using the services before the subscription expires.

Factors that may affect the retention rate of our existing users and the rate at which we attract new users for our drug and clinical reference tools include:

our ability to provide current, relevant and reliable healthcare content, drug and clinical reference tools, formulary hosting and other services that meet the needs of healthcare professionals, including physicians;

our ability to provide reliable applications and to enhance the functionality, availability, performance and features of our existing and future services to meet the evolving requirements and expectations of our existing and future users;

the availability, price, performance and functionality of competing products and services, including competing mobile, Web-based and traditional products and services, and electronic health records systems that incorporate drug and clinical reference tools;

deterioration of our reputation and brand for any reason, including user concerns with our privacy practices or our relationships with the healthcare industry; and

the ability of the developers of mobile operating systems and mobile devices with which our products are compatible to remain competitive in the marketplace and to be adopted into medical practice and practice workflow.

In addition, our paid products compete with free products offered by competitors or those available through online resources and searches which can be accessed through most mobile devices. The availability of download sites such as the Apple App StoreSM that offer numerous free or low-priced

12


Table of Contents


competing products at one location has also reduced the demand for our paid subscription products. We expect the use of such sites to expand, reducing the number of paying users for our drug and clinical reference tools as a percentage of total users.

In addition to the loss of subscription revenue, our inability to attract or retain users, especially physician users, may cause an even more significant decline in revenue from our interactive services. Revenue from such services is tied directly to our ability to maintain a large user network of healthcare professionals that is attractive to our industry clients.

If we have an insufficient number of users, especially physician users, with desired characteristics for some of our interactive services or those users do not update their mobile devices with sufficient frequency, we may become unable to timely fulfill the demand for some of our interactive services from healthcare companies.

Our ability to meet the demand for delivering clinical messages, formularies and other sponsored content to users' mobile devices is dependent upon our having a sufficient number of users, especially physician users, with desired characteristics, such as specialty and prescribing habits, updating their mobile devices through our servers with sufficient frequency during the period for delivery of the service. In addition, we have established business rules and structured our technology to limit the number of DocAlert messages and the mix of sponsored and non-sponsored messages delivered during any single update by a user in order to promote the quality of the user's experience with the clinical messaging service. It is possible that an insufficient number of users will update during a given service period for our interactive services, or that demand for promotional clinical messaging sponsorship will exceed the available supply for all or a subset of our users. In either of these events, our healthcare clients could become dissatisfied with our service. As a result, we may be unable to grow our interactive services revenue beyond the bounds of our business rules and technology structure, and changes to such business rules or technology structure could cause our users' satisfaction with and response to our interactive services to decrease, which could make such changes ineffective in addressing such inability to grow these revenues.

If the response of our users, especially physician users, to our interactive services decreases, the value of these services will be reduced and our revenue will decline.

In the past, we have obtained a positive response from our users to our interactive services, including offers to participate in market research studies, sponsored clinical messaging and other forms of communication. If, however, our users, particularly physician users, become less responsive to receiving communications or participating in such services, or elect not to use new services that we may offer, the value of these interactive services will likely decline. This could cause our revenue to remain flat or to decline.

If we are unable to continue to provide current, relevant and reliable drug and clinical reference tools and services, we will be unable to retain and attract users to our services and our revenue may decline.

Use of our clinical information and interactive services is based upon our ability to make available current, relevant and reliable drug and clinical reference tools, formulary hosting and other services that meet the needs of our users. Our ability to do so depends on our ability to:

hire and retain qualified physician and pharmacist editors and authors;
license accurate and relevant content from third parties;
contract with health plans and insurers to host formulary information; and
monitor and respond to changes in user interest in specific topics.

13


Table of Contents

For several of the clinical references included in our Epocrates® Essentials and Epocrates® Essentials Deluxe products, we are particularly dependent on third-party content providers. For example, we license Stedman's Medical Dictionary 28th Edition and information regarding ICD-9 and CPT® codes from third parties.

We cannot assure you that we will be able to continue to develop or acquire needed content at a reasonable cost, that there will not be errors or omissions in our developed or licensed content, or that our competitors will not obtain exclusive access to or develop content that healthcare professionals consider superior to ours. If any of these risks materialize for any reason, the value of the content and services that we offer would diminish. As a result, we may be unable to attract and retain users.

If we are unable to maintain credibility of our independence, our business and financial condition could suffer.

The credibility of our brand is dependent in large part on the medical community's continued perception of us as independent from our healthcare industry clients, particularly pharmaceutical companies. If healthcare professionals believe that we are too closely associated with such clients as a result of the revenue we receive from their purchase or sponsorship of our interactive services, the credibility of our brand will diminish. Although we take precautions to remain independent from our healthcare industry clients, including separating the development of our application content from our commercial dealings with such clients and clearly labeling the source and responsibility of sponsored messages, programs and activities, we cannot assure you that the medical community will view our content as sufficiently unbiased. If the credibility of our brand is damaged, it will be difficult, expensive and time-consuming to restore the quality of our brand with healthcare professionals and our business could suffer.

We are dependent upon our senior executive management and other highly specialized personnel and the loss or failure to identify, hire, motivate and retain additional highly specialized personnel could negatively impact our ability to grow our business.

Our success and the execution of our growth strategy depend largely on the continued service of our senior executive management team. Several members of our management team, including our President and Chief Executive Officer, Chief Financial Officer and Chief Operations Officer have been with us for a relatively short period of time. Although these executives have joined us with a significant amount of professional experience, our future success could be hindered by their limited exposure to our business. Moreover, the loss of any members of our management team could have a negative impact on our ability to manage and grow our business effectively. We cannot assure you that in such an event we would be able to replace any member of our management team in a timely manner, or at all, on acceptable terms.

Our future success and the execution of our growth strategy also depend largely on our continuing ability to identify, hire, develop, motivate and retain highly specialized personnel, including software engineers, clinician authors and other technical, sales and marketing personnel. Our competitors, employers in other industries, healthcare providers, academic institutions and governmental entities and organizations also often seek persons with similar qualifications. We cannot assure you that we will be able to hire or retain a sufficient number of qualified personnel to meet our requirements, or that we will be able to do so at salary and benefit costs that are acceptable to us.

14


Table of Contents


If we are unable to adopt new technologies and offer our products and services on new and existing mobile platforms, we will be unable to retain and attract users to our services and our revenue may decline.

To keep pace with technological developments, satisfy increasingly sophisticated client requirements and sustain market acceptance, we will need to continue to deploy new tools and features for our clinical information and interactive services and develop new offerings with enhanced performance and functionality at competitive prices, including the incorporation of sophisticated clinical information into our electronic health record product. Accordingly, we will need to properly identify user needs, anticipate technological advances and potentially offer our products and services on new and existing mobile platforms.

The development and application of new technologies involve time, substantial costs and risks. Our inability, for technological or other reasons, to enhance, develop and introduce services in a timely manner, or at all, in response to changing market conditions or client requirements could result in our services losing market acceptance, and therefore adversely affect our operating results. The new technologies may be significant and expensive, and we cannot assure you that we will be able to implement them quickly and efficiently, or at all. Failure to do so could inhibit our ability to attract or retain users, which may cause our revenue to decline.

Our software applications and systems may contain defects or errors which could negatively affect our reputation and impair our ability to retain and attract users to our applications and clients purchasing our services.

While we test our applications and systems for defects and errors prior to release, defects or errors have been identified from time to time by our internal team and by our users and clients after release. Such defects or errors may occur in the future, particularly with respect to our electronic health records, or EHR, product, which is significantly more complex than the products and services that we currently offer.

Any defects or errors that affect the quality or reliability of our products and services or that cause interruptions to the availability of our services could result in:

lost or delayed market acceptance and sales of our applications and services;
loss of users and clients;
inability to attract new users and clients;
product liability or breach of contract suits against us;
diversion of development resources;
injury to our brand and reputation; and
increased maintenance and warranty costs.

While our subscription and interactive services agreements typically contain limitations of liability and disclaimers that purport to limit our liability for damages related to defects in our software or content, such limitations and disclaimers may not be enforced by a court or other tribunal or otherwise effectively protect us from related claims. We maintain liability insurance coverage, including coverage for errors and omissions. However, it is possible that claims could exceed the amount of our applicable insurance coverage, if any, or that this coverage may not continue to be available on acceptable terms or in sufficient amounts. Even if these claims do not result in liability to us, investigating and defending against them could be expensive and time consuming and could divert management's attention away from our operations. In addition, negative publicity caused by these events may delay or hinder market acceptance of our services, including unrelated services.

15


Table of Contents


The healthcare information market is highly competitive and we face significant competition for our drug and clinical reference tools and interactive services.

The markets in which we participate are competitive, dynamic and subject to developments in technology and the healthcare industry. Currently, we compete with other companies for users of the types of drug and clinical reference tools that we offer and for budget dollars from our pharmaceutical, managed care and market research clients.

We compete within a broad industry of healthcare content providers for the attention of healthcare professionals, who can choose to use mobile, online or print media to reference clinical information. Companies providing clinical content include Medscape, a division of WebMD, LLC, and UpToDate, Inc. Competition from each of these sources of clinical reference content may lead to a reduction in the retention of our existing users and the rate at which we attract new users for our clinical information.

Our primary competition for the promotional spend available from our clients in the area of interactive services is from companies, including WebMD, that help pharmaceutical companies market their products, programs and services to healthcare professionals.

In addition, our market research business competes with numerous companies which recruit physicians to participate in surveys, often by phone, fax, email or surface mail. We also compete with the recruitment arms of market research companies that have assembled their own survey panels of healthcare professionals. To the extent competing channels are available to access healthcare professionals, including physicians, the value of our interactive services to our clients is reduced.

Many of our competitors have greater financial, technical, product development, marketing and other resources than we do. They may also be better able to develop and deploy new products and services or to take advantage of new technologies than we are. Our inability, for technological or other reasons, to enhance, develop and introduce services in a timely manner, or at all, in response to changing market conditions, technology or client requirements could result in our services losing market acceptance, and therefore adversely affect our operating results. New technologies may be significant and expensive, and we cannot assure you that we will be able to implement them quickly and efficiently, or at all. We cannot assure you that we will be able to compete successfully against these organizations or any alliances they have formed or may form.

Moreover, the competitive market in which we participate may require us to reduce the prices of our services or the rates we charge our clients. If our competitors offer discounts on certain applications or services, we may be required to reduce prices or offer our products on terms less favorable to us to compete successfully. A reduction in the prices of our services would reduce our margins. Some of our competitors may bundle product offerings that compete with ours for promotional purposes or as a long-term pricing strategy. These practices could, over time, limit the prices that we can charge for our services. If we cannot offset price reductions with a corresponding increase in sales volume, our operating results would be adversely affected.

We have invested significant resources in the development of an electronic health record product, but the market for such products is competitive, our product has not yet been released and we have limited experience in that market.

EHRs are significantly more complex than the products and services that we have historically offered to healthcare professionals, involving sensitive personal health information protected by the Health Insurance Portability and Accountability Act, or HIPAA, and other laws as well as sophisticated data exchanges associated with electronic prescribing and other transactions. In addition, we will be

16


Table of Contents


dependent upon a number of vendors for components of the services associated with our EHR product, including lab ordering and retrieval, electronic prescribing and other matters. Many of our competitors have been participating in this market for many years and have invested significantly more resources in the development of their products than we have. In addition, under the American Recovery and Reinvestment Act of 2009, incentives to physicians and others will be available beginning in 2011 for the acquisition and use of EHRs, but only if those EHRs are certified and the use of the EHR constitutes "meaningful use" as will be defined by the law. Our EHR product has not yet been released or certified, and there is no guarantee that our product will be certified or that use of it will qualify for "meaningful use." Even if our product meets these requirements, we may be too late to the market to compete for the growing numbers of physicians and others expected to adopt such products in order to qualify for the government incentives beginning in 2011. Moreover, even if our EHR product is certified and qualifies for "meaningful use," numerous factors, including, but not limited to, development delays, unexpected intellectual property disputes and our inability to compete in the market could hinder client acceptance of the product.

We are not compatible with all mobile platforms.

Our mobile clinical information is not compatible with all mobile platforms. While we offer online services, the majority of our users and our interactive services are on mobile devices. We depend on the continuing compatibility of our clinical information and services with mobile operating systems and mobile devices and with evolving industry standards and protocols to run our mobile clinical information.

In addition, we are dependent on the ability of the developers of mobile platforms with which our drug and clinical reference tools are compatible to remain competitive in the medical community and the general marketplace. To remain competitive, developers of such mobile platforms may need to timely enhance their products, develop new operating systems or devices or take other actions which are outside of our control. If a mobile platform that is incompatible with our products achieve widespread use and acceptance in the medical community, or if Internet resources or other non-mobile device resources becomes more attractive than what is offered for mobile platforms, we may be unable to retain or attract users to our products. In particular, our mobile products are not compatible with Symbian-based devices.

We may not sustain our revenue growth, and we may not be able to manage future growth effectively.

We have experienced significant revenue growth in a short period of time. Our revenue increased from $65.6 million for the year ended December 31, 2007 to $93.7 million for the year ended December 31, 2009. You should not rely on our revenue growth, gross margins, or operating results for any prior quarter or annual period as an indication of our future operating performance. If we are unable to maintain adequate revenue growth in absolute dollars, we may not sustain our recent profitability and our share price could decline.

Our future operating results depend to a large extent on our ability to successfully manage our anticipated expansion and growth. To manage our growth successfully, among other things, we must effectively:

add additional sales and marketing personnel in various locations;

control expenses;

maintain and enhance our information technology support for enterprise resource planning, accounting and design engineering by adapting and expanding our systems and tool capabilities;

17


Table of Contents

recruit, hire, train and manage additional qualified people; and

manage operations in multiple locations and time zones.

We are increasing our investment in research and development, sales and marketing, general and administrative and other functions to grow our business. We are likely to recognize the costs associated with these increased investments earlier than some of the anticipated benefits and the return on these investments, if any, may be lower, may develop more slowly than we expect, or may not materialize.

If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new products or enhancements to existing products and we may fail to satisfy client requirements, maintain product quality, execute our business plan, or respond to competitive pressures, which could result in lower revenue and profitability and a decline in our share price.

Our operating results have fluctuated and are likely to continue to fluctuate, which might make our quarterly results difficult to predict and could cause our stock price to decline or exhibit volatility.

Our operating results are likely to fluctuate as a result of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful and you should not rely on our past results as an indication of future performance. Each of the following factors, among others, could cause our operating results to fluctuate from quarter to quarter:

demand for and market acceptance of our services;

factors relating to pharmaceutical company budget cycles and other factors that may affect the timing of promotional campaigns for specific products or demand for our services by our clients;

changes in pharmaceutical company demand as a result of delays or changes in product approvals, changes in marketing strategies, modifications of client budgets and similar matters;

the length of sales cycles and fulfillment periods of our services to pharmaceutical companies and other segments of the healthcare industry;

expansion of marketing and support operations;

the timing of new product introductions, including our new EHR product, and product enhancements by us or our competitors; and

the cost of being a public company.

The majority of our clinical information subscriptions have terms of one year and our contracts with our other healthcare industry clients for our interactive services typically range from one to three years. We cannot assure you that our current users and other clients will continue to participate in our existing programs beyond the terms of their existing contracts or that they will enter into any additional contracts for new programs that we offer.

In addition, the time between the date of the signing of the contract with a client for a program, the actual fulfillment of the services under such contract and the revenue recognition associated with such revenues may be lengthy, especially for larger contracts with multiple deliverables, and may be subject

18


Table of Contents


to delays over which we have little or no control, including those that result from the client's need for internal approvals. Other factors that could affect the timing of our interactive services revenue include:

variations in the marketing budgets allocated for the types of services we offer;

the timing of federal Food and Drug Administration, or FDA, approval for new pharmaceutical products or for new approved uses for existing products;

regulatory concerns related to the marketing of pharmaceutical products; and

factors that may affect the timing of promotional campaigns for specific products.

Because we recognize revenue from our drug and clinical reference tool subscriptions and certain of our interactive services over the term or at the end of the service period, a significant downturn in our business may not be reflected immediately in our operating results, which may make it more difficult to evaluate our prospects.

We recognize revenue from subscription agreements monthly over the terms of these agreements, which are typically one year. In most cases, we recognize revenue from our interactive services over the terms of these agreements or upon delivery of each service element. As a result, a significant portion of the revenue we report in each quarter is generated from subscription and service agreements entered into during prior periods. Consequently, a decline in new or renewed subscriptions or service agreements in any one quarter may not materially affect our financial performance in that quarter but will negatively affect our revenue in future quarters. In addition, we may be unable to adjust our costs, many of which are fixed, in response to reduced revenue. Accordingly, the effect of significant declines in sales and market acceptance of our services may not be reflected in our short-term results of operations, which would make our reported results less indicative of our future prospects.

Developments in the healthcare industry could negatively affect our business.

Most of our revenue is derived from the healthcare industry and could be reduced by changes affecting healthcare spending. General reductions in expenditures by healthcare companies could result from, among other things:

government regulation or private initiatives that affect the manner in which healthcare providers interact with patients, pharmaceutical companies, payors or other healthcare industry participants, including changes in pricing or means of delivery of healthcare products and services;

consolidation of healthcare companies;

reductions in governmental funding for healthcare; and

adverse changes in business or economic conditions affecting healthcare payors or providers, the pharmaceutical industry or other healthcare companies.

We are particularly dependent upon pharmaceutical companies for our interactive services revenue. Our business will be harmed if business or economic conditions or government regulations result in the reduction of purchases by such clients, the non-renewal of our agreements with such clients, or the need to materially revise our offerings.

19


Table of Contents

Even if general expenditures by healthcare companies remain the same or increase, developments in the healthcare industry may result in reduced spending in some or all of the specific segments of the market we serve or are planning to serve. For example, purchase of our services could be affected by:

a decrease in the number of, or the market exclusivity available to, new drugs coming to market;

decreases in marketing expenditures by pharmaceutical companies as a result of governmental regulation or private initiatives that discourage or prohibit advertising or sponsorship activities by pharmaceutical companies;

state or federal legislation requiring the disclosure of, or otherwise regulating, honorarium payments to physicians for participation in market research activities; and

changes in the design of health insurance plans.

In addition, our clients' expectations regarding pending or potential industry developments may also affect their budgeting processes and spending plans with respect to services of the types we provide.

The healthcare industry has changed significantly in recent years and we expect that significant changes will continue to occur. However, the timing and impact of developments in the healthcare industry are difficult to predict. We cannot assure you that the markets for our services will continue to exist at current levels or that we will have adequate technical, financial and marketing resources to react to changes in those markets.

We may be subject to claims brought against us as a result of the services we provide.

Healthcare professionals access information, including information regarding particular medical conditions and the use of particular medications, through our drug and clinical reference tools, interactive services and, when launched, our EHR product. If our content, or content we obtain from third parties, contains inaccuracies, or we introduce inaccuracies in the process of implementing third party content, it is possible that patients, physicians, consumers, the providers of the third party content or others may sue us if they are harmed as a result of such inaccuracies. We have editorial procedures in place to provide quality control of the information that we publish or provide. However, we cannot assure you that our editorial and other quality control procedures will be sufficient to ensure that there are no errors or omissions in particular content and we have had content errors in the past. Although our agreements for the performance of our services contain terms and conditions, including disclaimers of liability, that are intended to reduce or eliminate our liability, the law governing the validity and enforceability of online agreements and other electronic transactions is evolving. We could be subject to claims by users or third parties that our online agreements are unenforceable. A finding by a court that these agreements are invalid and that we are subject to liability could harm our business and financial condition and require costly changes to our business.

In addition, third parties may assert claims against us alleging infringement of copyrights, trademark rights, or other proprietary rights, or alleging unfair competition or violations of privacy rights. We could also be subject to claims for indemnification resulting from infringement claims made against our clients and third-party service providers for third-party products and content that are incorporated into our clinical information if they are found to infringe the intellectual property rights of others, which could increase our defense costs and potential damages. Any of these events could be expensive and time consuming to resolve or defend, may require us to change our business practices and could have a negative effect on our business, operating results and financial condition.

20


Table of Contents

We could be required to spend significant amounts of time and money to defend ourselves against any such claims. Although we may be indemnified against such costs, the indemnifying party may be unable to fulfill its obligations. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products and services while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms, or at all. Even if potential claims do not result in liability to us, investigating and defending against these claims could be expensive and time consuming and could divert management's attention away from our operations. We maintain general liability insurance coverage, including coverage for errors and omissions, however this coverage may not be sufficient to cover one or more large claims against us or otherwise continue to be available on acceptable terms. Further, the insurer could disclaim coverage as to any future claim. In addition, our business is based on establishing the reputation of our services as trustworthy and reliable sources of clinical information. Allegations of impropriety or inaccuracy, even if unfounded, could therefore harm our reputation and business.

Healthcare and consumer protection regulations and legislation create risks and challenges with respect to our compliance efforts and our business strategies.

The healthcare industry is highly regulated and is subject to changing political, legislative, regulatory and other influences. Existing and new laws and regulations affecting the healthcare industry could create unexpected liabilities for us, cause us to incur additional costs and restrict our operations. Many healthcare laws are complex and their application to specific products and services may not be clear, particularly as we develop and release new and more sophisticated products and services. In particular, many existing healthcare laws and regulations, when enacted, did not contemplate the clinical information and interactive services that we provide. However, these laws and regulations may nonetheless be applied to our services. We are also subject to various federal and state consumer protection laws. Our failure to accurately anticipate the application of these laws and regulations, or other failure to comply with them, could create liability for us, result in adverse publicity and negatively affect our businesses. Some of the risks we face from healthcare and consumer protection regulations are as follows:

Regulation of drug and medical device advertising and promotion.    We provide services involving promotion of prescription and over-the-counter drugs and medical devices. Any increase in regulation of these areas by the FDA, the Federal Trade Commission, or FTC, or other governmental bodies at the federal, state or local level, could make it more difficult for us to contract for certain of our interactive services. Physician groups and others have criticized the FDA's current policies and have called for restrictions on advertising of prescription drugs and for increased FDA enforcement. In response, the FDA has conducted hearings and sought public comment regarding its regulation of information concerning drugs on the Internet and the relationships between pharmaceutical companies and those disseminating information on drugs. We cannot predict what actions the FDA or industry participants may take in response to these criticisms. It is also possible that new laws would be enacted that impose restrictions on such marketing and advertising. Our interactive services revenues could be materially reduced by additional restrictions on the marketing or advertising of prescription drugs and medical devices, whether imposed by law or regulation or by policies adopted by industry members.

If the FDA, the FTC or another governmental body finds that any information available on our website or distributed by us violates FDA, FTC or other laws or regulations, they may take regulatory or judicial action against us or the advertiser or sponsor of that information. State attorneys general may also take similar action based on their state's consumer protection statutes or other new or existing laws.

Anti-kickback laws.    Healthcare anti-kickback laws prohibit any person or entity from offering, paying, soliciting or receiving anything of value, directly or indirectly, for the referral of patients covered by

21


Table of Contents


federal healthcare programs or the leasing, purchasing, ordering or arranging for or recommending the lease, purchase or order of any item, good, facility or service covered by these programs. Many states also have similar anti-kickback laws that are not necessarily limited to items or services for which payment is made by a federal healthcare program. These laws may restrict how we and some of our clients market products to healthcare providers. The laws in this area are broadly written and it is often difficult to determine precisely how the laws will be applied in specific circumstances. Penalties for violating the federal anti-kickback laws include imprisonment, fines and exclusion from participating, directly or indirectly, in federal healthcare programs. Any determination by a state or federal regulatory agency that any of our practices violate any of these laws could subject us to civil or criminal penalties and require us to change or terminate some portions of our operations. Even an unsuccessful challenge by regulatory authorities of our practices could result in negative publicity and it could be costly for us to respond.

Legislation relating to payments to physicians.    Recent legislation enacted or pending in several states and enacted at the federal level as part of the Patient Protection and Affordable Care Act and the Healthcare and Education Reconciliation Act of 2010 mandates public disclosure of, or otherwise regulates or limits the providing of, certain gifts and payments by pharmaceutical companies to physicians. These state laws may be interpreted to cover honorarium payments made to physicians for participation in market research activities sponsored by pharmaceutical companies. Because we currently provide market research services involving participants from our user network, the increased adoption and enforcement of these laws and the application of any public disclosure requirements or other limitations may have a negative impact on the ability of pharmaceutical companies to sponsor these activities or the willingness of physicians to participate in the market research. To date, we have not experienced a significant reduction in our market research services business as a result of these laws in the few jurisdictions in which they have been enacted and become effective. However, we cannot predict how pharmaceutical companies or physicians will respond if such legislation becomes more widespread or becomes effective at the federal level. A significant decline in the sponsorship of our market research services by pharmaceutical companies or the agencies that represent such companies, or a significant decline in physicians' willingness to participate in such studies could negatively impact our operating results.

Medical professional regulation.    The practice of most healthcare professions requires licensing under applicable state law. In addition, the laws in some states prohibit business entities from practicing medicine. We do not believe that we engage in the practice of medicine and we have attempted to structure our services, strategic relationships and other operations to avoid violating these state licensing and professional practice laws. We employ and contract with physicians who provide only medical information to users, some of whom may be consumers, and we do not intend to provide medical care or advice. Any determination that we are a healthcare provider and acted improperly as a healthcare provider may result in liability to us.

Anti-spam regulation.    We may also be required to comply with current or future anti-spam legislation by limiting or modifying some of our interactive services, such as our clinical messaging, which may result in a reduction in our revenue. One such law, the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, or CAN-SPAM, became effective in the United States on January 1, 2004. CAN-SPAM imposes complex and often burdensome requirements in connection with the sending of commercial e-mail. CAN-SPAM or similar laws may impose burdens on our user communication practices and on certain of our services, which in turn could harm our ability to attract new clients and increase revenues.

Privacy and other consumer protection regulation.    The Children's Online Privacy Protection Act, or COPPA, applies to operators of commercial websites and online services directed to U.S. children under the age of 13 that collect personal information from children and operators of general audience

22


Table of Contents


sites with actual knowledge that they are collecting information from U.S. children under the age of 13. Our sites are not directed at children and we employ a kick-out procedure whereby anyone identifying themselves as being under the age of 13 during the registration process is not allowed to register to obtain our clinical information or participate in our services. COPPA, however, is a relatively new law, can be applied broadly and is subject to interpretation by courts and other governmental authorities. The failure to accurately anticipate the application or interpretation of this law could create liability for us, result in adverse publicity and negatively affect our business.

The FTC and many state attorneys general are applying federal and state consumer protection laws to require that the online collection, use and dissemination of data, and the presentation of website or other electronic content, comply with certain standards for notice, choice, security and access. Courts may also adopt these developing standards. A number of states, including California, have enacted laws or are considering the enactment of laws governing the release of credit card or other personal information received from consumers. In many cases, the specific limitations imposed by these standards are subject to interpretation by courts and other governmental authorities. A determination by a state or federal agency or court that any of our practices do not meet these standards could result in liability and adversely affect our business. New interpretations of these standards could also require us to incur additional costs and restrict our business operations.

In addition, several foreign governments have regulations dealing with the collection and use of personal information obtained from their citizens. Those governments may attempt to apply such laws extraterritorially or through treaties or other arrangements with U.S. governmental entities. We might unintentionally violate such laws, such laws may be modified and new laws may be enacted in the future which may increase the chance that we violate them unintentionally. Any such developments, or developments stemming from enactment or modification of other laws, or the failure to accurately anticipate the application or interpretation of these laws could create liability to us, result in adverse publicity and negatively affect our business.

In connection with our planned entry into the EHR market, we have begun to handle personal health information and therefore have become subject to HIPAA's numerous requirements regarding the handling and use of the information subject to its requirements. The failure to accurately anticipate the application or interpretation of this law as we develop our EHR product or a failure by us to comply with its requirements could create liability for us, result in adverse publicity and negatively affect our business.

We rely on Internet service providers, co-location data center providers, other third parties and our own systems for key aspects of the process of providing and updating content to our users and performing services for our clients, and any failure or interruption in the services provided by these third parties or our own systems could harm our business.

Our users expect to be able to update our applications and access our services 24 hours a day, seven days a week, without interruption. However, we have experienced and expect that we will in the future experience interruptions and delays in services and availability from time to time. We rely on internal systems, as well as third-party vendors, including a co-location service provider and Internet service providers, to provide our online services.

We have computing and communications hardware operations located at our facilities in San Mateo, California, and in a co-location service administered by AT&T, Inc. in Redwood City, California. In the event of a catastrophic event at one of these sites, we may experience an extended period of system unavailability which could negatively impact our relationship with users and adversely affect our brand and our business. In particular, both of our co-location facilities are located in the same seismically active location in the San Francisco Bay Area.

23


Table of Contents

Any disruption in the network access or co-location services provided by these third-party providers or any failure of or by these third-party providers or our own systems to handle current or higher volume of use could significantly harm our business. We exercise little control over these third-party vendors, which increases our vulnerability to problems with services they provide.

Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and interactive services or our own systems could negatively impact our relationships with users and clients, adversely affect our brand and our business and potentially expose us to liability to third parties. Although we maintain insurance for our business, the coverage under our policies generally only covers losses due to our negligence, and therefore may not be adequate to compensate us for all losses that may occur. In addition, we cannot provide assurance that we will continue to be able to obtain adequate insurance coverage at an acceptable cost.

If the systems we use to provide our services experience security breaches or are otherwise perceived to be insecure, our business could suffer.

We retain and transmit confidential information in the processing centers and other facilities we use to provide online services. It is critical that such facilities and infrastructure remain secure and be perceived by the marketplace as secure. A security breach could damage our reputation or result in liability. We may be required to expend significant capital and other resources to protect against security breaches and hackers or to alleviate problems caused by breaches. Despite the implementation of security measures, this infrastructure or other systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, computer viruses, programming errors, attacks by third parties or similar disruptive problems. As we enter the EHR market and begin to handle personal health information, we become subject to HIPAA, which increases our liability in the event of security breaches. Any compromise of our security, whether as a result of our own systems or the systems that they interface with, could reduce demand for our services and could subject us to legal claims from our clients and users, including claims for breach of contract or breach of warranty, or regulatory enforcement actions against us by the government.

We may not be successful in protecting our intellectual property and proprietary rights.

Our success depends to a significant degree on our proprietary technology and ability to establish, maintain and enforce our intellectual property rights. We rely on a combination of copyright, trademark, trade secret, patent and other intellectual property laws and confidentiality procedures to protect our proprietary rights. Despite these measures, any of our intellectual property rights could, however, be challenged, invalidated, circumvented or misappropriated, or such intellectual property rights may not be sufficient to permit us to take advantage of current market trends or otherwise to provide competitive advantages, which could result in redesign efforts, discontinuance of certain product offerings or other competitive harm. Further, the laws of certain countries do not protect proprietary rights to the same extent as the laws of the United States. Therefore, in certain jurisdictions, we may be unable to protect our proprietary technology adequately against unauthorized third party copying or use, which could adversely affect our competitive position.

Our pending patent and trademark registration applications may not be allowed, and our competitors or other third parties may challenge the validity or scope of our patents or trademark registrations. If the patents or trademark registrations we seek do not issue, or if other problems arise with our intellectual property, our competitiveness could be significantly impaired and our business, operations and prospects may suffer. There can also be no assurance that any of our issued patents or registered trademarks, or any patents and trademarks that may issue in the future, will adequately protect our

24


Table of Contents


intellectual property, or that such patents and trademarks will not be challenged by our competitors or other third parties or found by a judicial authority to be invalid or unenforceable.

We enter into confidentiality and invention assignment agreements with our employees and consultants and with the parties with whom we have strategic relationships and business alliances, and our agreements with subscribers limit their use of the software and content provided to them. These agreements may be breached and we may not have adequate remedies for any such breach. Further, no assurance can be given that these agreements will be effective in preventing the unauthorized access to, or use of, our clinical and other proprietary information or the reverse engineering of our technology. In any event, these agreements do not prevent our competitors from independently developing technology or authoring clinical information that is substantially equivalent or superior to our technology or the information we distribute.

Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation could result in substantial costs and diversion of management resources and can put our patents at risk of being invalidated or interpreted narrowly. The occurrence of any of these events may seriously harm our business.

We may be subject to claims by third parties that we are infringing their intellectual property, we may be prevented from selling certain services and we may incur significant expenses in resolving these claims.

Much of our business relies on technology and content developed or licensed by third parties. We also expect to seek to license technology and content from third parties for future products and services. We may not be able to obtain or continue to obtain licenses, content and technologies from these third parties on commercially reasonable terms or at all. Our inability to retain our current third party licenses or obtain third party licenses required to develop new products or product enhancements could require that we change our product and design plans, any of which could harm or delay our ability to sell our products and adversely affect our business.

We may receive claims of intellectual property infringement from third parties or otherwise become aware of relevant patents or other intellectual property rights of third parties that may lead to disputes and litigation. Any claims made against us regarding patents or other intellectual property rights could be expensive and time consuming to resolve or defend and could have a negative effect on our business. We expect that software application developers will increasingly be subject to infringement claims as the number of products and competitors grows and the functionality of products in different industry segments overlaps. Our competitors or other third parties may challenge the validity or scope of our intellectual property rights. Third parties may also claim that the technology that we acquire or license from other third parties infringes their intellectual property rights and we may not be indemnified for such claims.

We may also be required to indemnify our clients and third-party service providers for third-party products and content that are incorporated into our clinical information if they are found to infringe the intellectual property rights of others. Although many of our third-party service providers are obligated to indemnify us if their products infringe the rights of others, such indemnification may not be effective or adequate to protect us or the indemnifying party may be unable to uphold its contractual obligations.

Litigation could be costly for us to defend, distract management's attention and resources, have a negative effect on our operating results and financial condition or require us to devote additional research and development resources to change our products or to obtain licenses to any intellectual property we may be found to infringe. Claims of intellectual property infringement might require us to redesign affected products, delay affected product offerings, enter into costly settlement or license

25


Table of Contents


agreements or pay costly damage awards or face a temporary or permanent injunction prohibiting us from marketing, selling or distributing the affected products. If we cannot or do not license the infringed technology on reasonable terms or at all, or substitute similar technology from another source, our revenue and earnings could be adversely impacted. There can be no assurance that any such litigation can be avoided or successfully concluded.

Our use of "open source" software could adversely affect our ability to sell our products and subject us to possible litigation.

A significant portion of the products or technologies licensed, developed and/or distributed by us incorporate so-called "open source" software and we may incorporate open source software into other products in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses. Some open source licenses contain requirements that we disclose source code for modifications we make to the open source software and that we license such modifications to third parties at no cost. In some circumstances, distribution of our software in connection with open source software could require that we disclose and license some or all of our proprietary code in that software as well as distribute our products that use particular open source software at no cost to the user. We monitor our use of open source software in an effort to avoid uses in a manner that would require us to disclose or grant licenses under our proprietary source code, however, there can be no assurance that such efforts will be successful. Open source license terms are often ambiguous and such use could inadvertently occur. There is little legal precedent governing the interpretation of many of the terms of certain of these licenses, and the potential impact of these terms on our business may result in unanticipated obligations regarding our products and technologies. Companies that incorporate open source software into their products have, in the past, faced claims seeking enforcement of open source license provisions and claims asserting ownership of open source software incorporated into their product. If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of an open source license, we could incur significant legal costs defending ourselves against such allegations. In the event such claims were successful, we could be subject to significant damages or be enjoined from the distribution of our products. In addition, if we combine our proprietary software with open source software in certain ways, under some open source licenses we could be required to release the source code of our proprietary software, which could substantially help our competitors develop products that are similar to or better than ours and otherwise adversely affect our business.

We face potential liability related to the privacy and security of personal information we collect from healthcare professionals through our products and interactive services.

Online user privacy is a major concern in both the United States and abroad. The European Union, or EU, adopted the Data Protection Directive, or DPD, imposing strict regulations and establishing a series of requirements regarding the collection and use of personally identifiable information online. DPD provides for specific regulations requiring all non-EU countries doing business with EU member states to provide adequate data privacy protection when receiving personal data from any of the EU member states. Similarly, Canada's Personal Information and Protection of Electronic Documents Act provides Canadian residents with privacy protections in regard to transactions with businesses and organizations in the private sector and sets out ground rules for how private sector organizations may collect, use or disclose personal information in the course of commercial activities. We have privacy policies posted with our services that we believe comply with applicable laws requiring notice to users about our information collection, use and disclosure practices. However, whether and how existing local and international privacy and consumer protection laws in various jurisdictions apply to the Internet and other online technologies is still uncertain and may take years to resolve. United States and international privacy laws and regulations, if drafted or interpreted broadly, could be deemed to apply to the technology we use, and could restrict our information collection methods or decrease the

26


Table of Contents


amount and utility of the information that we would be permitted to collect. Any legislation or regulation in the area of privacy of personal information could affect the way we operate our online services and could harm our business. The costs of compliance with, and the other burdens imposed by, these and other laws or regulatory actions may prevent us from selling our products or increase the costs associated with selling our products, and may affect our ability to invest in or jointly develop products in the United States and in foreign jurisdictions. Further, we cannot assure you that the privacy policies and other statements on our applications or our practices will be found sufficient to protect us from liability or adverse publicity relating to the privacy and security of personal information. In the conduct of our market research activities outside the United States, we rely upon a third party to identify and recruit respondents for the market research and to comply with the applicable privacy laws in each jurisdiction in which it operates. If this third party failed to comply with such laws, it could affect its ability to continue to support our business or negatively affect our reputation.

The Privacy Standards under HIPAA establish a set of basic national privacy standards for the protection of individually identifiable health information by health plans, healthcare clearinghouses, healthcare providers and their business associates. With our planned entry into the EHR market, we will become subject to HIPAA and other similar state and federal laws governing the collection, dissemination, use, access to and confidentiality of patient-identifiable information.

Some users of our products and services are located outside of the United States, we recruit for market research internationally and we may in the future establish international operations and, as a result, face diverse risks related to engaging in international business.

Although the substantial majority of our users are located in the United States, we currently have users in numerous other countries. We are, or may become, subject to the risks of conducting business internationally, including:

unexpected changes in regulatory requirements, taxes, trade laws, tariffs, export quotas, custom duties or other trade restrictions;

exposure to a broader, more diverse set of regulations;

more stringent regulations relating to data privacy and the unauthorized use of, or access to, commercial and personal information, particularly in Europe and Canada;

changes in a specific country's or region's political or economic conditions;

unfavorable currency exchange rates;

exposure to competitors who are more familiar with local markets;

limited or unfavorable intellectual property protection; and

restrictions on repatriation of earnings.

In addition, in the future, we may expand geographically through product development and strategic alliances. However, our products and services may not be accepted in international markets and any potential international operations involve a variety of risks. We have limited experience in marketing, selling and supporting our services abroad. In addition, while Symbian is the most widely used mobile operating system in Europe, our clinical information and interactive services are not compatible with Symbian-based devices. If we invest substantial time and resources to expand our international

27


Table of Contents


operations and are unable to do so successfully and in a timely manner, our business and operating results will suffer.

We will incur significantly increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, and rules of the Securities and Exchange Commission, or SEC, and The NASDAQ Global Market, have imposed various requirements on public companies including requiring establishment and maintenance of effective disclosure and financial controls. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain the same or similar coverage.

The Sarbanes-Oxley Act of 2002 requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, beginning with our annual report on Form 10-K for the fiscal year ending December 31, 2011. Our compliance with Section 404 of the Sarbanes-Oxley Act will require that we incur substantial accounting expense and expend significant management efforts. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identify additional deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would require additional financial and management resources.

Our ability to successfully implement our business plan and comply with Section 404 requires us to be able to prepare timely and accurate financial statements. We expect that we will need to continue to improve existing, and implement new operational and financial systems, procedures and controls to manage our business effectively. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, may cause our operations to suffer and we may be unable to conclude that our internal control over financial reporting is effective and to obtain an unqualified report on internal control from our auditors as required under Section 404 of the Sarbanes-Oxley Act. Moreover, we cannot be certain that these measures would ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Even if we were to conclude, and our auditors were to concur, that our internal control over financial reporting provided reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, because of its inherent limitations, internal control over financial reporting may not prevent or detect fraud or misstatements. This, in turn, could have an adverse impact on the trading price for our common stock, and could adversely affect our ability to access the capital markets.

28


Table of Contents


If we acquire or invest in other companies, assets or technologies and we are not able to effectively integrate them with our business, or we do not realize the anticipated financial and strategic goals for any of these transactions, our financial performance may be impaired.

If appropriate opportunities present themselves, we may consider acquiring or making investments in companies, assets or technologies that we believe to be strategic, such as our recent acquisition of Modality, Inc. We do not have significant experience in acquisitions and investments in other companies, and our acquisition of Modality exposes us, and if we acquire or invest in additional companies, assets or technologies, we will be further exposed, to a number of risks, including:

we may find that the acquired company, asset or technology does not further our business strategy, that we overpaid for the company, asset or technology or that the economic conditions underlying our acquisition decision have changed;

we may have difficulty integrating the assets, technologies, operations or personnel of an acquired company, or retaining the key personnel of the acquired company;

our ongoing business and management's attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically or culturally diverse enterprises;

we may encounter difficulty entering and competing in new product or geographic markets, and we may face increased competition, including price competition or intellectual property litigation; and

we may experience significant problems or liabilities associated with product quality, technology and legal contingencies relating to the acquired business or technology, such as intellectual property or employment matters.

In addition, from time to time we may enter into negotiations for acquisitions or investments that are not ultimately consummated. These negotiations could result in significant diversion of management time, as well as substantial out-of-pocket costs. If we were to proceed with one or more significant acquisitions or investments in which the consideration included cash, we could be required to use a substantial portion of our available cash, including the proceeds of this offering. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options and warrants, existing stockholders might be diluted and earnings per share amounts might decrease. In addition, acquisitions and investments may result in the incurrence of debt, large one-time write-offs, such as of acquired in-process research and development costs, and restructuring charges.

We intend to expand our operations and increase our expenditures in an effort to grow our business. If we are not able to manage this growth and expansion, or if our business does not grow as we expect, our operating results may suffer.

We significantly expanded our operations in 2009 and 2010. For example, during the period from December 31, 2008 to September 30, 2010, we increased the number of our employees and full-time contractors by approximately 29%, from 255 to 328. We anticipate that further expansion of our infrastructure and headcount will be required to achieve planned expansion of our product offerings, particularly the development of our EHR solution, projected increases in our user network and anticipated growth in the number of product deployments. Our rapid growth has placed, and will continue to place, a significant strain on our administrative and operational infrastructure. Our ability to manage our operations and growth will require us to continue to refine our operational, financial and management controls, human resource policies and reporting systems and procedures. Further, we

29


Table of Contents


intend to grow our business by developing new product and service offerings and pursuing new clients. If we fail to timely or efficiently expand operational and financial systems in connection with such growth or if we fail to implement or maintain effective internal controls and procedures, resulting operating inefficiencies could increase costs and expenses more than we planned and might cause us to lose the ability to take advantage of market opportunities, enhance existing products, develop new products, satisfy client requirements, respond to competitive pressures or otherwise execute our business plan. Additionally, if we increase our operating expenses in anticipation of the growth of our business and such growth does not meet our expectations, our financial results likely would be negatively impacted.

Business interruptions due to natural disasters and other events could adversely affect our business.

Our operations can be subject to natural disasters and other events beyond our control, such as earthquakes, fires, power failures, telecommunication losses, terrorist attacks and acts of war. For example, the majority of our operations are based in Northern California near major earthquake faults that are considered seismically active. Such events, whether natural or manmade, could cause severe destruction or interruption to our operations, and as a result, our business could suffer serious harm.

Although we carry business interruption insurance, it only covers some, but not all, of these potential events, and even for those events that are covered, may not be sufficient to compensate us fully for losses or damages that may occur as a result of such events, including, for example, loss of market share and diminution of our brand, reputation and client loyalty.

Risks related to ownership of our common stock and this offering

As our common stock has not been publicly traded, we expect that the price of our common stock may fluctuate substantially.

Before this offering, there has been no public market for our common stock. An active public trading market may not develop after completion of this offering or, if developed, may not be sustained. The price of our common stock sold in this offering will not necessarily reflect the market price of our common stock after this offering. The market price for our common stock after this offering will be affected by a number of factors, including:

quarterly variations in our operating results, or the operating results of our competitors;

the timing of revenue recognition;

the volume and timing of orders from our clients and users;

the announcement of new products or service enhancements by us or our competitors;

announcements related to litigation;

changes in earnings estimates, investors' perceptions, recommendations by securities analysts or our failure to achieve analysts' earning estimates;

the depth and liquidity of the market for our common stock;

changing legal or regulatory requirements;

developments in our industry or the medical or pharmaceutical industries generally; and

30


Table of Contents

general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors.

In addition, the stock market has experienced substantial price and volume volatility that is often seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its common stock. We may become involved in this type of litigation in the future. Any securities litigation claims brought against us could result in substantial expense and the diversion of our management's attention from our business.

Securities analysts may not initiate coverage of our common stock or may issue negative reports, and this may have a negative impact on the market price of our common stock.

Securities analysts may elect not to provide research coverage of our common stock after the completion of this offering. If securities analysts do not cover our common stock after the completion of this offering, the lack of research coverage may adversely affect the market price of our common stock. In addition, the trading market for our common stock may be affected in part by the research and reports that industry or financial analysts do publish about us or our business. If one or more of the analysts who elect to cover us downgrades our stock, our stock price may decline. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.

New investors in our common stock will experience immediate and substantial dilution after this offering.

The assumed initial public offering price is substantially higher than the net tangible book value per share of our outstanding common stock will be immediately after this offering. If you purchase common stock in this offering, you will incur immediate dilution of $12.36 per share based on the assumed initial public offering price of $14.00 per share, the mid-point of the price range set forth on the cover page of this prospectus. This dilution is due in large part to earlier investors in our company having paid substantially less than the assumed initial public offering price when they purchased their shares. Investors who purchase shares of common stock in this offering will contribute approximately 56.1% of the total amount we have raised to fund our operations, but will own only approximately 16.0% of our common stock, based upon the number of shares outstanding as of September 30, 2010. The exercise of outstanding options and a warrant and other future equity issuances, including future public offerings or private placements of equity securities and any additional shares issued in connection with acquisitions, may result in further economic dilution to investors. For a further description of dilution that you will experience immediately after this offering, see the section of this prospectus entitled "Dilution."

Sales of a substantial number of shares of our common stock may cause the price of our common stock to decline.

If our stockholders sell substantial amounts of our common stock in the public market after this offering or the public market perceives that existing stockholders might sell shares of common stock, the market price of our common stock could decline. After this offering, we will have 22,465,579 shares of common stock outstanding based on the number of shares outstanding as of December 31, 2010. All of the 5,360,000 shares offered under this prospectus will be freely tradable without restriction or further registration under the federal securities laws, unless purchased by our "affiliates" as that term is defined in Rule 144 under the Securities Act of 1933. Of the remaining shares outstanding upon the

31


Table of Contents


closing of this offering, 16,790,680 shares may be sold pursuant to Rule 144 and 701 upon the expiration of lock-up agreements that expire 180 days after the date of this prospectus unless otherwise extended or waived as described in "Shares eligible for future sale."

Following this offering, existing stockholders holding an aggregate of 12,337,300 shares of common stock on an as-converted basis, including 16,540 shares of common stock issuable upon the exercise of an outstanding warrant, will have rights, subject to some conditions, that permit them to require us to file a registration statement with the SEC or include their shares in registration statements that we may file for ourselves or other stockholders. If we register the sale of their shares of common stock following the expiration of the lock-up agreements, they can sell those shares in the public market. Promptly following this offering, we intend to register 7,570,462 shares of common stock for issuance under our stock plans. As of December 31, 2010, 6,268,212 shares were subject to outstanding options, with a weighted average exercise price of $9.45 per share, of which 3,347,946 shares were vested. In addition, 171,219 shares were subject to restricted stock units, of which 19,650 shares were vested. Once we register these shares, they can be freely sold in the public market upon issuance and vesting, subject to the lock-up agreements referred to above and the restrictions imposed on our affiliates under Rule 144.

Our directors, officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.

After this offering, our officers, directors and principal stockholders each holding more than 5% of our common stock collectively will control approximately 50.0% of our outstanding common stock, without giving effect to the purchase of shares by any such persons in this offering. As a result, these stockholders, if they act together, will be able to control our management and affairs and most matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change of control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of our other stockholders.

We have broad discretion in the use of proceeds of this offering for working capital and general corporate purposes.

The net proceeds of this offering will be used to pay aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010 (and accruing at a rate of approximately $237,000 per month)), with the balance to be used for general corporate purposes. Other than the repayment of cumulative dividends, we have not determined the specific allocation of the net proceeds of this offering. Our management will have broad discretion over the use and investment of the net proceeds of this offering, and accordingly investors in this offering will need to rely upon the judgment of our management with respect to the use of proceeds, with only limited information concerning management's specific intentions. Our management may spend a portion or all of the net proceeds from this offering in ways that our stockholders may not desire or that may not yield a favorable return. The failure of our management to apply the net proceeds of this offering effectively could harm our business, financial condition and results of operations. Please see the section of this prospectus entitle "Use of proceeds" for a further description of how we intend to use the net proceeds of this offering.

Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated bylaws, and Delaware law, contain provisions that could discourage a takeover.

In addition to the effect that the concentration of ownership by our officers, directors and significant stockholders may have, our amended and restated certificate of incorporation and our amended and

32


Table of Contents


restated bylaws to be effective upon completion of this offering contain provisions that may enable our management to resist a change of control. These provisions may discourage, delay or prevent a change in our ownership or a change in our management. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. Such provisions, to be set forth in our amended and restated certificate of incorporation or amended and restated bylaws effective upon the completion of this offering, include:

our board of directors will be authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as "blank check" preferred stock, with rights senior to those of common stock;

advance notice will be required of stockholders to nominate candidates to serve on our board of directors or to propose matters that can be acted upon at stockholder meetings;

stockholder action by written consent will be prohibited;

special meetings of the stockholders will be permitted to be called only by a majority of our board of directors, the chairman of our board of directors or our chief executive officer;

stockholders will not be permitted to cumulate their votes for the election of directors;

newly created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors will be filled only by majority vote of the remaining directors, even though less than a quorum is then in office;

our board of directors will be expressly authorized to modify, alter or repeal our amended and restated bylaws; and

stockholders will be permitted to amend our amended and restated bylaws only upon receiving at least two-thirds of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, our amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including delaying or impeding a merger, tender offer or proxy contest involving us. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

33


Table of Contents


Special note regarding forward-looking statements

This prospectus contains forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the sections of this prospectus entitled "Summary," "Risk factors," "Management's discussion and analysis of financial condition and results of operations," "Business" and "Compensation discussion and analysis." Forward-looking statements include, but are not limited to, statements about:

expectations of future operating results or financial performance;
business strategies;
competitive position;
industry environment and market opportunities;
introduction of new products and services;
plans for growth and future operations; and
the strength and size of our user network.

In some cases, you can identify forward-looking statements by terms such as "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "project," "should," "will," "would" and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this prospectus in greater detail in the section of this prospectus entitled "Risk factors." Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify all of our forward-looking statements by these cautionary statements.

Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

34


Table of Contents


Use of proceeds

We estimate that we will receive approximately $44.2 million in net proceeds from the sale of the shares of common stock offered by us in this offering, or approximately $54.6 million if the underwriters' over-allotment option is exercised in full, based upon an assumed initial public offering price of $14.00 per share, the mid-point of the estimated price range set forth on the cover page of this prospectus, after deducting underwriting discounts and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of shares by the selling stockholders. A $1.00 increase (decrease) in the assumed initial public offering price of $14.00 per share would increase (decrease) net proceeds by $3.3 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discounts and estimated offering expenses payable by us.

We expect to use our net proceeds from this offering as follows:

to pay aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010 (and accruing at a rate of approximately $237,000 per month)); and

the balance for general corporate purposes, including working capital, research and development, sales and marketing and capital expenditures.

We will retain broad discretion in the allocation of a substantial portion of the net proceeds of this offering. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses, technologies, services or products. We have no current plans, agreements or commitments with respect to any such acquisition or investment, and we are not currently engaged in any negotiations with respect to any such transaction.


Dividend policy

Other than aggregate cumulative dividends that we are obligated to pay to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010 (and accruing at a rate of approximately $237,000 per month)) with a portion of the net proceeds from this offering, we have not declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings to finance the growth and development of our business, and therefore do not anticipate paying any other cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend upon our financial condition, operating results, capital requirements, any contractual restrictions and restrictions that may be imposed by applicable law and such other factors that our board of directors deems appropriate.

35


Table of Contents


Capitalization

The following table sets forth our capitalization as of September 30, 2010:

on an actual basis;

on a pro forma as adjusted basis to give effect to:

the conversion of all outstanding shares of our preferred stock into an aggregate of 11,089,201 shares of common stock upon the closing of this offering;

the payment of aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010); and

the sale by us of 3,574,285 shares of our common stock at an assumed initial public offering price of $14.00 per share, the mid-point of the estimated price range set forth on the cover page of this prospectus, after deducting underwriting discounts and estimated offering expenses payable by us.

You should read this table together with the section of this prospectus entitled "Management's discussion and analysis of financial condition and results of operations" and our financial statements and related notes appearing elsewhere in this prospectus.

 
  As of September 30, 2010  
 
  Actual   Pro Forma As
Adjusted(1)
 
 
  (in thousands, except share and per share data)
 

Financing liability

  $   $  

Mandatorily redeemable convertible preferred stock, including aggregate cumulative dividends of $28.6 million; $0.001 par value per share; 15,303,866 shares authorized, 13,142,352 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma as adjusted

    72,632      
           

Preferred stock, $0.001 par value per share; no shares authorized, issued or outstanding, actual; 10,000,000 shares authorized, no shares issued and outstanding, pro forma as adjusted

         

Common stock, $0.001 par value per share; 30,129,404 shares authorized, 7,618,898 shares issued and outstanding, actual; 100,000,000 shares authorized, 22,282,384 shares issued and outstanding, pro forma as adjusted

    8     22  

Additional paid-in capital

    9,742     98,012  

Accumulated other comprehensive income

    3     3  

Accumulated deficit

    (44,715 )   (44,715 )
           

Total stockholders' equity (deficit)

    (34,962 )   53,322  
   

Total capitalization

 
$

37,670
 
$

53,322
 
           

(1)
A $1.00 increase (decrease) in the assumed initial public offering price of $14.00 per share would increase (decrease) each of additional paid-in capital, total stockholders' equity (deficit) and total capitalization by $3.3 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and estimated offering expenses payable by us.

36


Table of Contents

The foregoing information regarding the number of shares of our common stock to be outstanding immediately after this offering is based on 18,708,099 shares outstanding as of September 30, 2010, on an as-converted basis, and excludes:

5,598,246 shares of common stock issuable upon the exercise of outstanding options under our 2008 Equity Incentive Plan as of September 30, 2010, with a weighted average exercise price of $8.45 per share;

58,950 shares of common stock issuable upon the vesting of restricted stock units under our 2008 Equity Incentive Plan as of September 30, 2010;

1,309,992 additional shares of common stock reserved and available for future issuance under our 2008 Equity Incentive Plan as of September 30, 2010; and

16,540 additional shares of common stock, on an as-converted basis, issuable upon the exercise of an outstanding warrant to purchase Series B preferred stock, with an exercise price of $5.71 per share.

37


Table of Contents


Dilution

If you invest in our common stock in this offering, your ownership will be diluted to the extent of the difference between the initial public offering price per share of our common stock in this offering and the net tangible book value per share of our common stock immediately after this offering.

Pro forma net tangible book value per share represents total tangible assets less total liabilities, divided by the number of shares of common stock outstanding, assuming the conversion of all outstanding shares of preferred stock into common stock. Pro forma net tangible book value as of September 30, 2010 was approximately $21.0 million, or approximately $1.12 per share of common stock. After giving effect to the sale by us of 3,574,285 shares of common stock in this offering at an assumed initial public offering price of $14.00 per share, after deducting underwriting discounts and estimated offering expenses payable by us, and the payment of aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010) with a portion of the net proceeds of this offering, our pro forma as adjusted net tangible book value as of September 30, 2010 would have been approximately $36.6 million, or approximately $1.64 per share of common stock. This represents an immediate increase in net tangible book value of $0.52 per share to existing stockholders and an immediate dilution of $12.36 per share to new investors.

The following table illustrates this dilution on a per share basis:

Assumed initial public offering price per share

        $ 14.00  
 

Pro forma net tangible book value per share as of September 30, 2010

  $ 1.12        
 

Increase in pro forma net tangible book value per share attributable to this offering

  $ 0.52        
             

Pro forma as adjusted net tangible book value per share after this offering

        $ 1.64  
             

Dilution per share to new investors

        $ 12.36  
             

A $1.00 increase (decrease) in the assumed initial public offering price of $14.00 per share would increase (decrease) our pro forma as adjusted net tangible book value by $3.3 million, or $0.15 per share, and the dilution in as adjusted pro forma net tangible book value per share to new investors by $0.85 per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and estimated offering expenses payable by us.

If the underwriters exercise their over-allotment option to purchase 804,000 additional shares from us, our pro forma as adjusted net tangible book value per share as of September 30, 2010 would have been $2.04 per share, representing an immediate increase in net tangible book value to our existing stockholders of $0.92 per share and an immediate dilution of $11.96 per share to new investors in this offering.

The following table summarizes as of September 30, 2010, on the pro forma as adjusted basis described above, the number of shares of our common stock purchased from us, the total consideration paid to us and the average price per share paid to us by existing stockholders and to be paid by new investors purchasing shares of our common stock in this offering. The table assumes an initial public offering

38


Table of Contents


price of $14.00 per share, before deducting underwriting discounts and estimated offering expenses payable by us.

 
  Shares purchased   Total consideration    
 
 
  Average
price per
share
 
 
  Number   Percent   Amount   Percent  

Existing stockholders

    18,708,099     84.0 % $ 39,123,539     43.9 % $ 2.09  

New investors in this offering

    3,574,285     16.0     50,039,990     56.1 % $ 14.00  
                         
 

Total

    22,282,384     100 % $ 89,163,529     100 %      
                         

The sale by the selling stockholders of 1,785,715 shares in this offering will cause the number of shares held by existing stockholders to be reduced to 16,922,384 shares, or 75.9% of the total number of shares of our common stock outstanding after this offering.

A $1.00 increase (decrease) in the assumed initial public offering price of $14.00 per share would increase (decrease) total consideration paid by new investors by $3.6 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

If the underwriters' over-allotment option to purchase 804,000 additional shares from us in this offering is exercised in full, the following will occur:

the percentage of shares of common stock held by existing stockholders after the completion of this offering, and after giving effect to the sale by the selling stockholders of 1,785,715 shares in this offering, will be approximately 73.3% of the total number of shares of our common stock outstanding after this offering; and

the number of shares held by new investors after the completion of this offering will be 6,164,000, or approximately 26.7% of the total number of shares of our common stock outstanding after this offering.

The foregoing information as to the number of shares of our common stock to be outstanding immediately after this offering is based on 18,708,099 shares outstanding as of September 30, 2010, on an as-converted basis, and excludes:

5,598,246 shares of common stock issuable upon the exercise of outstanding options under our 2008 Equity Incentive Plan as of September 30, 2010, with a weighted average exercise price of $8.45 per share;

58,950 shares of common stock issuable upon the vesting of restricted stock units under our 2008 Equity Incentive Plan as of September 30, 2010;

1,309,992 shares of common stock reserved and available for future issuance under our 2008 Equity Incentive Plan as of September 30, 2010; and

16,540 shares of common stock, on an as-converted basis, issuable upon the exercise of an outstanding warrant to purchase Series B preferred stock, with an exercise price of $5.71 per share.

Assuming the exercise in full of all of our outstanding options and the issuance of 16,540 shares of common stock, on an as-converted basis, upon exercise of an outstanding warrant to purchase Series B preferred stock as of September 30, 2010, pro forma net tangible book value before this offering at September 30, 2010 would be $0.86 per share, representing an immediate dilution of $0.26 per share to

39


Table of Contents


our existing stockholders and, after giving effect to the sale of 3,574,285 shares of common stock by us in this offering at an assumed initial public offering price of $14.00 per share, after deducting underwriting discounts and estimated offering expenses payable by us, and the payment of aggregate cumulative dividends due to the holders of our Series B preferred stock (approximately $28.6 million accrued through September 30, 2010) with a portion of the net proceeds of this offering, there would be an immediate dilution of $12.69 per share to purchasers of our common stock in this offering.

40


Table of Contents


Selected financial data

The selected statements of operations data for the years ended December 31, 2007, 2008 and 2009 and the balance sheet data as of December 31, 2008 and 2009 are derived from our audited financial statements included elsewhere in this prospectus. The statement of operations data for the nine months ended September 30, 2009 and 2010 and the balance sheet data as of September 30, 2010 are derived from our unaudited financial statements included elsewhere in this prospectus. The statement of operations data for the years ended December 31, 2005 and 2006 and the balance sheet data as of December 31, 2005, 2006 and 2007 are derived from our audited financial statements that are not included in this prospectus. The unaudited financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of our management, reflect all adjustments necessary for the fair presentation of the financial information set forth in those statements. Our historical results are not necessarily indicative of our operating results or financial condition to be expected in the future. The following selected financial data should be read in conjunction with the financial statements and related notes included elsewhere in this prospectus and the section of this prospectus entitled "Management's discussion and analysis of financial condition and results of operations."

Pro forma net income per share has been calculated assuming the conversion of all outstanding shares of our preferred stock into 11,089,201 shares of our common stock at the beginning of 2009. Pro forma net income per share also assumes the outstanding preferred stock warrant converts into a warrant to purchase common stock at the beginning of 2009. Pro forma net income per share further gives effect, in the weighted shares used in the calculation, to the additional 2.3 million shares, which (when multiplied by the assumed initial public offering price of $14.00 per share (the midpoint of the range set forth on the cover page of this prospectus), and after giving effect to a pro rata allocation of offering costs) would have been required to be issued to generate net proceeds sufficient to pay the accrued Series Preferred B dividend of $28.6 million (as of September 30, 2010). Pro forma diluted net income per share attributable to common stockholders further includes the incremental shares of common stock issuable upon the exercise of stock options and warrants outstanding as of the dates thereof.

41


Table of Contents

Statements of operations data

 
  Years Ended December 31,   Nine Months Ended September 30,  
 
  2005   2006   2007   2008   2009   2009   2010  
 
  (in thousands, except per share data)
 

Total revenues, net

  $ 32,536   $ 49,517   $ 65,611   $ 83,345   $ 93,654   $ 66,248   $ 73,703  

Total cost of revenues(1)

    12,369     17,371     22,805     24,786     29,452     21,945     23,330  
                               

Gross profit

    20,167     32,146     42,806     58,559     64,202     44,303     50,373  

Operating expenses:(1)

                                           
 

Sales and marketing

    11,725     14,975     16,887     18,167     22,704     16,306     22,011  
 

Research and development

    6,483     8,748     10,519     12,430     14,663     10,555     14,512  
 

General and administrative

    5,119     10,725     11,983     14,888     11,587     8,630     11,249  
 

Change in fair value of contingent consideration

                            885  
                               

Total operating expenses

    23,327     34,448     39,389     45,485     48,954     35,491     48,657  
                               

Income (loss) from operations

    (3,160 )   (2,302 )   3,417     13,074     15,248     8,812     1,716  

Interest income

    440     1,078     1,714     1,180     127     109     73  

Interest expense

            (285 )   (855 )   (855 )   (641 )   (214 )

Other income (expense), net

    (130 )   (189 )   (233 )   545     (73 )   (74 )   2  

Gain on sale-leaseback of building

                            1,689  
                               

Income (loss) before income taxes and cumulative effect of change in accounting principle

    (2,850 )   (1,413 )   4,613     13,944     14,447     8,206     3,266  

Benefit (provision) for income taxes

    (57 )   (28 )   21,126     (6,510 )   (6,788 )   (4,050 )   (2,142 )
                               

Income (loss) before cumulative effect of change in accounting principle

    (2,907 )   (1,441 )   25,739     7,434     7,659     4,156     1,124  

Cumulative effect of change in accounting principle, net of taxes(2)

    (3 )                        
                               

Net income (loss)

    (2,910 )   (1,441 )   25,739     7,434     7,659     4,156     1,124  

Less: accretion of Series B mandatorily redeemable preferred stock dividends

    3,738     3,754     3,747     3,523     3,523     2,643     2,643  

Less: allocation of net income to participating preferred stockholders

            14,965     2,290     2,433     887      
                               

Net income (loss) available to common stockholders—basic

  $ (6,648 ) $ (5,195 ) $ 7,027   $ 1,621   $ 1,703   $ 626   $ (1,519 )

Undistributed earnings re-allocated to common stockholders

            1,447     219     205     76      
                               

Net income (loss) available to common stockholders—diluted

  $ (6,648 ) $ (5,195 ) $ 8,474   $ 1,840   $ 1,908   $ 702   $ (1,519 )
                               

42


Table of Contents

 
  Years Ended December 31,   Nine Months Ended September 30,  
 
  2005   2006   2007   2008   2009   2009   2010  
 
  (in thousands, except per share data)
 

Net income (loss) per common share—basic

  $ (1.55 ) $ (0.96 ) $ 1.18   $ 0.21   $ 0.22   $ 0.08   $ (0.20 )
                               

Net income (loss) per common share—diluted

  $ (1.55 ) $ (0.96 ) $ 1.06   $ 0.19   $ 0.20   $ 0.07   $ (0.20 )
                               

Weighted average shares used in computing net income (loss) per common share—basic

    4,283     5,414     5,967     7,847     7,758     7,816     7,517  

Weighted average shares used in computing net income (loss) per common share—diluted

    4,283     5,414     7,966     9,852     9,491     9,519     7,517  

Pro forma net income per share—basic (unaudited)

                          $ 0.36         $ 0.05  
                                         

Pro forma net income per share—diluted (unaudited)

                          $ 0.34         $ 0.05  
                                         

Pro forma weighted average common shares outstanding—basic

                            20,990           20,992  
                                         

Pro forma weighted average common shares outstanding—diluted

                            22,730           22,551  
                                         


                                           

(1)              As discussed in greater detail in Note 11 to our audited financial statements included elsewhere in this prospectus, we changed the manner in which we account for stock-based compensation in 2006. Stock-based compensation is included in cost of revenue and operating expenses in the following amounts (in thousands):

 

Cost of revenues

 
$

31
 
$

58
 
$

178
 
$

158
 
$

213
 
$

155
 
$

218
 

Sales and marketing

    275     503     1,127     676     1,221     953     1,320  

Research and development

    225     334     747     511     899     595     1,237  

General and administrative

    434     374     1,135     2,275     2,201     1,620     1,929  
(2)
In 2005, we changed the manner in which we account for freestanding warrants for redeemable convertible preferred stock resulting in this cumulative change in accounting principle.

43


Table of Contents

Balance sheet data

 
  As of December 31,   As of September 30,  
 
  2005   2006   2007   2008   2009   2010  
 
  (in thousands)
 

Cash, cash equivalents, and short-term investments

  $ 20,135   $ 25,804   $ 72,620 (1) $ 58,265   $ 65,319   $ 70,178  

Total assets

    30,693     42,688     135,565     116,359     125,465     122,240  

Deferred revenue

    35,458     45,821     58,250     58,439     62,308     55,615  

Financing liability(2)

            20,314     20,314     20,314      

Other long-term obligations

    174     181     694     1,577     2,642     18,261  

Mandatorily redeemable convertible preferred stock(3)

    62,026     64,866     64,822     67,662     70,502     72,632  

Accumulated deficit

    (72,464 )   (75,584 )   (51,522 )   (44,088 )   (43,962 )   (44,715 )

Stockholders' deficit

    (73,207 )   (75,991 )   (48,381 )   (40,067 )   (37,664 )   (34,962 )

(1)
Cash, cash equivalents and short-term investments excludes a book overdraft for certain of our disbursement cash accounts of $28.4 million as of December 31, 2007. Please refer to the section of this prospectus entitled "Management's discussion and analysis of financial condition and results of operations—Liquidity and capital resources" included elsewhere in this prospectus for more information.

(2)
Represents a financing liability incurred in connection with the build-out of our San Mateo facility. Please refer to the section of this prospectus entitled "Management's discussion and analysis of financial condition and results of operations—Critical accounting policies and estimates" and Note 6 of our audited financial statements included elsewhere in this prospectus for more information.

(3)
Mandatorily redeemable convertible preferred stock includes $28.6 million of aggregate cumulative dividends to be paid in cash from the proceeds of this offering to the holders of our Series B preferred stock.

44


Table of Contents


Management's discussion and analysis of financial condition
and results of operations

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this prospectus should be read as applying to all related forward-looking statements wherever they appear in this prospectus. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under the section of this prospectus entitled "Risk factors" and elsewhere in this prospectus.

Business overview

Epocrates is a leading provider of mobile drug reference tools to healthcare professionals and interactive services to the healthcare industry. Most commonly used on mobile devices at the point of care, our products help healthcare professionals make more informed prescribing decisions, enhance patient safety and improve practice productivity. Our user network consists of over one million healthcare professionals, including over 300,000, or over 45% of, U.S. physicians. We offer our products on all major U.S. mobile platforms including Apple (iPhone, iPod touch and iPad), Android, BlackBerry, Palm and Windows Mobile devices. To date, our interactive services clients have included all of the top 20 global pharmaceutical companies by sales and over 350 individual pharmaceutical brands.

Our proprietary drug content is the most frequently used mobile reference product and provides healthcare professionals with convenient access to information they need at the point of care. Healthcare professionals are able to access information such as dosing, drug/drug interactions, pricing and insurance coverage for thousands of brand, generic and over-the-counter drugs. Physicians trust Epocrates for accurate content and innovative offerings and use our products more than any other mobile drug reference tool. Our strong brand has enabled us to build a large and active network of users, which enhances our ability to market our interactive services.

Through our interactive services, we provide the healthcare industry, primarily pharmaceutical companies, access to our user network to deliver targeted information and conduct market research in a cost-effective manner. Our services include DocAlert clinical messages that deliver product news and alerts to healthcare professionals. Our Virtual Representative Services, including drug detailing, sampling, patient literature delivery and the ability to contact drug manufacturers, are designed to supplement and replicate the activities of pharmaceutical sales representatives.

We are developing an affordable, easy-to-use electronic health records, or EHR, product that will serve the needs of solo and small group practices and will allow users to qualify for subsidies under the HITECH Act. We believe our experience developing information technology tools used at the point of care by physicians provides us the insight and experience to deliver a product that physicians will find easy to learn and use.

On November 12, 2010, we acquired Modality, Inc. in exchange for $13.8 million in cash. We acquired Modality for its current applications for the Apple iPod touch and iPhone as well as its existing personnel and processes in place to develop additional applications.

45


Table of Contents

Financial operations overview

We generate revenue by providing healthcare companies with interactive services to communicate with our network of users and through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals. For the year ended December 31, 2009, we recorded total net revenues of $93.7 million, a 12% increase from 2008. For the year ended December 31, 2008, we recorded total net revenues of $83.3 million, a 27% increase from 2007. For the nine months ended September 30, 2010, we recorded total net revenues of $73.7 million, a 11% increase from the nine months ended September 30, 2009. For the year ended December 31, 2009, our deferred revenue increased from $58.4 million at December 31, 2008 to $62.3 million at December 31, 2009, a 7% increase. As of September 30, 2010, our deferred revenue balance was $55.6 million, a 11% decrease from December 31, 2009.

The timing of our revenue has been affected by seasonal factors, primarily as a result of the annual budget approval process of many of our customers in the pharmaceutical industry. As a result, our contract bookings and revenue have historically been highest in the fourth quarter of each calendar year. We expect this trend to continue but to become less pronounced in 2010 due to the adoption of new revenue recognition guidance which will result in revenue being recognized in a manner that more closely matches delivery of the contracted services. As revenues have grown, operating expenses have also increased in absolute dollars, but have decreased as a percentage of revenue. We expect this trend will continue to the extent that we are successful in growing our business.

As of September 30, 2010, our worldwide user network consisted of over one million healthcare professionals. Maintaining this large user network of U.S. physicians is important because it will be a key driver of interactive services revenue growth over the long term. The number of users who are U.S. physicians increased approximately 13%, from approximately 264,000 at September 30, 2009 to almost 300,000 at September 30, 2010. This high growth rate was largely due to rapid iPhone adoption by physicians. We expect our network of users to continue to increase at a lower rate.

The majority of healthcare professionals in our network use our free products. Users who paid for a subscription represented 32%, 16%, 12% and 9% of total active users as of December 31, 2007, December 31, 2008, December 31, 2009 and September 30, 2010, respectively. A key focus of our business during 2010 and beyond is to strengthen and maintain our user network. We intend to do so by enhancing the clinical functionality of our free services by adding new content and features that are currently only available with our premium products. As part of our strategy to strengthen and maintain our network of users and leverage this network to generate high margin revenue streams from healthcare industry clients, we plan to devote significant resources to expanding our free product offerings and more actively focus our marketing efforts on increasing awareness and adoption of our free products and services. We expect paid users to continue to represent a decreasing percentage of total active users. As a result, we expect revenues from subscriptions to our premium products to decrease as a percentage of total revenue in the future.

To date we have not experienced significant price pressure from competitors other than for our market research services. Competition is high among market research firms, and price has become a major driver in a client's decision about which vendor to use. We have attempted to limit reductions in price because we believe our sizable network of healthcare professionals contributes significantly to a superior result for our clients. This price pressure has caused revenue from market research services to remain essentially flat since 2007.

Currently, our customer base is located almost entirely within the United States. No single customer accounted for more than 10% of our net revenue during the years ended December 31, 2007, 2008 and 2009, or during the nine months ended September 30, 2009 or 2010. No single customer accounted for more than 10% of net accounts receivable as of September 30, 2010. One customer accounted for 11%

46


Table of Contents


of net accounts receivable as of December 31, 2009. Two customers accounted for 13% and 11% of net accounts receivable, respectively, as of December 31, 2008.

We have generated positive cash flow from operations since the year ended December 31, 2003. Cash, cash equivalents and short-term investments increased from $58.3 million at December 31, 2008 to $65.3 million at December 31, 2009 to $70.2 million at September 30, 2010. Our users pay for one year of our premium subscriptions up front. This amount is deferred and recognized ratably over the term of the subscription. Typically, interactive services clients are billed half of the contracted fee upon signing the contract with the balance billed 90 days after the contract is signed. The amounts collected are deferred and recognized as services are delivered. Because a significant amount of cash is collected near the beginning of the contract, we have generated strong cash flow from operations relative to revenue recognized. This is expected to continue but become less pronounced due to the adoption of new revenue recognition guidance which will result in revenue being recognized in a manner that more closely matches delivery of the contracted services.

We have invested significant development and marketing resources during the nine months ended September 30, 2010 to develop and deliver new products and we expect to continue to invest significant resources through the remainder of 2010 and beyond. Specifically, we have recorded $6.1 million in operating expenses related to the EHR product during the nine months ended September 30, 2010. This investment of resources has caused operating margins to decrease significantly in 2010 compared to 2009. We expect that this trend will continue at least through the middle of 2011 when the EHR product is scheduled to release and expected to generate revenue. To the extent we are successful in generating revenue from our EHR product, we expect operating margins to begin to increase in the latter half of 2011.

The EHR product has not generated any revenue as it has not yet been released. The market for such products is competitive and we have limited experience in that market. Several of our competitors have been participating in this market for many years and have invested significantly more resources in the development of their products than we have. Even if our product meets the requirements of meaningful use as defined by American Recovery and Reinvestment Act of 2009, and is certified as such, we may be too late to the market to compete for the growing number of physicians and others expected to adopt such products in order to qualify for the government incentives beginning in 2011. In addition, numerous other factors, including, but not limited to, development delays, unexpected intellectual property disputes and our inability to compete in the market could hinder customer acceptance of the product.

Our operating results will also be subject to fluctuations due to a requirement under GAAP to record changes in the fair value of our contingent consideration liability in our operating income. We have recorded contingent consideration related to the acquisition of certain intangible assets from two companies. We accounted for the acquisition of these intangible assets as business combinations under GAAP. The sellers would receive contingent consideration in the form of additional cash compensation based upon the financial performance of products incorporating the acquired technologies. Management estimates the fair value of contingent consideration each quarter based on its most recent financial forecast. To the extent our forecast increases, the fair value of the contingent consideration will increase with the change in fair value recorded to operating expense. Conversely, to the extent our forecast decreases, the fair value of the contingent consideration will decrease with the change in fair value recorded as a reduction in operating expense.

In addition, our operating results will be subject to fluctuations due to variable accounting resulting from the repricing of certain stock options in 2003. Assuming that none of these outstanding options are exercised, canceled or expire (all such options will expire by December 31, 2013), each $1.00 increase or decrease in the fair market value of our common stock would result in a corresponding increase or decrease in stock-based compensation of $0.1 million.

47


Table of Contents

We are not a capital-intensive business. Most of our expenditures have been related to sales and product development and we expect this to continue. However, during 2007, we spent $4.0 million in construction costs for our San Mateo facility. Of these expenditures, $2.7 million were reimbursed by our landlord as dictated by the terms of our lease.

The following table sets forth our statements of operations data based on the amounts and percentage relationship of the items listed to net revenue for each period presented (in thousands):

 
  Years Ended December 31,   Nine Months Ended September 30,  
 
  2007   2008   2009   2009   2010  
 
  Amount   %
Revenue
  Amount   %
Revenue
  Amount   %
Revenue
  Amount   %
Revenue
  Amount   %
Revenue
 
 
   
   
   
   
   
   
  (unaudited)
  (unaudited)
 

Total revenues, net

  $ 65,611     100.0%   $ 83,345     100.0%   $ 93,654     100.0%   $ 66,248     100.0%   $ 73,703     100.0%  

Total cost of revenues

    22,805     34.8%     24,786     29.7%     29,452     31.4%     21,945     33.1%     23,330     31.7%  
                                                     

Gross profit

    42,806     65.2%     58,559     70.3%     64,202     68.6%     44,303     66.9%     50,373     68.3%  

Operating expenses:

                                                             
 

Sales and marketing

    16,887     25.7%     18,167     21.8%     22,704     24.2%     16,306     24.6%     22,011     29.9%  
 

Research and development

    10,519     16.0%     12,430     14.9%     14,663     15.7%     10,555     15.9%     14,512     19.7%  
 

General and administrative

    11,983     18.3%     14,888     17.9%     11,587     12.4%     8,630     13.0%     11,249     15.3%  
 

Change in fair value of contingent consideration

        0.0%         0.0%         0.0%         0.0%     885     1.2%  
                                                     
   

Total operating expenses

    39,389     60.0%     45,485     54.6%     48,954     52.3%     35,491     53.6%     48,657     66.0%  
                                                     

Income from operations

    3,417     5.2%     13,074     15.7%     15,248     16.3%     8,812     13.3%     1,716     2.3%  

Interest income

    1,714     2.6%     1,180     1.4%     127     0.1%     109     0.2%     73     0.1%  

Interest expense

    (285 )   (0.4% )   (855 )   (1.0% )   (855 )   (0.9% )   (641 )   (1.0% )   (214 )   (0.3% )

Other income (expense), net

    (233 )   (0.4% )   545     0.7%     (73 )   (0.1% )   (74 )   (0.1% )   2     0.0%  

Gain on sale-leaseback of building

        0.0%         0.0%         0.0%         0.0%     1,689     2.3%  
                                                     

Income before income taxes

    4,613     7.0%     13,944     16.7%     14,447     15.4%     8,206     12.4%     3,266     4.4%  

Benefit (provision) for income taxes

    21,126     32.2%     (6,510 )   (7.8% )   (6,788 )   (7.2% )   (4,050 )   (6.1% )   (2,142 )   (2.9% )
                                                     

Net income

    25,739     39.2%     7,434     8.9%     7,659     8.2%     4,156     6.3%     1,124     1.5%  
                                                     

Critical accounting policies and estimates

Our management's discussion and analysis of financial condition and results of operations is based upon our financial statements and notes to our financial statements, which were prepared in accordance with GAAP. The preparation of the financial statements requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We evaluate our estimates on an ongoing basis, including those related to revenue recognition, stock-based compensation, sales tax accrual, the build-out of our San Mateo facility, accounting for business combinations and the provision for income taxes. We base our estimates and judgments on our historical experience, knowledge of factors affecting our business and our belief as to what could occur in the future considering available information and assumptions that are believed to be reasonable under the circumstances.

The accounting estimates we use in the preparation of our financial statements will change as new events occur, more experience is acquired, additional information is obtained and our operating environment changes. Changes in estimates are made when circumstances warrant. Such changes in estimates and refinements in estimation methodologies are reflected in our reported results of operations and, if material, the effects of changes in estimates are disclosed in the notes to our financial statements. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these estimates.

48


Table of Contents

While our significant accounting policies are more fully described in Note 2 of our financial statements included elsewhere in this prospectus, we believe the following reflect our critical accounting policies and our more significant judgments and estimates used in the preparation of our financial statements.

Revenue recognition and deferred revenue

Revenue is recognized only when:

there is persuasive evidence that an arrangement exists, in the form of a written contract, amendments to that contract, or purchase orders from a third party;

delivery has occurred or services have been rendered;

the price is fixed or determinable after evaluating the risk of concession; and

collectability is probable and/or reasonably assured based on customer creditworthiness and past history of collection.

Determining whether and when some of these criteria have been satisfied often involves judgments that can have a significant impact on the timing and amount of revenue we report. For example, our assessment of the likelihood of collection is a critical element in determining the timing of revenue recognition. If we do not believe that collection is probable and/or reasonably assured, revenue will be deferred until cash is received.

In October 2009, the FASB amended the accounting guidance for multiple deliverable revenue arrangements to:

provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated and how the consideration should be allocated;

require an entity to allocate revenue in an arrangement using best evidence of selling price, or BESP, if a vendor does not have vendor specific evidence, or VSOE, of fair value or third party evidence, or TPE, of fair value; and

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

We elected to early adopt this accounting guidance for all contracts signed or materially modified on or after January 1, 2009. We expect that this new accounting guidance will better align revenue recognition with the delivery of services. Under the new guidance, if we cannot establish VSOE of fair value, we then determine if we can establish TPE of fair value. TPE is determined based on competitor prices for similar deliverables when sold separately. Our services differ significantly from those of our peers and our offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot generally be obtained. Furthermore, we are unable to reliably determine what similar competitor products' selling prices are on a stand-alone basis. Therefore, we are typically not able to determine TPE.

If both VSOE and TPE do not exist, we then use BESP to establish fair value and to allocate total consideration to each element in the arrangement and consideration related to each element is then recognized as each element is delivered. Any discount or premium inherent in the arrangement is allocated to each element in the arrangement based on the relative fair value of each element.

The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for a product or service by considering

49


Table of Contents


multiple factors including an analysis of recent stand-alone sales of that product, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. As these factors are mostly subjective, the determination of BESP requires significant judgment. If we had chosen different values for BESP, our revenue and deferred revenue could have been materially different.

We regularly review VSOE, TPE and BESP and maintain internal controls over the establishment and updates of these estimates. There were no material impacts during the nine months ended September 30, 2010 nor do we currently expect a material impact in the near term from changes in VSOE, TPE, or BESP.

Net revenue as reported and pro forma net revenue that would have been reported during the year ended December 31, 2009, had we not adopted the new guidance, is shown in the following table (in thousands):

 
  As reported   Pro forma basis
(as if previous
guidance was
in effect)
 

Total revenues

  $ 93,654   $ 91,595  
           

For contracts that were signed prior to January 1, 2009 that were not materially modified after January 1, 2009, we use and will continue to use the prior revenue recognition guidance. Under this guidance, if VSOE or TPE of fair value exists for the last undelivered element, we apply the residual method whereby only the fair value of the undelivered element is deferred and the remaining residual fee is recognized when delivered. If VSOE or TPE of fair value does not exist for the last undelivered element, the entire fee is deferred and recognized over the period of delivery of the last undelivered element. As of December 31, 2009, we expect that approximately $18.0 million of deferred revenue will continue to be recognized under old rules and that the majority of this amount will be recognized during 2010.

Stock-based compensation

The following table summarizes stock-based compensation charges for the years ended December 31, 2007, 2008 and 2009 and for the nine months ended September 30, 2009 and 2010 (in thousands):

 
  Years ended December 31,   Nine months ended
September 30,
 
 
  2007   2008   2009   2009   2010  
 
   
   
   
  (unaudited)
  (unaudited)
 

Employee stock-based compensation expense

  $ 1,782   $ 3,641   $ 4,760   $ 3,500   $ 4,370  

Amortization of deferred employee stock-based compensation

    221     132     14     14      

Stock-based compensation associated with outstanding repriced options

    1,184     (153 )   (240 )   (191 )   334  
                       

Total stock-based compensation

  $ 3,187   $ 3,620   $ 4,534   $ 3,323   $ 4,704  
                       

For options and restricted stock units, or RSUs, granted on or after January 1, 2006, stock-based compensation is measured at grant date based on the fair value of the award and is expensed on a straight-line basis over the requisite service period. For options granted prior to January 1, 2006, we continue to recognize compensation expense on the remaining unvested awards under the intrinsic value method unless such grants are materially modified.

50


Table of Contents

We considered the fair value of our common stock and the exercise price of the grant as variables in the Black-Scholes option pricing model to determine employee stock-based compensation. This model requires the input of assumptions on each grant date, some of which are highly subjective, including the expected term of the option, expected stock price volatility and expected forfeitures.

We determined the expected term of our options based upon historical exercises, post-vesting cancellations and the contractual term of the option. We concluded that it was not practicable to calculate the volatility of our share price due to the fact that our securities are not publicly traded and therefore there is no readily determinable market value for our stock. Therefore, we based expected volatility on the historical volatility of a peer group of publicly traded entities for the same expected term of our options. We intend to continue to consistently apply this process using the same or similar entities until a sufficient amount of historical information regarding the volatility of our own share price becomes available, or unless circumstances change such that the identified entities are no longer similar to us. In this latter case, more suitable entities whose share prices are publicly available would be utilized in the calculation. We based the risk-free rate for the expected term of the option on the U.S. Treasury Constant Maturity Rate as of the grant date. We determined the forfeiture rate based upon our historical experience with pre-vesting option cancellations. If we had made different assumptions and estimates than those described above, the amount of our recognized and to be recognized stock-based compensation expense, net loss and net loss per share amounts could have been materially different.

Certain employees have received grants for which the ultimate number of shares that will be subject to vesting is dependent upon the achievement of certain financial targets for the year. Such determination is not made until the grant's vesting determination date which is the date our audited financial statements are available. The grant is initially recorded for that number of shares that is most likely to be subject to vesting based on available financial forecasts as of the date of grant. This amount is adjusted on a quarterly basis as new financial forecasts become available. Stock-based compensation expense for these grants is recorded over the requisite service period, generally four years. Such options generally vest ratably for 36 months from the vesting determination date.

Because our common stock is not publicly traded, our board of directors exercises significant judgment in determining the fair value of our common stock on the date of grant based on a number of objective and subjective factors. Factors considered by our board of directors included:

company performance, our growth rate and financial condition at the approximate time of the option grant;

the value of companies that we consider peers based on a number of factors including, but not limited to, similarity to us with respect to industry, business model, stage of growth, financial risk or other factors;

changes in the company and our prospects since the last time the board approved option grants and made a determination of fair value;

amounts recently paid by investors for our common stock in arm's-length transactions with stockholders;

the rights, preferences and privileges of preferred stock relative to those of our common stock;

the likelihood of achieving a liquidity event, such as an initial public offering or sale of all or a portion of the company;

future financial projections; and

51


Table of Contents

valuations completed near the time of the grant.

From December 31, 2007 through December 31, 2009, we prepared valuations on at least an annual basis in a manner consistent with the method outlined in the AICPA Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Since December 31, 2009, we have prepared these valuations on a semi-annual basis. These valuations used a probability-weighted combination of a market-comparable approach and an income approach and were used to estimate our aggregate enterprise value at each valuation date. The market-comparable approach estimates the fair market value of a company by applying market multiples of publicly-traded firms in the same or similar lines of business to the results and projected results of the company being valued. When choosing the market-comparable companies to be used for the market-comparable approach, we focused on companies operating within the healthcare information technology space. The comparable companies remained largely unchanged during the valuation process. The income approach involves applying an appropriate risk-adjusted discount rate to projected debt free cash flows, based on forecasted revenue and costs.

We prepared financial forecasts for each valuation report date used in the computation of the enterprise value for both the market-comparable approach and the income approach. The financial forecasts were based on assumed revenue growth rates that took into account our past experience and contemporaneous future expectations. The risks associated with achieving these forecasts were assessed in selecting the appropriate cost of capital, which was 20%.

If different comparable companies had been used, the market multiples and resulting estimates of the fair value of our stock would have been different. The income approach involves applying appropriate risk-adjusted discount rates to estimated debt-free cash flows, based on forecasted revenue and costs. The financial forecasts used in connection with this valuation were based on our expected operating performance over the forecast period. There is inherent uncertainty in these estimates. If different discount rates or other assumptions had been used, the valuations could have been materially different.

As an additional indicator of fair value, we considered the pricing of all sales of our common stock for transactions occurring near the respective valuation dates. During the year ended December 31, 2009, a number of investors purchased, or attempted to purchase shares from employees, former employees and other stockholders. In some instances, we exercised our right of first refusal with regard to such proposed purchases and, accordingly, purchased the shares for the price proposed by these investors. In other instances, we chose not to exercise our right of first refusal and permitted these investors to complete the transactions with the sellers on the terms disclosed to us.

Also, in December 2007 and again in June 2009, we offered to repurchase a limited number of shares of our common stock at the then fair value. In December 2007, we allowed only holders of common stock who were not current employees and certain preferred stockholders to participate. In June 2009, we allowed only employees with five years or more of tenure to participate.

In addition, we also considered in our determination of fair value that in December 2007 we issued 3.8 million shares of common stock to a single accredited investor for an aggregate price of $40.0 million.

While these transactions were not consummated in a highly liquid market, we do believe that the transactions provide an additional indicator of fair value based on the volume and number of buyers. These transaction prices have indicated, as additional support to our valuation analyses, that we have not historically determined fair market values below the indications of value for transactions in our common stock.

52


Table of Contents

We believe that we have used reasonable methodologies, approaches and assumptions consistent with the AICPA Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, to determine the fair value of our common stock. We have reviewed key factors and events between each date below and have determined that the combination of the factors and events described above reflect a true measurement of the fair value of our common stock over an extended period of time and believe that the fair value of our common stock is appropriately reflected in the chart below.

Date of grant
  Options
granted
  Exercise
price
  Fair value
per share
  Grant date
fair value
 
 
  (In thousands)
   
   
  (In thousands)
 

February 11, 2009

    68   $ 12.11   $ 12.11   $ 376  

March 2, 2009

    858   $ 12.11   $ 12.11   $ 4,674  

May 8, 2009

    301   $ 12.11   $ 12.11   $ 1,593  

August 6, 2009

    111   $ 12.11   $ 12.11   $ 540  

December 17, 2009

    980   $ 10.17   $ 10.17   $ 4,692  

February 3, 2010

    97   $ 10.17   $ 10.17   $ 372  

August 25, 2010

    452   $ 13.36   $ 13.36   $ 2,699  

October 28, 2010

    478   $ 13.36   $ 13.36   $ 2,799  

November 12, 2010

    8   $ 13.36   $ 13.36   $ 50  

December 22, 2010

    715   $ 13.99   $ 13.99   $ 3,533  

As of September 30, 2010, the aggregate fair value of outstanding vested and unvested options was $48.5 million and $29.1 million, respectively, based on an assumed initial public offering price of $14.00 per share, the midpoint of the price range set forth on the cover page of this prospectus.

We performed annual retrospective valuations of our common stock as of December 31, 2003, 2004, 2005 and 2006 and determined that some grants were made with exercise prices that were below the fair value of our common stock at the date of grant. For the years ended December 31, 2004 and 2005, we recorded a total of $1.2 million of deferred stock-based compensation for the difference between the reassessed fair value of our common stock and the amount that the employee must pay to acquire the stock. We amortized this deferred stock-based compensation using the straight-line method over the vesting periods of the stock options, which is generally four years. Deferred stock-based compensation recorded as expense was $221,000, $152,000 and $14,000 during the years ended December 31, 2007, 2008 and 2009, respectively. At December 31, 2009, all deferred stock-based compensation had been fully amortized.

Discussion of specific valuation inputs from January 2009 through December 2010

February 11, 2009, March 2, 2009, May 8, 2009 and August 6, 2009.    On these dates, our board of directors determined a fair value of our common stock of $12.11 per share based on a valuation report as of December 31, 2008 and evidence from a recent tender offer for our common stock at a price of $12.11 per share on June 1, 2009. We also considered that in April 2008, we filed a registration statement on Form S-1, but that due to the economic conditions in the U.S. equity markets toward the end of 2008, we withdrew our registration statement in December 2008.

The valuation used a risk-adjusted discount rate of 20%, a non-marketability discount of 34% and an estimated time to an initial public offering of two years. The expected outcomes were weighted 100% toward remaining a private company. This valuation indicated a fair value of $12.11 per share for our common stock as of December 31, 2008.

53


Table of Contents

We also considered the fact that on June 1, 2009, we repurchased 0.6 million shares at $12.11 per share from 52 existing employees for an aggregate $5.8 million pursuant to a tender offer. The tender offer was made to existing employees with five or more years of tenure as of June 1, 2009 to repurchase up to 15.8% of their stock holdings. A total of 52 employees out of an eligible 59 employees elected to participate.

We determined to set the fair value of our common stock at $12.11 per share based on these factors for all four grant dates during this period because it was supported by the valuation we received in December 2008 and by the tender offer in June 2009. During the period covered by these options grants of February 2009 to August 2009, there were no events specific to our company that would indicate that the fair value of our common stock would have materially changed.

December 17, 2009 and February 3, 2010.    On these dates, our board of directors determined a fair value of our common stock of $10.17 per share based upon a valuation report as of December 15, 2009, evidence from a tender offer to current employees on June 1, 2009 and the price at which multiple investors purchased, or attempted to purchase shares from employees, former employees and other stockholders during the fourth quarter of 2009 and the first quarter of 2010.

The valuation used a risk-adjusted discount rate of 20%, a non-marketability discount of 21% and an estimated time to an initial public offering of 12 months. The expected outcomes were weighted 100% toward remaining a private company. This valuation indicated a fair value of $10.17 per share for our common stock as of December 15, 2009.

In addition, we considered that between November 2009 and January 2010, 12 individuals, including current employees, former employees, and former directors, entered into binding agreements to sell common stock held by them to one of three different accredited investors. Certain of these agreements contained provisions in which the investor would share 20% of the proceeds in excess of $22.26 per share upon the ultimate disposition of such shares above $22.26 per share. The total number of shares involved was over 1.5 million and the contracted prices ranged from $6.42 to $9.54. In certain instances, we elected to exercise our right of first refusal by purchasing the shares from these individuals at contracted prices ranging from $6.42 to $9.89 per share. During the three months ended December 31, 2009, we exercised our right of first refusal to repurchase 0.2 million shares for an aggregate purchase price of $2.1 million. During the nine months ended September 30, 2010, we exercised our right of first refusal for an additional 0.2 million shares at contracted prices ranging from $6.42 to $9.89 for an aggregate purchase price of $2.1 million.

We determined to set the fair value of our common stock at $10.17 per share based on these factors for these two grant dates during this period because it was supported by the valuation as of December 15, 2009 and by several recent sales of our common stock.

August 25, 2010, October 28, 2010 and November 11, 2010.    On these dates, our board of directors determined a fair value of our common stock of $13.36 per share based upon a valuation report as of August 20, 2010 and based on a preliminary indication of valuation discussed with our underwriters.

December 22, 2010.    On this date, our board of directors determined a fair value of our common stock of $13.99.

The valuation used a risk-adjusted discount rate of 25% and a non-marketability discount of 10%. We used a probability weighted expected return method with the expected outcomes weighted 80% toward a liquidity exit event within nine months and 20% toward remaining a private company. This valuation indicated a fair value of $13.36 per share for our common stock as of August 20, 2010.

54


Table of Contents

Sales tax accrual

Prior to 2008, we neither charged nor remitted sales tax on any of our sales. We recorded expense of $0.8 million and $0.2 million related to uncollected and unremitted sales tax including estimated penalties and interest of $0.2 million and $22,000 for the years ended December 31, 2007 and 2008, respectively. The expense related to sales tax was recorded as cost of revenue and the expense related to penalties and interest was recorded as other income (expense), net.

The liability for uncollected and unremitted sales tax, including penalties and interest, was $0.3 million and $0 as of December 31, 2008 and 2009, respectively.

These estimates were based on highly subjective factors including the following:

in which states we have nexus for sales tax purposes;

the potential penalty and interest that would be charged by each state;

whether certain of our products would be considered subject to sales tax and in which states; and

the treatment of multiple element arrangements where only some of the items in the arrangement are subject to sales tax.

In late 2007, we hired a consulting firm to assist us in determining the manner in which our products would be taxed in the various states in which we have nexus. This same consulting firm sent anonymous letters on our behalf to the states in which we had determined we had nexus as of that date indicating our desire to enter into Voluntary Disclosure Agreements, or VDAs, with each of these states. All of the responses we received from the states where we had taxable sales included certain reductions that the state would agree to make to the amount owed such as waiving penalties or setting a later start date for our liability. These adjustments were subject to certain contingencies, such as submission of a detailed schedule of taxes due and full payment of the amount owed.

We adjusted our prior estimate of the liability as of December 31, 2007 of $2.6 million by reversing sales tax of $0.8 million and interest and penalties of $0.5 million during the year ended December 31, 2008, to reflect the manner in which our products would be taxed in each of the states in which we had nexus and to reflect written confirmation of the states' agreements to reduce the liabilities.

As of December 31, 2009, we have complied with all VDAs and have begun collecting and remitting sales tax in all states in which we have nexus.

Build-out of our San Mateo facility

In April 2007, we began a build-out of existing office space at our San Mateo facility. During 2007, we spent $4.0 million in construction costs for this facility. Of these expenditures, $2.7 million were reimbursed by our landlord as dictated by the terms of our lease.

When we signed the lease, the construction of the space we would lease was unfinished. There was no heating, ventilation or air conditioning, no plumbing or electricity, no networking capability and no internal walls or offices. As such, the space was not capable of being occupied by any lessee. We

55


Table of Contents


concluded that under GAAP, we should be considered the owner of the construction project for two reasons:

Under the lease agreement, we were responsible for any cost overruns, to make the building ready for occupancy. Per GAAP, if a lessee's guarantee exceeds 90% of the total project costs it should be considered the owner of the project. A lessee's unlimited obligation to cover costs over a certain amount would result in our maximum guarantee to be in excess of 90% of the total project costs. Under GAAP, the probability of the lessee having to make such payments should not be considered in performing the maximum guarantee test.

Per GAAP, regardless of the 90% test discussed above, a lessee should be considered the owner of a construction project if the lessee is responsible for paying directly any cost of the project other than normal tenant improvements. Normal tenant improvements exclude costs of structural elements of the project and any equipment that would be a necessary improvement for any lessee. Under the lease agreement, we were responsible for direct payment to the contractor for completing construction of the leased space.

Therefore, we have capitalized the fair value of the unfinished portion of the building that we occupy of $17.6 million with a corresponding credit to financing liability pursuant to the financing method under GAAP. The fair value was determined as of May 2007 using an average of the sales comparison and income approaches. In addition, we capitalized $4.0 million in construction costs to complete the space. Each major construction element has been capitalized and is being depreciated over its useful life. The reimbursement from the sublandlord of $2.7 million has also been recorded as a liability as of December 31, 2007. The total amount recorded as a financing liability was $20.3 million.

Subsequent to the completion of construction, we did not qualify for sale-leaseback accounting under GAAP because of a provision in the lease which constituted continuing involvement. There was a requirement to issue the sublandlord a letter of credit in lieu of a cash security deposit. Our bank required us to maintain a restricted deposit at least equal to the amount of the letter of credit. Under GAAP, providing collateral on behalf of the buyer-lessor, including a collateralized letter of credit, constitutes continuing involvement. Further, a financial institution's right of offset against any amounts on deposit against a letter of credit constitutes collateral. Therefore, we expect the building to remain on our books throughout the term of the lease or until we no longer have continuing involvement. Interest expense on the financing obligation is recorded over the term of the obligation.

Because we are considered the owner of the building for accounting purposes, the building is being depreciated on a straight-line basis over its useful life which we determined to be 40 years. We determined that certain improvements, including plumbing, electrical, wiring, concrete, structural steel, carpentry, ceiling, fire sprinklers and heating and air conditioning have a weighted average life of 29 years.

In April 2010, we modified the terms of the building lease. Under the terms of the modified lease, the letter of credit was replaced with a cash security deposit. This provision allowed us to qualify for sale-leaseback accounting and to begin accounting for the lease as an operating lease. In connection with the sale-leaseback of the building we wrote off the remaining asset value of the building, related accumulated depreciation and the financing liability. As a result of these accounting transactions, we recorded a gain on sale-leaseback of $1.7 million. Since April 2010, the lease has been accounted for as an operating lease.

56


Table of Contents

Accounting for business combinations

Intangible assets consist of purchased intellectual property acquired in transactions that were accounted for as business combinations under GAAP and are measured at fair value at the date of acquisition. We amortize all intangible assets on a straight-line basis over their expected lives. As of September 30, 2010, we had $6.0 million of intangible assets, net. We evaluate our intangible assets for impairment by assessing the recoverability of these assets whenever adverse events or changes in circumstances or business climate indicate that expected undiscounted future cash flows related to such intangible assets may not be sufficient to support the net book value of such assets. An impairment is recognized in the period of identification to the extent the carrying amount of an asset exceeds the fair value of such asset. Based on our analysis, no impairment was recorded in fiscal year 2009 or during the nine months ended September 30, 2010.

Goodwill is currently our only indefinite-lived intangible asset. As of September 30, 2010, we had $10.7 million of goodwill. Goodwill is tested for impairment at the reporting unit level at least annually on September 30 of each calendar year or more often if events or changes in circumstances indicate the carrying value may not be recoverable. Based on this analysis, no impairment was recorded in fiscal year 2009 or during the nine months ended September 30, 2010. As of September 30, 2010, we have identified two reporting units. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Circumstances that could affect the valuation of goodwill include, among other things, a significant change in our business climate and buying habits of our customers along with increased costs to provide systems and technologies required to support the technology. We have assigned a portion of goodwill to each of our two reporting units. Based on our analysis in 2009, no impairment of goodwill was indicated. We have determined that a 10% change in our cash flow assumptions as of the date of our most recent goodwill impairment test would not have changed the outcome of the test.

Significant judgments are required in assessing impairment of goodwill and intangible assets include the identification of reporting units, identifying whether events or changes in circumstances require an impairment assessment, estimating future cash flows, determining appropriate discount and growth rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value whether an impairment exists and if so the amount of that impairment.

When an acquisition includes a liability contingent consideration, this liability must be adjusted to its fair value each quarter, with changes in fair value recorded to operating expense. Management estimates the fair value of contingent consideration each quarter based on its most recent financial forecast. To the extent our forecast increases, the fair value of the contingent consideration will increase with change in fair value recorded to operating expense. Conversely, to the extent our forecast decreases, the fair value of the contingent consideration will decrease with change in fair value recorded as a reduction to operating expense.

Significant judgment is required in developing the assumptions required to determine the purchase price and in allocating that purchase price to the assets. If any of these assumptions were different, the amount recorded as goodwill, intangible assets and contingent consideration would have been different. The fair value of contingent consideration is likely to fluctuate as our marketing strategy evolves and as new market data becomes available.

57


Table of Contents

In June 2009, we acquired certain intangible assets of Caretools, Inc. The acquisition was accounted for as a business combination under GAAP. Certain intangible assets acquired from Caretools will be used in our EHR product. Contingent consideration is calculated based on an estimate of royalties on revenue generated through June 2013 from the sale of products incorporating Caretools' technology. For the nine months ended September 30, 2010, we recorded an increase in the fair value of the contingent consideration for Caretools of $1.3 million. The change in the fair value of the contingent consideration was due to changes in discount periods as well as new estimates of revenue to be generated using the acquired technology. These new estimates were based on new information including the following events which occurred during the nine months ended September 30, 2010:

We filled several open engineering positions giving us more certainty regarding our ability to get a product to market in a timely manner.

We continued to obtain and conduct our own market research, which indicated an increase in the expected adoption rate of EHR among U.S. physicians.

We issued a press release stating our intention to enter the EHR market.

We established an internal timeline for beta testing of the new product.

We began initiatives to market the EHR product including a planned redesign of our ecommerce and support websites.

We increased our expected pricing for the product based on continued monitoring of competition, evolving trends in expected adoption rates among U.S. physicians, and our ability to release a product with more features and functionality than originally anticipated.

We signed contracts or letters of intent with several collaborative partners which will allow us to develop a more robust product with more features than originally anticipated. We expect that this will make us more competitive and increase the size and timing of our expected market penetration.

For the nine months ended September 30, 2010, we recorded a decrease in the fair value of the contingent consideration for MedCafe of $0.4 million. The change in the fair value of the contingent consideration was due to changes in discount periods as well as new estimates of revenue expected to be generated using the acquired technology. These new estimates were based on revised revenue and expense forecasts as a result of a delay in the launch of products using the acquired technology.

Valuation of deferred tax assets

Our deferred tax assets are comprised primarily of net operating loss carryforwards and research and development credits. At December 31, 2009, we had federal and state tax net operating loss carryforwards of $0.2 million and $12.4 million, respectively. The federal and state net operating losses will begin to expire in 2019 and 2013, respectively. At December 31, 2009, we had federal and state research tax credit carryforwards of $1.1 million and $1.0 million, respectively. The federal research credit carryforward begins to expire in 2026. The state research credit carryforwards do not expire. At December 31, 2009, we had federal alternative minimum tax, or AMT, credit carryforwards of $0.7 million. The federal AMT credits carryforwards do not expire.

A valuation allowance of $25.6 million at December 31, 2006 had been recorded to offset deferred tax assets as we were unable to conclude that it is more likely than not that such deferred tax assets will be realized. During the fourth quarter of 2007, we determined that it would be more likely than not that

58


Table of Contents


the cumulative net operating loss and other deferred tax benefits would be recoverable by us, creating a $21.1 million income tax benefit due to the deferred tax asset recorded on our balance sheet at the end of 2007. The determination of when to adjust the valuation allowance requires significant judgment on the part of management based on our historical experience, knowledge of current business factors and our belief of what could occur in the future. Although realization is not assured, we have concluded that it is more likely than not that the deferred tax assets at December 31, 2007 for which a valuation allowance was determined to be unnecessary will be realized in the ordinary course of operations based on the available positive and negative evidence, primarily our projected earnings. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if actual future earnings are lower than estimated, or if there are differences in the timing or amount of future reversals of existing taxable or deductible temporary differences.

The future utilization of our net operating loss and research and development credit carryforwards to offset future taxable income may be subject to an annual limitation as a result of ownership changes. We have had two change of ownership events that limit the utilization of net operating loss and credit carryforwards. The change of ownership events occurred in September 1999 and August 2000. As a result, utilization of net operating loss and tax credits prior to the change of ownership events will be significantly limited. The limitation resulted in the expiration of unused federal net operating loss, state net operating loss and federal tax credit carryforwards of $4.3 million, $4.2 million and $0.1 million, respectively.

59


Table of Contents

Results of operations

Nine months ended September 30, 2009 vs. September 30, 2010

The following table summarizes our results of operations for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2010 (in thousands):

 
  Nine months ended
September 30,
   
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2009   2010  
 
  (unaudited)
  (unaudited)
   
   
 

Total revenues, net

  $ 66,248   $ 73,703   $ 7,455     11.3 %

Total cost of revenues

    21,945     23,330     1,385     6.3 %
                     

Gross profit

    44,303     50,373     6,070     13.7 %

Operating expenses:

                         
 

Sales and marketing

    16,306     22,011     5,705     35.0 %
 

Research and development

    10,555     14,512     3,957     37.5 %
 

General and administrative

    8,630     11,249     2,619     30.3 %
 

Change in fair value of contingent consideration

        885     885     *  
                     
   

Total operating expenses

    35,491     48,657     13,166     37.1 %
                     

Income from operations

    8,812     1,716     (7,096 )   (80.5 %)

Interest income

    109     73     (36 )   (33.0 %)

Interest expense

    (641 )   (214 )   427     (66.6 %)

Other income (expense), net

    (74 )   2     76     *  

Gain on sale-leaseback of building

        1,689     1,689     *  
                     

Income before income taxes

    8,206     3,266     (4,940 )   (60.2 %)

Provision for income taxes

    (4,050 )   (2,142 )   1,908     (47.1 %)
                     

Net income

    4,156     1,124     (3,032 )   (73.0 %)
                     

*
not meaningful

Historically, we were organized as one segment. Beginning in 2010, we organized our operations into the following two principal segments: subscriptions and interactive services and electronic health records.

60


Table of Contents

To date, we have not yet generated revenue from our EHR segment as our EHR product has not yet been launched. We do not allocate certain expenses to our segments that benefit both segments, such as stock-based compensation and certain general and administrative, marketing, and research and development expenses. These costs are reported as corporate expenses. The following table summarizes our operating results by segment for the nine months ended September 30, 2010 (in thousands):

 
  Nine months ended September 30, 2010  
 
  Subscriptions
and interactive services
  Electronic
health records
  Corporate   Consolidated  
 
  (unaudited)
  (unaudited)
  (unaudited)
  (unaudited)
 

Total revenue, net

    73,703             73,703  

Cost of revenue

    23,112         218 (1)   23,330  
                   

Gross profit

    50,591         (218 )   50,373  

Sales and marketing

    14,616     2,152     3,923     20,691  

Research and development

    8,374     2,697     2,203     13,274  

General and administrative

            9,321     9,321  

Stock-based compensation expense

            4,486     4,486  

Change in fair value of contingent consideration

    (392 )   1,277         885  
                   

Income (loss) from operations

    27,993     (6,126 )   (20,151 )   1,716  
                   

(1)
Employee stock based compensation charged to cost of revenue.

Revenues.    We generate revenue through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals and by providing healthcare companies with interactive services to communicate with our network of users.

Subscriptions revenue.    The majority of healthcare professionals in our network use our free products and services and do not purchase any of our premium subscriptions. Subscription options include:

a subscription to one of three premium mobile products we offer that a user downloads to their mobile device;

a subscription to our premium online product or site licenses for access via the Internet on a desktop or laptop; and

license codes that can be redeemed for such mobile or online premium products.

Most commonly used on mobile devices at the point of care, our drug and clinical reference products help healthcare professionals make more informed prescribing decisions, enhance patient safety and improve practice productivity.

Subscriptions are recognized as revenue ratably over the term of the subscription as services are delivered. Billings for subscriptions occur in advance of services being performed; therefore these amounts are recorded as deferred revenue when billed. A license code allows a holder to redeem the code for a subscription. Typically, license codes must be redeemed within six months to one year of issuance. When a license code is redeemed for a mobile subscription, revenue is recognized ratably over the term of the subscription. If a license code expires before it is redeemed, revenue is recognized upon expiration.

61


Table of Contents

Interactive services revenue.    Our interactive services include:

DocAlert clinical messaging.    DocAlert messages are short clinical alerts delivered to our users when they connect with Epocrates' databases to receive updated content. The majority of these DocAlert messages are not sponsored and include useful information for recipients such as new clinical studies, practice management information and industry guidelines. The balance of DocAlert messages are sponsored by our clients. These messages serve as a vehicle to communicate key scientific and medical information to clinicians as a way to keep them informed. We work with clients to ensure that their messages are clinically relevant and of interest to our user network. All sponsored messages are clearly marked as such and subject to review by our editorial team. Each sponsored message is available to users for four weeks and are targeted to all or a subset of physicians to increase the value and relevance to recipients. Clients contract with us to publish an agreed upon number of DocAlert messages over the contract period, typically one year.

Virtual Representative Services.    Our Virtual Representative Services, including drug detailing, sampling, patient literature delivery and the ability to contact drug manufacturers, are designed to supplement, and in some cases replicate, the activities of pharmaceutical sales representatives. Our pharmaceutical clients contract with us to make one or more of these services available to its users for a period of time, typically one year.

Epocrates market research programs.    We recruit healthcare professionals to participate in market research activities. Participants can share valuable insights and earn cash honoraria. Concurrently, this service offers market research specialists, marketers and investors the opportunity to survey their target audience. Customers contract with us and pay a fee to us for access to a targeted group of our users whom they wish to survey. We pay a portion of this fee to the survey participants to induce them to participate. Upon completion of the survey, which typically runs for approximately one month, we bill the customer the entire amount due. We have concluded that we act as the primary obligor. Accordingly, we recognize the entire fee paid by our customers as revenue upon confirmation of completion of the survey, and the compensation paid by us to survey participants is recorded as a cost of revenue when earned by the participant.

Formulary hosting.    Healthcare professionals have the option to download health plan formulary lists for their geographic area or patient demographic at no cost. Clients, usually health insurance providers, contract with us to host their formulary and make it available to our users for a one to three year period.

Mobile resource centers.    This educational service allows healthcare professionals to stay current on clinical developments for a variety of disease conditions and topics. Typically sponsored by a pharmaceutical company for a year at a time, each resource center is developed in conjunction with a key opinion leader for that specific disease or condition.

We often enter into multiple element arrangements that contain various combinations of services from the above described subscriptions and interactive services. Typically, clients are billed half of the contracted fee upon signing the contract with the balance being billed 90 days after the contract is signed. Because billings for sponsored content typically occur in advance of services being performed, these amounts are recorded as deferred revenue when billed. Revenue is recognized over the contracted term as delivery occurs. Each element typically has a delivery period of one year, but the various elements may or may not be delivered concurrently.

62


Table of Contents

The following is a breakdown of net revenue from subscriptions and interactive services for the nine months ended September 30, 2009 and 2010 (in thousands):

 
  Nine months ended September 30,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2009   2010  
 
  (unaudited)
  (unaudited)
   
   
 

Subscriptions

  $ 13,766   $ 17,315   $ 3,549     25.8 %

Interactive services

    52,482     56,388     3,906     7.4 %
                     

  $ 66,248   $ 73,703   $ 7,455     11.3 %
                     

Total net revenues increased $7.5 million, or 11%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. Subscription revenue increased $3.5 million, or 26%, and interactive services increased $3.9 million, or 7%.

Of the $3.5 million increase in subscription revenue, $2.4 million was due to a large number of license code expirations during the nine months ended September 30, 2010 and the remainder was due to an increase in paid subscription revenue from iPhone users. A license code allows a holder to redeem the code for a subscription. Typically, license codes must be redeemed within six months to one year of issuance. When a license code is redeemed for a mobile subscription, revenue is recognized ratably over the term of the subscription. If a license code expires before it is redeemed, revenue is recognized upon expiration. List prices for our subscription products did not change during 2010. We expect the percentage of users who pay for a subscription to continue to decrease. As a result, we expect revenue from subscriptions to our premium products to decrease as a percentage of total revenue in the future.

As of September 30, 2010, our worldwide user network consisted of over one million healthcare professionals. Maintaining this large user network of U.S. physicians is important because it will be a key driver of interactive services revenue growth over the long-term. The number of users who are U.S. physicians increased approximately 13% from approximately 260,000 at September 30, 2009 to almost 300,000 at September 30, 2010. This high growth rate was due to rapid iPhone adoption by physicians. We do not expect our network of users to continue to increase at a similar rate.

A key focus of our business during 2010 and beyond is to strengthen and maintain our user network and generate revenue from our interactive services. We intend to devote significant resources to enhancing the clinical functionality of our free offerings and more actively focus our marketing efforts on increasing awareness and adoption of these products and services. We expect the percentage of users who purchase a premium subscription to decrease during 2010 and beyond. As a result, we expect revenues from subscriptions to our premium products to decrease as a percentage of total revenue in the future.

The $3.9 million increase in interactive services revenue was driven by $1.1 million of new Virtual Representative services which were launched in the first quarter of 2010, with the remainder due to growth of DocAlert clinical messaging services. Most of the increase in DocAlert clinical messaging services was due to an increase in the number of contracts fulfilled during the nine months ended September 30, 2010 as the average price per contract was similar to the nine months ended September 30, 2009.

Historically, our interactive services revenue and particularly our clinical messaging revenues have grown at a much faster rate than subscriptions. We expect this trend to continue as the use of electronic services as a medium to communicate with healthcare providers continues to gain acceptance within the pharmaceutical industry. In addition, we introduced new services late in 2009 and plan to

63


Table of Contents


introduce new services in 2010, which we expect will also drive continued growth in interactive services revenue.

Cost of revenues.    Cost of revenues consists of the costs related to providing services to customers. These costs include salaries and related personnel expenses, stock-based compensation, service support costs, payments to participants in market research surveys we conduct for our customers, third party royalties and allocated overhead.

Much of the content in our premium drug and reference products is licensed from third parties. Royalty costs consist of fees that we pay to branded content owners for the use of their intellectual property. Contracts with certain licensors include minimum guaranteed royalty payments, which are payable regardless of ultimate sales. Additional royalties may be due based on sales. We record these minimum payments as cost of revenue when incurred.

We allocate overhead expenses such as rent, occupancy charges and information technology costs to all departments based on headcount. As a result, such expenses are reflected in costs of revenues, as well as in the research and development, sales and marketing and general and administrative expense categories. Depreciation and amortization expense is also allocated to cost of revenues.

The following is a breakdown of cost of revenue related to subscriptions and interactive services for the nine months ended September 30, 2009 and 2010 (in thousands):

 
  Nine months ended
September 30,
   
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2009   2010  
 
  (unaudited)
  (unaudited)
   
   
 

Subscriptions

  $ 5,091   $ 4,819   $ (272 )   (5.3 %)

Interactive Services

    16,854     18,511     1,657     9.8 %
                     

  $ 21,945   $ 23,330   $ 1,385     6.3 %
                     

Cost of subscription revenue as a percentage of subscription revenue was 37% and 28% for the nine months ended September 30, 2009 and 2010, respectively. This decrease was due to the fact that subscription cost of revenue remained flat while subscription revenue increased due to the expiration of license codes as discussed in "—Results of Operations—Subscription Revenue." In the short term, we expect that cost of subscription revenue will increase.

Cost of interactive services increased $1.7 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009, which was primarily due to $0.6 million in outside consulting services and a $0.6 million increase in the amortization of intangible assets. Cost of interactive services revenue as a percentage of interactive service revenue was 32% and 33% for the nine months ended September 30, 2009 and 2010, respectively. In the short term, we expect that the cost of interactive services revenue will increase.

Sales and marketing expense.    Sales and marketing expense consists primarily of salaries and related personnel expenses, sales commissions, stock-based compensation, trade show expenses, promotional expenses, public relations expenses and allocated overhead. Commissions are expensed upon collection of customer invoices.

Sales and marketing expense increased $5.7 million, or 35%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. This increase was primarily due to increased salary and other personnel costs for additional headcount to support corporate marketing efforts of $2.9 million, increased consulting costs to support the launch of our EHR product of

64


Table of Contents


$1.2 million, increased salary and other personnel costs to support the launch of our EHR product of $0.9 million and increased stock-based compensation of $0.4 million. Sales and marketing expense as a percentage of total net revenue for the nine months ended September 30, 2009 and 2010 was 25% and 30%, respectively. We expect sales and marketing expense to continue to increase.

Research and development expense.    Research and development expense consists primarily of salaries and related personnel expenses, stock-based compensation, allocated overhead, consultant fees and expenses related to the design, development, testing and enhancements of our services.

Research and development expense increased $4.0 million, or 38%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. This increase was primarily due to increased salary and other personnel costs to support the development of our EHR product of $1.9 million, increased consulting costs to support the development of our EHR product of $0.7 million and an increase in stock-based compensation of $0.6 million. Research and development expense as a percentage of total net revenue for the nine months ended September 30, 2009 and 2010 was 16% and 20%, respectively. We expect research and development expense to increase as we continue to develop new services.

General and administrative expense.    General and administrative expense consists primarily of salaries and related personnel expenses, stock-based compensation, consulting, audit fees, legal fees, allocated overhead and other general corporate expenses.

General and administrative expense increased $2.6 million, or 30%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. This increase was primarily due to increased salary and other personnel expenses of $1.1 million, an increase in stock-based compensation of $0.3 million, increased recruiting costs of $0.3 million and increased audit and tax fees of $0.2 million. General and administrative expense as a percentage of total net revenue for the nine months ended September 30, 2009 and 2010 was 13% and 15%, respectively. We expect general and administrative expense to increase due to significant costs we expect to incur as we continue to build and maintain the infrastructure necessary to comply with the regulatory requirements of being a public company.

Change in fair value of contingent consideration.    We acquired certain intangible assets of Caretools, Inc., in June 2009 and of MedCafe Inc., in February 2010. These acquisitions were accounted for as business combinations under GAAP. For the nine months ended September 30, 2010, we recorded contingent consideration expense of $1.3 million related to revaluing the contingent consideration liability for Caretools to its fair value as of September 30, 2010. The change in the fair value of the contingent consideration was due to changes in discount periods as well as new estimates of revenue expected to be generated using Caretools technology. Also during the nine months ended September 30, 2010, we recorded a reduction to contingent consideration expense of $0.4 million related to revaluing the contingent consideration liability for MedCafe to its fair value as of September 30, 2010. The change in the fair value of the contingent consideration was due to changes in discount periods as well as new estimates of revenue expected to be generated using MedCafe technology. We have not yet made any contingent payments to the sellers and do not expect to begin making significant payments until 2011. To the extent we are successful in developing and then successfully launching our new products using the acquired companies' technology, we will record additional contingent consideration expense. Conversely, to the extent we are not successful in developing and then successfully launching our new products using the acquired companies' technology, we will record a reduction to contingent consideration expense.

65


Table of Contents

Interest income.    Interest income was essentially flat for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. Although average cash and short-term investment balances increased during the nine months ended September 30, 2010, the continued decline in prevailing interest rates in 2010 compared to 2009 resulted in a slight decrease in interest income.

Interest expense.    We incurred interest expense of $0.2 million for the nine months ended September 30, 2010 compared to $0.6 million for the nine months ended September 30, 2009. Interest expense relates to rent payments on our San Mateo facility which we capitalized as discussed in "Critical accounting policies and estimates—Build-out of the San Mateo facility" above. Interest expense decreased during the nine months ended September 30, 2010 due to a sale-leaseback of our San Mateo facility also discussed above.

Provision for income taxes.    We incurred a provision for income taxes of $2.1 million for the nine months ended September 30, 2010 compared to a provision for income taxes of $4.1 million for the nine months ended September 30, 2009. We estimate that our effective tax rate for 2010 will be 58% compared to 47% for 2009. This rate is driven primarily by pretax book income which we expect will be lower in 2010 compared to 2009 coupled with the fact that we must still provide for income tax on approximately $2.6 million of stock-based compensation related to incentive stock options, or ISOs. GAAP does not allow us to record a benefit on incentive stock options unless and until there is a disqualifying disposition of the stock. In addition, California amended its tax law effective 2011 lowering the amount of income that is subject to tax in California for certain California corporations. As a result, our deferred tax assets in California had to be written down which drove up the overall effective rate.

Years ended December 31, 2008 vs. December 31, 2009

The following table summarizes our results of operations for the year ended December 31, 2009 compared to the year ended December 31, 2008 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2008   2009  

Total revenues, net

  $ 83,345   $ 93,654   $ 10,309     12.4%  

Total cost of revenues

    24,786     29,452     4,666     18.8%  
                     

Gross profit

    58,559     64,202     5,643     9.6%  

Operating expenses:

                         
 

Sales and marketing

    18,167     22,704     4,537     25.0%  
 

Research and development

    12,430     14,663     2,233     18.0%  
 

General and administrative

    14,888     11,587     (3,301 )   (22.2% )
                     
   

Total operating expenses

    45,485     48,954     3,469     7.6%  
                     

Income from operations

    13,074     15,248     2,174     16.6%  

Interest income

    1,180     127     (1,053 )   (89.2% )

Interest expense

    (855 )   (855 )        

Other income (expense), net

    545     (73 )   (618 )   *  

Income before income taxes

    13,944     14,447     503     3.6%  

Provision for income taxes

    (6,510 )   (6,788 )   (278 )   4.3%  
                     

Net income

    7,434     7,659     225     3.0%  
                     

*
not meaningful

66


Table of Contents

Revenues.    The following is a breakdown of net revenue from subscriptions and interactive services for the years ended December 31, 2008 and 2009 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2008   2009  

Subscriptions

  $ 20,099   $ 19,001   $ (1,098 )   (5.5% )

Interactive services

    63,246     74,653     11,407     18.0%  
                     

  $ 83,345   $ 93,654   $ 10,309     12.4%  
                     

Total net revenues increased $10.3 million, or 12%, in 2009 compared to 2008. Subscription revenue decreased $1.1 million, or 6%, and interactive services revenue increased $11.4 million, or 18%. Total revenues were $2.1 million higher than they would have been had we not early adopted new revenue accounting guidance for contracts signed or materially modified on or after January 1, 2009, as discussed in "Critical accounting policies and estimates—Revenue recognition and deferred revenue" above.

The $1.1 million decrease in subscription revenue was due entirely to a decrease in the number of users with subscriptions to our premium products. List prices for our subscription products did not change during 2009 compared to 2008. The majority of healthcare professionals in our network use our free drug reference tool, and do not purchase any of our premium subscriptions. Users who paid for a subscription represented 16%, and 12% of total active subscribers as of December 31, 2008, and December 31, 2009, respectively.

As of December 31, 2009, our user network consisted of over 850,000 healthcare professionals. Maintaining and strengthening this large user network is important because it will be a key driver of interactive services revenue growth over the long-term. The number of users who are U.S. physicians increased approximately 17% from approximately 235,000 at December 31, 2008 to approximately 275,000 at December 31, 2009. This growth was largely due to the wide adoption of our product on the iPhone platform which was made available in July 2008.

The $11.4 million increase in interactive services revenue was driven by a $4.4 million increase in our DocAlert clinical messaging services, a $2.9 million increase in revenue from Formulary hosting services, a $1.9 million increase in revenue from Epocrates market research services and a $2.0 million increase in revenue from mobile resource centers.

Of the $5.4 million increase in DocAlert clinical messaging services revenue, $1.5 million represents revenue that we would not have recognized had we not early adopted new revenue accounting guidance for contracts signed or materially modified on or after January 1, 2009, as discussed in "Critical accounting policies and estimates—Revenue recognition and deferred revenue" above. The remainder of the increase was driven by a 31% increase in the number of contracts in process during 2009 compared to 2008 offset by a 13% decrease in revenue recognized per contract in process. Of the $2.9 million increase in formulary hosting services revenue $0.3 million was due to the adoption of the new revenue recognition guidance discussed in "Critical accounting policies and estimates—Revenue recognition and deferred revenue" above. The remainder of the increase was driven by a 14% increase in the number of contracts in process during 2009 compared to 2008 and a 51% increase in revenue recognized per contract in process. The entire $2.0 million increase in revenue from mobile resource centers was due to the fact that mobile resource centers launched late in 2008 and only generated $0.3 million of revenue in 2008. The $1.9 million increase in Epocrates market research revenue was due to a 10% increase in the number of contracts in process during 2009 compared to 2008.

67


Table of Contents

Cost of revenues.    The following is a breakdown of cost of revenue related to subscriptions and interactive services for the years ended December 31, 2008 and 2009 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2008   2009  

Subscriptions

  $ 5,558   $ 6,558   $ 1,000     18.0 %

Interactive services

    19,228     22,894     3,666     19.1 %
                     

  $ 24,786   $ 29,452   $ 4,666     18.8 %
                     

Cost of subscription revenue increased $1.0 million, or 18%, in 2009 compared to 2008. This increase was due primarily to an increase in third party royalty costs. Cost of subscription revenue as a percentage of subscription revenue was 28% and 35% in 2008 and 2009, respectively.

Cost of interactive service revenue increased $3.7 million, or 19%, for 2009 compared to 2008. This increase was primarily due to increased costs for customer support personnel of $1.5 million, increased compensation paid to participants in our market research programs of $0.9 million, and third-party consulting costs of $0.8 million. Cost of interactive services revenue as a percentage of interactive service revenue was 30% and 31% in 2008 and 2009, respectively. In the short term, we expect that cost of interactive services revenue will increase.

Sales and marketing expense.    Sales and marketing expense increased $4.5 million, or 25%, in 2009 compared to 2008. This increase was primarily due to increased salary and other personnel costs of $3.0 million for the additional headcount needed to support our revenue growth, an increase in consulting costs of $0.7 million and an increase in employee stock-based compensation of $0.5 million. Sales and marketing expense as a percentage of total net revenue in 2008 and 2009 was 22% and 24%, respectively. We expect sales and marketing expense to continue to increase.

Research and development expense.    Research and development expense increased $2.2 million, or 18%, in 2009 compared to 2008. This increase was primarily due to increased salary and other personnel costs of $1.4 million for the additional headcount needed to support the release of our subscription product on additional operating platforms, a $0.4 million increase in employee stock-based compensation, and an increase in consulting costs of $0.4 million. Research and development expense as a percentage of total net revenue in 2008 and 2009 was 15% and 16%, respectively. We expect research and development expense to increase as we continue to invest heavily in the development of new products and services.

General and administrative expense.    General and administrative expense decreased $3.3 million, or 22%, in 2009 compared to 2008. This decrease was primarily due to decreased external audit and tax fees of $1.9 million and decreased legal fees of $1.0 million. In 2008, we incurred significant audit fees in connection with the audit of our 2008 financial statements and the filing of a registration statement on Form S-1. In addition, when we decided not to pursue our initial public offering in December 2008, we expensed $1.8 million of legal, accounting and printer fees in connection with the filing of our S-1 that had been capitalized throughout 2007 and 2008. General and administrative expense as a percentage of total net revenue in 2008 and 2009 was 18% and 12%, respectively. We expect general and administrative expense to increase due to costs we expect to incur as we continue to build and maintain the infrastructure necessary to comply with the regulatory requirements of being a public company.

68


Table of Contents

Interest income.    Interest income decreased $1.1 million, or 89%, in 2009 compared to 2008. Although average cash balances increased during 2009 the decline in prevailing interest rates in 2009 compared to 2008 resulted in a significant decrease in interest income.

Interest expense.    We incurred interest expense of $0.9 million in both 2008 and 2009. Interest expense relates to rent payments on our San Mateo facility which we have capitalized as discussed in "Critical accounting policies and estimates—Build-out of our San Mateo facility" above.

Other income (expense), net.    Other expense was $0.1 million in 2009 compared to other income of $0.5 million in 2008. Other income (expense) primarily includes interest and penalties for the non-remittance of sales tax in the states where we believe we have nexus. Historically, we did not charge nor remit sales tax on any of our sales as discussed in "Critical accounting policies and estimates—Sales tax accrual" above. In 2008, we changed our estimate as of December 31, 2007 and reversed $0.5 million of the liability for interest and penalties.

Provision for income taxes.    We incurred a provision for income taxes of $6.8 million in 2009 compared to $6.5 million in 2008. In 2008, we had an effective tax rate of 46.7% and we utilized $18.7 million of our net operating loss to offset our actual tax liability. In 2009, we had an effective tax rate of 47.0% and we utilized $8.8 million of our federal net operating loss to offset a portion of our actual tax liability. The state of California has suspended the use of California net operating loss carryforwards for the years 2008 and 2009.

Years ended December 31, 2007 vs. December 31, 2008

The following table summarizes our results of operations for the year ended December 31, 2007 compared to the year ended December 31, 2008 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2007   2008  

Total revenues, net

  $ 65,611   $ 83,345   $ 17,734     27.0%  

Total cost of revenues

    22,805     24,786     1,981     8.7%  
                     

Gross profit

    42,806     58,559     15,753     36.8%  

Operating expenses:

                         
 

Sales and marketing

    16,887     18,167     1,280     7.6%  
 

Research and development

    10,519     12,430     1,911     18.2%  
 

General and administrative

    11,983     14,888     2,905     24.2%  
                     
   

Total operating expenses

    39,389     45,485     6,096     15.5%  
                     

Income from operations

    3,417     13,074     9,657     282.6%  

Interest income

    1,714     1,180     (534 )   (31.2% )

Interest expense

    (285 )   (855 )   (570 )   200.0%  

Other income (expense), net

    (233 )   545     778     *  

Income before income taxes

    4,613     13,944     9,331     202.3%  

Benefit (provision) for income taxes

    21,126     (6,510 )   (27,636 )   *  
                     

Net income

    25,739     7,434     (18,305 )   (71.1% )
                     

*
not meaningful

69


Table of Contents

Revenues.    The following is a breakdown of net revenue from subscriptions and interactive services for the years ended December 31, 2007 and 2008 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2007   2008  

Subscriptions

  $ 19,732   $ 20,099   $ 367     1.9 %

Interactive services

    45,879     63,246     17,367     37.9 %
                     

  $ 65,611   $ 83,345   $ 17,734     27.0 %
                     

Total net revenues increased $17.7 million, or 27%, in 2008 compared to 2007. There was an increase in subscription revenue of $0.4 million, or 2%, and an increase in interactive services revenue of $17.4 million, or 38%.

The $0.4 million increase in subscription revenue was due to an increase in site license revenue. List prices for our subscription products did not change during 2008 compared to 2007. Revenue from license code, mobile subscriptions and internet subscriptions did not materially change in 2008 compared to 2007.

As of December 31, 2008, our user network consisted of over 625,000 healthcare providers including over one out of every three U.S. physicians. The number of users who are U.S. physicians increased approximately 15% from approximately 205,000 at December 31, 2007 to approximately 235,000 at December 31, 2008. This increase was primarily due to the availability of our product on the iPhone operating system which was launched in July 2008.

The $17.4 million increase in interactive services revenue was driven almost entirely by an increase in our DocAlert clinical messaging services. Approximately $7.9 million of this increase was due to a change in the terms of our standard clinical messaging contracts. In February 2008, we removed the language from our standard DocAlert clinical messaging contracts that provides these customers with the right to receive complementary license codes. Therefore, for stand-alone contracts with no rights to receive such codes, revenue for most of our clinical messaging contracts is recognized over the delivery period of each message rather than recognizing all such revenue upon completion of the last deliverable. The remaining increase was a result of a 5% increase in the number of contracts that were fulfilled in 2008 compared to 2007 as well as a 45% increase in our average revenue per contract.

Cost of revenues.    The following is a breakdown of cost of revenue related to subscriptions and interactive services for the years ended December 31, 2007 and 2008 (in thousands):

 
  Years ended December 31,    
   
 
 
  Increase/
(Decrease)
$
  Increase/
(Decrease)
%
 
 
  2007   2008  

Subscriptions

  $ 5,808   $ 5,558   $ (250 )   (4.3% )

Interactive services

    16,997     19,228     2,231     13.1%  
                     

  $ 22,805   $ 24,786   $ 1,981     8.7%  
                     

Cost of subscription revenue decreased $0.3 million, or 4%, in 2008 compared to 2007. This decrease was primarily due to a $1.1 million decrease in expense associated with uncollected and unremitted sales tax due to us having become compliant with voluntary disclosure agreements in most of the states in which we have sales tax nexus during 2008. Historically, we did not charge nor remit sales tax on any of our sales and the estimated amount due for uncollected and unremitted sales tax was charged to cost of revenue as discussed in "Critical accounting policies and estimates—Sales tax accrual" above.

70


Table of Contents

This decrease was partially offset by an increase in customer support personnel of $0.5 million. Cost of subscription revenue as a percentage of subscription revenue was 29% and 28% for 2007 and 2008, respectively.

Cost of interactive service revenue increased $2.2 million, or 13%, in 2008 compared to 2007. This increase was primarily due to increased compensation paid to participants in our market research programs of $0.5 million, increased costs for customer support personnel of $0.7 million and an increase in outsourced services of $0.6 million. Cost of interactive services revenue as a percentage of interactive service revenue was 37% and 30% for 2007 and 2008, respectively.

Sales and marketing expense.    Sales and marketing expense increased $1.3 million, or 8%, in 2008 compared to 2007. This increase was primarily due to increased salary and other personnel costs of $1.0 million for the additional headcount needed to support our revenue growth and increased public relations and advertising costs of $0.3 million, partially offset by a decrease in employee stock-based compensation of $0.5 million. Sales and marketing expense as a percentage of total net revenue was 26% and 22% for 2007 and 2008, respectively.

Research and development expense.    Research and development expense increased $1.9 million, or 18%, in 2008 compared to 2007. This increase was primarily due to increased salary and other personnel costs of $1.2 million for the additional headcount needed to support the release of our subscription product on additional mobile platforms and increased temporary personnel of $0.4 million, partially offset by a decrease in employee stock-based compensation of $0.2 million. Research and development expense as a percentage of total net revenue was 16% and 15% in 2007 and 2008, respectively.

General and administrative expense.    General and administrative expense increased $2.9 million, or 24%, in 2008 compared to 2007. This increase was primarily due to the write-off of $1.8 million of capitalized audit and legal fees concurrent with our decision not to pursue our initial public offering late in 2008, increased employee stock-based compensation of $1.1 million mostly due to the modification of certain options, severance costs of $0.4 million and increased salary and other personnel expenses of $0.4 million, partially offset by a decrease in temporary personnel costs of $0.7 million. General and administrative expense as a percentage of total net revenue was 18% for both 2007 and 2008.

Interest income.    Interest income decreased $0.5 million, or 31%, in 2008 compared to 2007. Although average cash balances increased during 2008 the decline in prevailing interest rates throughout 2008 resulted in a significant decrease in interest income.

Interest expense.    We incurred interest expense of $0.9 million in 2008 compared to $0.3 million in 2007. Interest expense relates entirely to rent payments on our San Mateo facility which we have capitalized as discussed in "Critical accounting policies and estimates—Build-out of our San Mateo facility" above.

Other income (expense), net.    Other income was $0.5 million in 2008 and other expense was $0.2 million in 2007. Other income (expense) primarily includes interest and penalties for the non-remittance of sales tax in the states where we believe we have nexus. Historically, we did not charge nor remit sales tax on any of our sales as discussed in "Critical accounting policies and estimates—Sales tax accrual" above. The decrease in other expense is due entirely to a decrease in penalties and interest for uncollected and unremitted sales tax due to us having become compliant with voluntary disclosure agreements in most of the states in which we have sales tax nexus during 2008.

Provision for income taxes.    We incurred a provision for income taxes of $6.5 million in 2008 compared to a benefit for income taxes of $21.1 million in 2007. The benefit for income taxes in 2007 was

71


Table of Contents

primarily due to the release of the entire valuation allowance against our deferred tax asset on December 31, 2007. In 2008 we utilized $18.7 million of our federal net operating loss to offset our actual tax liability. The state of California has suspended the use of California net operating loss carryforwards for the years 2008 and 2009.

The determination of when to adjust the valuation allowance requires significant judgment on the part of management based on our historical experience, knowledge of current business factors and our belief of what could occur in the future. In 2007, we concluded that it was more likely than not that our deferred tax assets would be realized before they expire. Management made this determination based on management's projections of pretax profitability in the future, and because in the fourth quarter of 2007, for the first time we had achieved cumulative profitability net of permanent tax differences for 12 cumulative quarters.

Quarterly results of operations

The following table sets forth selected unaudited quarterly statements of operations data for the seven quarters ending March 31, 2009 through September 30, 2010. The information for each of these quarters has been prepared on the same basis as the audited financial statements included in this prospectus and, in the opinion of management, includes all adjustments necessary for a fair statement of the results of operations for such periods. This data should be read in conjunction with the financial

72


Table of Contents

statements and the related notes included in this prospectus. These quarterly operating results are not necessarily indicative of our operating results for any future period.

 
  Three months ended  
 
  March 31,
2009
  June 30,
2009
  September 30,
2009
  December 31,
2009
  March 31,
2010
  June 30,
2010
  September 30,
2010
 
 
  (in thousands)
 

Subscription revenues

  $ 4,669   $ 4,521   $ 4,576   $ 5,235   $ 5,754   $ 5,796   $ 5,765  

Interactive services revenues

    20,056     14,823     17,603     22,171     18,582     19,481     18,325  
                               

Total revenues, net

    24,725     19,344     22,179     27,406     24,336     25,277     24,090  

Subscription cost of revenues

   
1,810
   
1,691
   
1,589
   
1,468
   
1,805
   
1,574
   
1,440
 

Interactive services cost of revenues

    5,155     5,541     6,159     6,039     5,447     6,162     6,902  
                               

Total cost of revenues(1)

    6,965     7,232     7,748     7,507     7,252     7,736     8,342  

Gross profit

   
17,760
   
12,112
   
14,431
   
19,899
   
17,084
   
17,541
   
15,748
 

Operating expenses:(1)

                                           
 

Sales and marketing

    5,079     5,810     5,417     6,398     6,838     7,554     7,619  
 

Research and development

    3,284     3,405     3,866     4,108     4,519     4,865     5,128  
 

General and administrative

    2,849     3,064     2,717     2,957     4,025     3,925     3,299  
 

Change in fair value of contingent consideration

                    1,214     (569 )   240  
                               
   

Total operating expenses

    11,212     12,279     12,000     13,463     16,596     15,775     16,286  
                               

Income (loss) from operations

    6,548     (167 )   2,431     6,436     488     1,766     (538 )
 

Interest income

    47     40     22     18     20     28     25  
 

Interest expense

    (214 )   (213 )   (214 )   (214 )   (214 )        
 

Other income (expense), net

        (75 )   1     1     2          
 

Gain on sale-leaseback of building

                        1,689      
                               

Income (loss) before income taxes

    6,381     (415 )   2,240     6,241     296     3,483     (513 )

Benefit (provision) for income taxes

   
(3,123

)
 
114
   
(1,041

)
 
(2,738

)
 
(270

)
 
(2,721

)
 
849
 
                               

Net income (loss)

  $ 3,258   $ (301 ) $ 1,199   $ 3,503   $ 26   $ 762   $ 336  
                               

(1)
Includes stock-based compensation in the following amounts:

 

Cost of revenue

    51     52     52     58     69     81     68  
 

Sales and marketing

    245     333     375     268     395     546     379  
 

Research and development

    163     181     251     304     359     367     511  
 

General and administrative

    394     585     641     581     710     608     611  

The timing of our revenue has been affected by seasonal factors, primarily as a result of the annual budget approval process of many of our customers in the pharmaceutical industry. As a result, our revenue is generally highest in the fourth quarter of each calendar year. We have experienced fluctuations in our quarterly results, and we expect these fluctuations to continue in the future. The occurrence of a number of factors might cause our operating results to vary widely, including:

budgeting patterns of our customers;

the timing of revenue recognition;

our ability to retain and increase sales to existing customers;

our ability to attract new customers;

the length of time to complete our obligations under existing contracts;

changes in our pricing policies;

73


Table of Contents

the mix of services we sell;

new product introductions and product enhancements by us or by our competitors;

effectiveness of our sales force;

general economic conditions in the United States; and

regulatory compliance.

Due to these and other factors, we believe that quarter-to-quarter comparisons of operating results will not be meaningful and should not be relied upon as an indication of future performance. Other factors may also impact results in any given quarter, particularly with respect to the timing of revenue. For instance, in the third quarter of 2010 revenue was adversely affected by the failure of certain customer contracts to be executed, many of which we expect to instead be executed in subsequent periods. Net income has also been impacted as we generate product development expenses in advance of the commercial introduction of our new EHR product.

Selected Quarterly Financial Data

The table below sets forth a reconciliation of net income (loss) to Adjusted EBITDA:

 
  March 31,
2009
  June 30,
2009
  September 30,
2009
  December 31,
2009
  March 31,
2010
  June 30,
2010
  September 30,
2010
 

Net income (loss)

  $ 3,258   $ (301 ) $ 1,199   $ 3,503   $ 26   $ 762   $ 336  

Interest income

    (47 )   (40 )   (22 )   (18 )   (20 )   (28 )   (25 )

Interest expense

    214     213     214     214     214          

Building rent expense

    (214 )   (213 )   (214 )   (214 )   (214 )        

Other income (expense)

        75     (1 )   (1 )   (2 )        

Benefit (provision) for income taxes

    3,123     (114 )   1,041     2,738     270     2,721     (849 )

Depreciation and amortization

    695     730     729     735     721     716     803  

Amortization of purchased intangibles

                    8     17     523  

Stock-based compensation

    853     1,151     1,319     1,211     1,533     1,602     1,569  

Change in fair value of contingent consideration

                    1,214     (569 )   240  

Gain on sale-leaseback of building

                        (1,689 )    
                               

Adjusted EBITDA

  $ 7,882   $ 1,501   $ 4,265   $ 8,168   $ 3,750   $ 3,532   $ 2,597  
                               

Adjusted EBITDA is not a measure of liquidity calculated in accordance with U.S. generally accepted accounting principles, or GAAP, and should be viewed as a supplement to—not a substitute for—our results of operations presented on the basis of GAAP. Adjusted EBITDA does not purport to represent cash flow provided by, or used in, operating activities as defined by GAAP. Our statement of cash flows presents our cash flow activity in accordance with GAAP. Furthermore, Adjusted EBITDA is not necessarily comparable to similarly-titled measures reported by other companies.

We believe Adjusted EBITDA is used by and is useful to investors and other users of our financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across companies and across periods. We believe that:

EBITDA is widely used by investors to measure a company's operating performance without regard to such items as interest expense, taxes, depreciation and amortization, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired; and

74


Table of Contents

investors commonly adjust EBITDA information to eliminate the effect of stock-based compensation expenses and other charges, which can vary widely from company to company and impair comparability.

Our management uses Adjusted EBITDA:

as a measure of operating performance to assist in comparing performance from period to period on a consistent basis;

as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations;

in communications with the board of directors, stockholders, analysts and investors concerning our financial performance; and

as a significant performance measurement included in our bonus plan.

Liquidity and capital resources

Cash flow from operating activities have been positive since 2003. Most of our expenditures are for personnel and facilities. As revenues have grown, operating expenses have also increased. However, spending as a percentage of revenue has decreased. We expect this trend will continue to the extent we are successful in growing our business.

Operating activities

Cash provided by operating activities was $9.8 million for the nine months ended September 30, 2010, which was primarily attributable to net income of $1.1 million plus stock-based compensation of $4.7 million and depreciation and amortization of $2.8 million.

Cash provided by operating activities was $11.5 million for the nine months ended September 30, 2009, which was primarily attributable to net income of $4.2 million plus stock-based compensation of $3.3 million and depreciation and amortization of $2.2 million.

Cash provided by operating activities was $17.0 million in 2009, which was primarily attributable to net income of $7.7 million plus employee stock-based compensation expense of $4.5 million and depreciation and amortization of $2.9 million.

Cash provided by operating activities was $16.8 million in 2008, which was primarily attributable to net income of $7.4 million plus employee stock-based compensation expense of $3.6 million and depreciation and amortization of $2.6 million.

Cash provided by operating activities was $23.4 million in 2007, which was primarily attributable to net income of $25.7 million plus employee stock-based compensation expense of $3.2 million, depreciation and amortization of $1.9 million and an increase in deferred revenue of $12.4 million, partially offset by an increase in our deferred tax asset of $21.6 million. The increase in the deferred tax asset was primarily due to the release of the valuation reserve of $21.1 million.

Investing activities

Our policy is to invest only in fixed income instruments denominated and payable in U.S. dollars. Our investment policy is as follows: investment in obligations of the U.S. government and its agencies,

75


Table of Contents


money market instruments, commercial paper, certificates of deposit, bankers' acceptances, corporate bonds of U.S. companies, municipal securities and asset backed securities are allowed. We do not invest in auction rate securities, futures contracts, or hedging instruments. Securities of a single issuer valued at cost at the time of purchase should not exceed 5% of the market value of the portfolio or $1.0 million, whichever is greater, but securities issued by the U.S. Treasury and U.S. government agencies are specifically exempted from these restrictions. Issue size should normally be greater than $50 million for corporate bonds. No single position in any issue should equal more than 10% of that issue. The final maturity of each security within the portfolio should not exceed 24 months.

The following table summarizes our investments in cash, cash equivalents and short-term investments as of December 31, 2007, 2008, and 2009 and as of September 30, 2010 (in thousands):

 
  December 31,    
 
 
  September 30,
2010
 
 
  2007   2008   2009  

Cash

    28,412     5,117     12,140     11,375  

Book overdraft

    (28,412 )            

Cash equivalents

    70,116     53,148     48,755     40,335  

Short-term investments

    2,504         4,424     18,468  
                   

Total cash, cash equivalents and short-term investments

    72,620     58,265     65,319     70,178  
                   

Unrealized gain (loss) on available-for-sale securities

   
15
   
   
(2

)
 
5
 
                   

Historically, we have not been a capital-intensive business; however, during 2007, we incurred $4.0 million in construction costs for our San Mateo facility. $2.7 million of these expenditures were reimbursed by our landlord as dictated by the terms of our lease.

Financing activities

Cash used in financing activities of $1.0 million for the nine months ended September 30, 2010 was due to repurchases of our stock from certain employees, former employees and former directors totaling $2.1 million, partially offset by proceeds from the exercise of employee stock options of $1.1 million. During the nine months ended September 30, 2010, certain individuals, including former employees and former directors, entered into binding agreements to sell common stock held by them to three accredited investors. During the nine months ended September 30, 2010, we exercised our right of first refusal for 0.2 million shares of common stock at contracted prices ranging from $6.42 to $9.89 for an aggregate purchase price of $2.1 million.

Cash used in financing activities for the nine months ended September 30, 2009 of $5.5 million was due to the acquisition of common stock from employees of $5.8 million pursuant to a tender offer discussed in the following paragraph, partially offset by proceeds from the exercise of employee stock options of $0.3 million.

Cash used in financing activities in 2009 was $6.9 million and was due to repurchases of our stock from employees and former employees totaling $7.9 million, partially offset by proceeds from the exercise of employee stock options of $0.9 million. On June 1, 2009, we repurchased 0.5 million shares of common stock from existing employees for an aggregate $5.8 million pursuant to a tender offer. Also, during the fourth quarter of 2009, certain former employees entered into binding agreements to sell common stock held by them to one of various accredited investors. In certain instances, we elected to exercise our right of first refusal by purchasing the shares from these individuals at contracted prices ranging from $8.27 to $9.54 per share. We exercised our right of first refusal to repurchase 0.2 million shares of common stock for an aggregate purchase price of $2.1 million.

76


Table of Contents

Cash used in financing activities in 2008 was $28.3 million and consisted primarily of the reversal of the book overdraft of $28.4 million discussed below.

Cash provided by financing activities in 2007 was $29.8 million and consisted primarily of a $28.4 million book overdraft and $40.0 million received in connection with the sale of shares of our common stock, offset by $41.7 million paid to acquire common stock pursuant to a tender offer for our common stock to certain of our existing stockholders. The book overdraft was created in connection with our transaction with Goldman Sachs Group, Inc., or Goldman, in which we sold them 3.0 million shares of stock for $40.0 million. In order to execute this transaction (that is, to have shares available for issuance), we repurchased 3.1 million shares of common stock from existing stockholders for $41.7 million, of which $28.4 million did not clear the bank until January 2008. The book overdraft was created because the proceeds for the sale of shares to Goldman and the payments made to existing stockholders to acquire the shares necessary to consummate the transaction were originated into different bank accounts for which no legal right of offset existed. We classified the bank overdraft as a financing activity in our statement of cash flows because it relates to a financing activity.

We believe that the net proceeds from this offering, together with our available cash resources and anticipated future cash flow from operations, will provide sufficient cash resources to meet our contractual obligations and our currently anticipated working capital and capital expenditure requirements for at least the next 12 months. However, prior to such time, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or convertible securities may result in additional dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that could restrict our operations. Any required additional capital may not be available on reasonable terms, if at all.

Our future liquidity and capital requirements will depend upon numerous factors, including retention of customers at current volume and revenue levels, our existing and new application and service offerings, competing technological and market developments and potential future acquisitions. In addition, our ability to generate cash flow is subject to numerous factors beyond our control, including general economic, regulatory and other matters affecting our customers and us.

Contractual obligations

The following table summarizes our contractual obligations as of December 31, 2009 (in thousands):

 
   
   
  2011-2012   2013-2014   2015+    
 
 
  Total   Less Than
1 Year
  1 - 3
Years
  3 - 5
Years
  More Than
5 Years
  Other  

Operating lease(1)

    3,085     2,296     789              

Operating leases(2)

    982     322     660              

Minimum royalty and contract license fees(3)

    2,215     1,649     534     32          

Engineering and content development(4)

    2,350     550     1,200     600          

Uncertain tax positions(5)

    668                     668  
                           

Accrued dividend on Series B

                                     
 

Mandatorily redeemable convertible preferred stock(6)

    26,491     26,491                  

Fair value of contingent consideration(7)

    1,300                     1,300  

Total

    37,091     31,308     3,183     632         1,968  
                           

77


Table of Contents

There were material modifications to the operating lease for our San Mateo facility subsequent to year end as discussed in "Critical accounting policies and estimates—Build-out of the San Mateo facility" above. In addition, we entered into an operating lease on a second facility in New Jersey. The following table summarizes our contractual obligations as of September 30, 2010 (in thousands):

 
  Total   Remainder
of 2010
  2011-2012   2013-2014   After
2014
  Other  

Operating lease(1)

    8,497     946     3,877     3,674          

Operating leases(2)

    2,114     123     1,447     544          

Minimum royalty and contract license fees(3)

    974     408     534     32          

Engineering and content development(4)

    1,950     150     1,200     600          

Uncertain tax positions(5)

    744                     744  
                           

Accrued dividend on Series B

                                     
 

Mandatorily redeemable convertible preferred stock(6)

    28,621     28,621                  

Fair value of contingent consideration(7)

    16,935                     16,935  

Total

    59,835     30,248     7,058     4,850         17,679  
                           

(1)
Relates to our facility in San Mateo, California which was amended in April 2010 (see Note 16 to our financial statements included elsewhere in this prospectus).

(2)
Relates to our facilities in New Jersey.

(3)
Relates to medical information licensed from third parties for use in our subscription services.

(4)
Relates to a contract with a consulting firm to provide product development and content development work.

(5)
Represents uncertain tax positions for which we could not make a reasonable estimate of the amount or the exact period of related future payments.

(6)
Payable in cash upon the effectiveness of this offering (see Note 9 of our audited financial statements included elsewhere in this prospectus).

(7)
Related to fair value of contingent consideration as of the indicated date pertaining to business combinations (see Note 5 of our audited financial statements included elsewhere in this prospectus).

Legal matters

From time to time, we may be involved in lawsuits, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters, which arise in the ordinary course of business. In accordance with GAAP, we record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impact of negotiations, settlements, ruling, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable. If any unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations of that period or on our cash and/or liquidity. Currently, we are not involved in any material litigation.

78


Table of Contents

Off-balance sheet arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. We do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions, or foreign currency forward contracts.

Sarbanes-Oxley compliance and corporate governance

As a public company, we will be subject to the reporting requirements of the Sarbanes-Oxley Act of 2002. Beginning with the year ending December 31, 2012, we will be required to establish and regularly evaluate the effectiveness of internal control over financial reporting. In order to maintain and improve the effectiveness of disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required. We also must comply with all corporate governance requirements of The NASDAQ Global Market.

Quantitative and qualitative disclosures about market risk

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in money market funds and high quality debt securities. Our investments in debt securities are subject to interest rate risk. To minimize the exposure due to an adverse shift in interest rates, we invest in short term securities and maintain an average portfolio duration of one year or less.

Our operations consist of research and development and sales activities in the United States. As a result, our financial results are not affected by factors such as changes in foreign currency exchange rates or economic conditions in foreign markets.

Recently adopted and recently issued accounting guidance

The following accounting guidance was either recently issued but not yet adopted or was adopted during the year ended December 31, 2009. With the exception of those items discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements that are of significance to us.

Effective July 1, 2009, we adopted changes issued by FASB to the authoritative hierarchy of GAAP. These changes establish the FASB Accounting Standards Codification, or Codification, as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission, or SEC, under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead the FASB will issue Accounting Standards Updates. Accounting Standards Updates will not be authoritative in their own right as they will only serve to update the Codification. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on our results of operations, financial position or cash flows.

Effective July 1, 2009, we adopted changes issued by the FASB that amend the other-than-temporary impairment guidance to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The adoption of this new guidance did not have a material effect on our results of operations, financial position or cash flows.

79


Table of Contents

Effective January 1, 2009, we adopted changes issued by the FASB that require entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. The amendments are required to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The adoption of this new guidance did not have a material effect on our financial position or cash flows, but did have a material effect on our results of operations. If we had not adopted the new guidance on January 1, 2009, revenue and net income would have been $2.1 million lower than reported.

Effective January 1, 2009, we adopted changes issued by the FASB that require an entity to recognize the assets acquired, liabilities assumed, contractual contingencies and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. With the adoption of this accounting standard update, any tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded through income tax expense, whereas the previous accounting treatment would require any adjustment to be recognized through the purchase price. The adoption of this new guidance did not have a material effect on our results of operations, financial position or cash flows.

80


Table of Contents


Business

Overview

Epocrates is a leading provider of mobile drug reference tools to healthcare professionals and interactive services to the healthcare industry. Most commonly used on mobile devices at the point of care, our products help healthcare professionals make more informed prescribing decisions, enhance patient safety and improve practice productivity. Our user network consists of over one million healthcare professionals, including over 300,000, or more than 45% of, U.S. physicians, as of November 2010. We offer our products on all major U.S. mobile platforms including Apple (iPhone, iPod touch and iPad), Android, BlackBerry, Palm and Windows Mobile devices. To date, our interactive services clients have included all of the top 20 global pharmaceutical companies by sales and over 350 individual pharmaceutical brands.

Our proprietary drug content is the most frequently used mobile reference product by healthcare professionals, based on studies conducted by Kantar Media and others, and provides healthcare professionals with convenient access to information they need at the point of care. Healthcare professionals are able to access information such as dosing, drug/drug interactions, pricing and insurance coverage for thousands of brand, generic and over-the-counter drugs. Physicians trust Epocrates for accurate content and innovative offerings and use our products more than any other mobile drug reference tool. Our strong brand has enabled us to build a large and active network of users, which enhances our ability to market our interactive services.

Through our interactive services, we provide the healthcare industry, primarily pharmaceutical companies, access to our user network to deliver targeted information in a cost-effective manner. Our services include:

DocAlert clinical messaging to deliver news and alerts including product approvals, clinical study results and formulary status changes;

Virtual Representative Services for drug detailing, drug sampling, patient literature delivery and the ability to contact drug manufacturers at the point of care; and

Market research programs to survey healthcare professionals.

In 2008, pharmaceutical companies spent over $12.8 billion on promotional activities including detailing, journal advertisements and ePromotion, according to SDI's 2009 Promotional Audits, or the SDI Audit. An increasing proportion of this annual pharmaceutical promotional spend may be redirected from traditional promotion, such as sales representatives and the print medium, to electronic channels. We believe the effectiveness of our interactive services and size and diversity of our network will enable us to capture an increasing portion of this spend.

We generate revenue by providing healthcare companies with interactive services to communicate with our network of users and through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals. We are increasing our emphasis on generating interactive services revenue from healthcare companies through the launch of innovative new products and services. We have increased our focus on product development and technology enhancement to continue to meet the demands of our clients and users. Our goal is to continue to strengthen and maintain our network through the promotion of our free subscription product and the introduction of additional tools to support healthcare professionals at the point of care.

81


Table of Contents

Market opportunity

Physicians are seeking ways to address growing administrative complexities, increasing reimbursement pressures and a constantly changing regulatory environment. As a result, physicians are increasingly adopting technology solutions that enable them to respond to these challenges while improving the quality of patient care. We believe these trends will continue to increase the demand for our drug and clinical reference tools. At the same time, pharmaceutical companies are seeking to improve the effectiveness of their interactions with physicians and other healthcare professionals. We believe our interactive services will continue to attract marketing spend from pharmaceutical companies seeking new channels for promotional activities.

Physicians

Physicians are under increasing time pressure.    According to a study by the Annals of Family Medicine conducted in 2005, primary care physicians spend nearly half of their work day on activities outside of the exam room, predominantly on follow-up and documentation. Paperwork adds at least 30 minutes to every hour of patient care provided, according to a study commissioned by the American Hospital Association in 2006. These constraints limit the amount of time physicians' have available to diagnose and treat patients. We believe physicians are adopting tools that integrate into their daily clinical workflow and to increase productivity inside the exam room.

Physicians are increasingly using mobile technologies.    Two-thirds of physicians used smartphones in 2009, according to a California HealthCare Foundation report. Healthcare professionals have adopted mobile technology for use during patient consultations and to enhance patient care by facilitating drug identification and interaction. Many physicians who use mobile devices with a drug reference product view it as essential to their practice.

Physicians need relevant and reliable information at the point of care.    An estimated 1.5 million Americans are harmed each year by drug errors, all of which are preventable, according to a 2006 report from the Institute of Medicine. Accurate drug reference information at the point of care helps reduce the likelihood of adverse drug events. Physicians are most likely to seek information pertinent to patient interactions when using a mobile device and primarily access medical information during patient visits, according to SDI's Mobile and Social Media Study conducted in 2009, or the SDI Mobile Study. In addition, the majority of physicians with a mobile device use it for accessing drug information, drug interactions and prescribing information.

Physicians are facing an information burden.    In order to make informed prescribing decisions, physicians require access to current, reliable and relevant clinical and pharmaceutical information. We believe the quantity and breadth of information available to physicians creates the need for tools to condense information into a quickly and easily understood form.

Pharmaceutical companies

Patents are expiring and new drug approvals are limited.    Patent expirations, particularly those for blockbuster drugs with over $1.0 billion in annual sales, and fewer new drug approvals are resulting in shrinking revenues and profit margins for pharmaceutical companies. As a result, pharmaceutical companies are reducing their sales forces and embracing cost-effective channels to communicate with physicians in a more targeted way, while generating a return on investment.

Traditional sales model is changing.    A pharmaceutical representative sales call, or detail, costs between $203 and $216, depending on physician type, according to a study by Cutting Edge Information in 2009. On average, primary care sales representatives only succeed in speaking with physicians on 59% of visits. Representatives then spend less than three minutes of quality time with physicians. Furthermore, as of 2009, one in five practices had eliminated access to physicians by pharmaceutical representatives

82


Table of Contents


due to increasing time pressure and many more had imposed additional scheduling restrictions. As a result, many pharmaceutical companies are reducing the size of their sales forces. These companies are seeking cost-effective ways to access physicians that both augment and replicate the services traditionally provided by pharmaceutical sales representatives.

Electronic health records

The Health Information Technology for Economic and Clinical Health Act, or HITECH Act, passed as part of the American Recovery and Reinvestment Act of 2009, was intended to fund and incentivize the adoption of Electronic Health Records, or EHR, by physicians. By 2016, $19.2 billion of government subsidies for EHR implementation are expected to be distributed.

EHR systems have had limited adoption by physicians due to the required information technology resource investment, usability concerns and potential workflow disruption. While EHR adoption is increasing, as of 2009, solo and small group practices had the lowest rate of adoption. According to Software Advice, 94% of office-based physicians did not have a fully functional EHR, as of 2009. Solo and small group practices are seeking a cost-effective, easy to implement and remotely-hosted product. This segment of the physician population has been the most difficult for EHR companies to access, resulting in high client acquisition costs.

Our solutions

Physicians

Our proprietary drug reference content is current, relevant and reliable.    We provide healthcare professionals with access to current drug and clinical information, specifically edited and formatted for use at the point of care. Our in-house team of pharmacists and physicians proactively collect, analyze and distribute relevant drug information that physicians need to make more informed clinical decisions.

We improve patient safety by reducing adverse drug events.    Physicians report that the use of our proprietary drug reference tool reduces the likelihood of adverse drug events and improves patient safety. More than 50% of physician users reported avoiding one or more medical errors every week, according to a survey conducted by Epocrates of over 2,800 physician users, or the 2010 Epocrates Study. The majority of physicians surveyed stated that Epocrates content has prompted a change in a prescribing decision, primarily to avoid potential drug interactions or adverse effects.

We improve practice productivity.    Over 40% of physician users reported saving more than 20 minutes per day using our drug reference tool, according to the 2010 Epocrates Study. For example, the formulary coverage information in our products can improve physicians' productivity by reducing the time required to determine appropriate, cost-effective prescriptions and decrease the number of pharmacy call-backs. Physicians refer to Epocrates numerous times throughout the day for quick access to clinical information.

We are available on all major mobile platforms in the United States.    We offer our drug reference tool on a broad array of mobile devices in order to provide physicians with flexibility in their choice of mobile platform. In addition, our support of all major U.S. mobile platforms helps us strengthen and maintain our network of healthcare professionals. In February 2010, we launched new products for the Google Android and Palm webOS platforms and have experienced significant early adoption from physicians. According to the SDI Mobile Study, 90% of physicians downloading medical applications to their mobile device downloaded Epocrates products.

83


Table of Contents

Pharmaceutical companies

We provide a targeted and controlled communication channel to physicians.    Through our interactive services, we provide access to physicians segmented by medical specialty and other characteristics allowing for more targeted communications. We believe that our communication channel offers less variability in information delivery to physicians than traditional detailing methods. The electronic delivery of our messaging results in consistent, focused and reliable communications with physicians. Additionally, we believe our established trust with physicians and knowledge of their information preferences increases the willingness of physicians to accept communications from pharmaceutical companies.

We provide services that augment and replicate sales representative activities.    Our Virtual Representative Services, including drug detailing, sampling, patient literature delivery and the ability to contact drug manufacturers are designed to supplement, and in some cases replicate, the activities of pharmaceutical sales representatives. Electronic promotional activities are more cost-effective than traditional sales calls for detailing. Our interactive services enable pharmaceutical companies to achieve returns on their marketing investments, increase the reach and frequency of interactions with prescribing physicians on new, niche and established brands, and more effectively support underserved geographic markets.

Our solutions generate significant return on investment and repeat business.    Communications to physicians through our DocAlert messaging service create significant return on investment for pharmaceutical companies in the form of increased prescription volume and accurate message recall. Our demonstrated return on investment results in repeat and expanded business from our pharmaceutical clients. Approximately 60% of our pharmaceutical clients have multiple contracts with us and our top 10 clients by revenue in 2009 have worked with us for an average of over seven and a half years.

Electronic health records

We are developing an affordable, easy-to-use EHR product that will serve the needs of solo and small group practices and will allow users to qualify for subsidies under the HITECH Act. We believe our experience developing information technology tools used at the point of care by physicians provides us the insight and experience to deliver a product that physicians will find easy to learn and use. We will offer our EHR product in a hosted, software-as-a-service, or SaaS, manner. We believe our SaaS delivery model, coupled with our monthly subscription business model, effectively replaces the large, front-loaded cost, typical of most traditional licensed enterprise software deployments, with a lower risk, pay-as-you-go model. As a result, we believe our EHR solution will require lower initial investment in third-party software, hardware and implementation services, and will have lower ongoing support costs than traditional enterprise software. In addition, our trusted reputation and ability to communicate with our network of over 300,000 physicians can result in low client acquisition costs for us.

Our strengths

We believe that we have the following key competitive strengths:

Recognized and trusted brand with healthcare professionals

Our brand is recognized and endorsed among healthcare professionals as a trusted and accurate source of drug and clinical information. According to a user satisfaction survey conducted by Epocrates in 2010, or the Epocrates 2010 Survey, 85% of respondents indicated that they were "very likely" or "likely" to recommend Epocrates to a colleague. Furthermore, over 50% of respondents had recommended Epocrates six or more times in the past year. Epocrates is the preferred mobile provider to facilitate communication between physicians and pharmaceutical companies, according to the SDI

84


Table of Contents


Mobile Study. We believe our trusted brand has contributed significantly to the growth of our network and our revenues.

Large and active network

Our large and active user network is a valuable asset for our business. We currently have over one million active healthcare professional users, including over 45% of U.S. physicians. We define an active user as an individual who has used our drug reference tool or services within a defined time period or subscribes to a premium clinical information product. Epocrates products are widely used by general and specialty physicians, with high penetration among emergency medicine (71%), family practice (58%) and cardiology (52%) physician populations, as estimated by Epocrates based on data from the American Medical Association and the Bureau of Labor Statistics. Additionally, we have extensive geographic reach with users in all 50 states. Across these demographics, Epocrates has become an integral part of the daily clinical workflow of users in our network, resulting in frequent use of our products and services. Approximately, 75% of physicians using Epocrates products access the content daily, with 43% of them using it four or more times per day, according to the Kantar Media Professional Health Non-Journal Media June 2010 Study.

Our current users play an important role in driving network growth through referrals to potential new users. In 2005, we established the Epocrates Advocate Program in which enthusiastic and influential healthcare professionals in our network promote the use of mobile medical technology and Epocrates' solutions. According to the Epocrates 2010 Survey, nearly 70% of the respondents were referred to Epocrates by a colleague, friend or medical school. For these reasons, we believe the breadth and loyalty of our user network are not easily replicated.

Proprietary drug reference tools

We select and format our drug and clinical content to provide healthcare professionals with information wherever and whenever they need it. Our proprietary drug content is developed and continually updated by a team of physicians and pharmacists who work to ensure accuracy and relevance. This team also works to provide objective and reliable information to our network. To develop our drug content, our team researches and reviews primary literature, specialty society recommendations, evidence-based medicine, clinical guidelines and manufacturer labeling. Our content is then formatted expressly for display on mobile devices to ensure integration with our users' workflow. We believe the quality, relevance and ease of use of our content drive our ability to attract and retain users.

Powerful business model

Our user network is primarily composed of healthcare professionals who access our free drug reference content. A smaller percentage of our users purchase one or more of our premium drug and clinical reference tools. Regardless of whether a healthcare professional pays for a subscription or uses our free version, our network provides a base for generating multiple revenue streams from healthcare industry clients. By providing our healthcare clients, primarily pharmaceutical companies, with opportunities to engage with our network of physicians, we monetize our network while incurring limited incremental expenses. In addition, we believe our revenue generating services enhance the product offerings to our users with additional free content that they may elect to download. We believe the power of our business model will increase as we strengthen our network and as our pharmaceutical clients shift more of their promotional spending to electronic communications.

Proven technology architecture

Our mobile products are not dependent on continuous access to the Internet, and therefore are fast and accessible to our users. For a substantial majority of our users, our drug and clinical reference tools reside directly on their mobile device. As a result, access to our clinical information by these users

85


Table of Contents


at the point of care is not subject to interruption or lags in Internet service. Our infrastructure is designed to seamlessly control and deploy robust and customized content to a large number of users, allowing for simple and efficient downloads and updates of our clinical information. Additionally, our products have been refined over the past ten years based on feedback from and usage data generated by our large network of healthcare professionals. We believe these attributes continue to be significant advantages in supporting our network.

Extensive industry relationships

We have developed relationships with key participants in the healthcare industry. Our large client base provides diversification across the healthcare industry and includes:

Pharmaceutical companies.  All of the top 20 global pharmaceutical companies by sales have worked with us to communicate to physicians. To date, we have entered into contracts covering over 350 individual brands. We deliver clinical messages for pharmaceutical brands on topics such as new drug indications, approvals and clinical findings. We continuously identify physician information needs and collaborate with our pharmaceutical clients to develop solutions that meet such needs and achieve specific marketing objectives.

Market research companies.  Over 250 market research firms have used our services to recruit healthcare professionals for market research surveys on behalf of the healthcare and financial services industries.

Healthcare payors.  Over 100 commercial and Medicaid health insurance plan clients, covering approximately 100 million lives, have paid us to host and disseminate their formulary information. In addition, we work with the Centers for Medicare and Medicaid Services, or CMS, to provide clinicians with insurance coverage information for all Medicare Part D plans.

In 2009, no one client represented more than 10% of our total net revenue.

We also have relationships with other important healthcare organizations, including:

Medical schools and associations.  Over 60% of the U.S. accredited medical schools distribute our premium products for free to their students. We also have marketing arrangements with over 26 leading state and national specialty associations to educate their members about our products.

Government agencies.  We collaborate with government agencies such as the Food and Drug Administration, or FDA, Centers for Disease Control, or CDC, and Agency for Healthcare Research and Quality, or AHRQ, to disseminate clinical information to healthcare professionals through our messaging system as a public service. Our medical editors review new guidelines and announcements from these agencies to share with our users to provide a concise source of clinical information.

Experienced management team

Our management team includes experienced healthcare, pharmaceutical and information technology industry executives. We benefit from their operational experience, thorough understanding of the marketplace and extensive relationships with pharmaceutical companies and other existing and potential clients.

86


Table of Contents

Our strategy

Our strategy is to strengthen our leadership position as a provider of proprietary drug reference and other point of care tools to healthcare professionals. Helping physicians and other healthcare professionals improve patient care, reduce medical errors and save time is central to the success of our business, and is our highest priority. By expanding our service offerings, we will provide pharmaceutical companies additional opportunities to more effectively engage with our user network. Key elements of our strategy include:

Strengthen and maintain our network

We believe that our focus on the needs of healthcare professionals is the foundation of our success and is critical to the growth of our business. We plan to strengthen our network by continuing to deliver innovative products for healthcare professionals that easily integrate into their workflow, thereby providing information wherever and whenever they need it. We intend to meet healthcare professionals' evolving needs by continuing to invest significant clinical, product development and marketing resources in our products. We strive to continually enhance the clinical functionality and efficiency of our products, both free and paid, through new content and features to help our growing and diverse network.

We recognize the importance of the Apple platform, as represented by the strong adoption to date and continued user growth trend. To continue supporting the needs of clinicians who choose this platform, further exploit the power of it and expand our offerings, we acquired Modality, Inc. Modality is a premier developer of digital learning, assessment, training and reference applications for Apple mobile devices. The acquisition will expand Epocrates' product portfolio and accelerate the delivery of innovative clinical solution