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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                   

 

Commission file number: 001-35062

 

Epocrates, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

 

94-3326769
(I.R.S. Employer
Identification No.)

 

1100 Park Place, Suite 300

San Mateo, California 94403

(Address of principal executive offices, including zip code)

 

(650) 227-1700

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares of common stock outstanding as of May 1, 2012 was 24,634,962.

 

 

 




Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item1. Financial Statements

 

EPOCRATES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETSUNAUDITED

(in thousands, except for par value)

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

72,765

 

$

75,326

 

Short-term investments

 

8,878

 

9,897

 

Accounts receivable, net of allowance for doubtful accounts of $71 and $85, respectively

 

23,127

 

22,748

 

Deferred tax asset

 

7,390

 

7,390

 

Prepaid expenses and other current assets

 

4,508

 

3,218

 

Total current assets

 

116,668

 

118,579

 

Property and equipment, net

 

7,554

 

7,283

 

Deferred tax asset

 

713

 

1,280

 

Goodwill

 

17,959

 

17,959

 

Other intangible assets, net

 

5,763

 

6,771

 

Other assets

 

354

 

352

 

Total assets

 

$

149,011

 

$

152,224

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

2,209

 

$

3,282

 

Deferred revenue

 

45,369

 

46,429

 

Other accrued liabilities

 

7,700

 

9,600

 

Total current liabilities

 

55,278

 

59,311

 

Deferred revenue, less current portion

 

8,565

 

8,088

 

Other liabilities

 

1,566

 

1,893

 

Total liabilities

 

65,409

 

69,292

 

Commitments and contingencies (Note 9)

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred stock: $0.001 par value; 10,000 shares authorized; no shares issued and outstanding at March 31, 2012 and December 31, 2011

 

 

 

Common stock: $0.001 par value; 100,000 shares authorized; 24,627 and 24,370 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively

 

25

 

24

 

Additional paid-in capital

 

131,346

 

129,238

 

Accumulated other comprehensive loss

 

(3

)

(2

)

Accumulated deficit

 

(47,766

)

(46,328

)

Total stockholders’ equity

 

83,602

 

82,932

 

Total liabilities and stockholders’ equity

 

$

149,011

 

$

152,224

 

 

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

 

3



Table of Contents

 

EPOCRATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS – UNAUDITED

(in thousands, except per share data)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Subscription revenues

 

$

4,676

 

$

6,209

 

Interactive services revenues

 

22,855

 

22,968

 

Total revenues, net

 

27,531

 

29,177

 

 

 

 

 

 

 

Cost of subscription revenues

 

1,949

 

2,043

 

Cost of interactive services revenues

 

8,338

 

7,347

 

Total cost of revenues (1)

 

10,287

 

9,390

 

Gross profit

 

17,244

 

19,787

 

 

 

 

 

 

 

Operating expenses (1):

 

 

 

 

 

Sales and marketing

 

6,082

 

7,121

 

Research and development

 

4,921

 

5,020

 

General and administrative

 

4,986

 

6,257

 

Facilities exit costs

 

 

560

 

Change in fair value of contingent consideration

 

 

506

 

Total operating expenses

 

15,989

 

19,464

 

Income from operations

 

1,255

 

323

 

Interest income

 

6

 

28

 

Other income, net

 

1

 

2

 

Income before income taxes

 

1,262

 

353

 

Benefit from (provision for) income taxes

 

141

 

(152

)

Income from continuing operations

 

1,403

 

201

 

Loss from discontinued operations, net of tax (1) 

 

(2,841

)

(1,326

)

Net loss

 

(1,438

)

(1,125

)

Unrealized losses on available-for-sale securities, net

 

(1

)

 

Comprehensive loss

 

(1,439

)

(1,125

)

 

 

 

 

 

 

Net loss attributable to common stockholders – basic and diluted

 

$

(1,438

)

$

(1,419

)

 

 

 

 

 

 

Net income (loss) per share – basic and diluted

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.06

 

$

(0.01

)

Discontinued operations, net of tax

 

(0.12

)

(0.07

)

Net loss per share attributable to common stockholders

 

$

(0.06

)

$

(0.08

)

 

 

 

 

 

 

Weighted average common shares outstanding basic

 

24,775

 

17,839

 

Weighted average common shares outstanding – diluted

 

25,258

 

20,146

 

 


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

 

Cost of revenues

 

$

49

 

$

107

 

Sales and marketing

 

202

 

747

 

Research and development

 

198

 

391

 

General and administrative

 

1,009

 

1,562

 

Discontinued operations

 

11

 

 

 

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

 

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Table of Contents

 

EPOCRATES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – UNAUDITED

(in thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(1,438

)

$

(1,125

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

 

 

 

 

 

Stock-based compensation

 

1,469

 

2,807

 

Depreciation and amortization

 

964

 

992

 

Amortization of intangible assets

 

1,008

 

1,030

 

Allowance for doubtful accounts and sales returns reserve

 

(14

)

70

 

Facilities exit costs

 

 

560

 

Contingent consideration expense

 

 

301

 

Changes in assets and liabilities, net of effect of acquisitions:

 

 

 

 

 

Accounts receivable

 

(365

)

(350

)

Deferred tax asset, current and noncurrent

 

240

 

 

Prepaid expenses and other assets

 

(1,292

)

(1,403

)

Accounts payable

 

(865

)

(936

)

Deferred revenue

 

(583

)

3,970

 

Other accrued liabilities and other payables

 

(1,953

)

338

 

Net cash (used in) provided by operating activities

 

(2,829

)

6,254

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(1,691

)

(2,711

)

Purchase of short-term investments

 

(1,482

)

(5,509

)

Sale of short-term investments

 

 

500

 

Maturity of short-term investments

 

2,500

 

7,950

 

Net cash (used in) provided by investing activities

 

(673

)

230

 

Cash flows from financing activities:

 

 

 

 

 

Net cash proceeds from issuance of common stock

 

 

64,208

 

Payment of accrued dividends on Series B mandatorily redeemable convertible preferred stock

 

 

(29,586

)

Proceeds from exercise of common stock options

 

941

 

326

 

Net cash provided by financing activities

 

941

 

34,948

 

Net (decrease) increase in cash and cash equivalents

 

(2,561

)

41,432

 

Cash and cash equivalents at beginning of period

 

75,326

 

35,987

 

Cash and cash equivalents at end of period

 

$

72,765

 

$

77,419

 

Non-Cash Investing and Financing Activities:

 

 

 

 

 

Unrealized loss on available-for-sale securities, net of tax effect

 

 

(1

)

Accrued purchase of property and equipment and other assets

 

482

 

622

 

Conversion of mandatorily redeemable convertible preferred stock into common stock

 

 

44,011

 

Reclassification of costs of issuance of common stock from prepaid and other current assets

 

 

2,025

 

 

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

 

5


 


Table of Contents

 

EPOCRATES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Background

 

Epocrates, Inc. (the “Company”) was incorporated in California in August 1998 as nCircle Communications, Inc. In September 1999, the Company changed its name to ePocrates, Inc., and in May 2006, the Company reincorporated in Delaware and changed its name to Epocrates, Inc.

 

The Company is a leading physician platform for essential clinical content, practice tools and health industry engagement at the point of care. Most commonly used on mobile devices at the point of care, the Company’s products help healthcare professionals make more informed prescribing decisions, enhance patient safety and improve practice productivity. Through the Company’s interactive services, it provides the healthcare industry, primarily pharmaceutical companies, opportunities to engage with its user network through delivery of targeted information and to conduct market research.

 

Initial Public Offering (“IPO”)

 

On February 1, 2011, the Company’s registration statement on Form S-1 (File No. 333-168176) was declared effective for its IPO, pursuant to which it registered the offering and sale of 5,360,000 shares of common stock at a public offering price of $16.00 per share and an aggregate offering price of $85.8 million, of which 3,574,285 shares were sold by the Company for an aggregate offering price of $57.2 million, and 1,785,715 shares were sold by the selling stockholders for an aggregate offering price of $28.6 million. On February 3, 2011, the overallotment option of 804,000 shares was exercised at a price of $16.00 per share for an aggregate of $12.9 million, all of which were sold by the Company, and the offering was completed with all of the shares subject to the registration statement having been sold.

 

As a result of the Company’s IPO and the exercise of the overallotment option on February 3, 2011, both of which closed on February 7, 2011, the Company received net proceeds of approximately $62.2 million, after underwriting discounts and commissions of $4.9 million. In addition, the Company incurred other expenses associated with its IPO of approximately $3.0 million. From these proceeds, aggregate cumulative dividends to the holders of Epocrates’ Series B preferred stock were paid in full, in the amount of approximately $29.6 million. Upon the consummation of the IPO, the outstanding shares of the Company’s preferred stock were converted into an aggregate of 11,089,201 shares of common stock.

 

After the completion of the IPO on February 7, 2011, the Company amended its certificate of incorporation and increased its authorized number of shares of common stock to 100,000,000 and reduced the authorized number of shares of preferred stock to 10,000,000. The Company also established the par value of each share of common and preferred stock to be $0.001 per share.

 

Common Stock Split

 

An Amended and Restated Certificate of Incorporation for a 1-for-0.786 reverse split approved by the Company’s Board of Directors on November 18, 2010, was filed with the Delaware Secretary of State on January 28, 2011 and was effected upon the closing of the IPO. All information related to common stock, stock options, restricted stock units (“RSUs”) and earnings per share, as well as all references to preferred stock or preferred stock warrants as converted into common stock, has been retroactively adjusted to give effect to the reverse split.

 

2. Summary of Significant Accounting Policies

 

Unaudited Interim Financial Information

 

The accompanying condensed consolidated financial statements and the notes to the condensed consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 are unaudited. These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended December 31, 2011, included in the Annual Report on Form 10-K filed with the SEC on March 19, 2012. The condensed consolidated balance sheet as of December 31, 2011 included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP.

 

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The interim financial data as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 is unaudited. In the opinion of management, the interim data includes all adjustments, consisting only of normal, recurring adjustments, necessary for the fair statement of the results for the interim periods. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2012 or any other future period.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates, and such differences could be material.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to credit risk consist principally of cash, cash equivalents, short-term investments and accounts receivable.

 

The Company limits its concentration of risk in cash equivalents and short-term investments by diversifying its investments among a variety of industries and issuers. The primary goals of the Company’s investment policy are, in order of priority, preservation of principal, liquidity and current income. The Company’s professional portfolio managers adhere to this investment policy as approved by the Company’s Board of Directors. Cash and cash equivalents and short-term investments are deposited at financial institutions or invested in securities that management believes are of high credit quality.

 

The Company’s investment policy is to invest only in fixed income instruments denominated and payable in U.S. dollars. Investments in obligations of the U.S. government and its agencies, money market instruments, commercial paper, certificates of deposit, bankers’ acceptances, corporate bonds of U.S. companies, municipal securities and asset-backed securities are allowed. The Company does not invest in auction rate securities, future 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 million, whichever is greater, although securities issued by the U.S. Treasury and U.S. government agencies are specifically exempted from these restrictions. Issue size is typically greater than $50 million for corporate bonds. No single position in any issue will equal more than 10% of that issue. The final maturity of each security within the portfolio shall not exceed 24 months.

 

The Company’s accounts receivable are derived from clients located principally in the U.S. The Company performs a regular review of its clients’ payment histories and associated credit risks and does not require collateral from its clients. The Company has not experienced significant credit losses from its accounts receivable. There was one client that accounted for more than 10% of accounts receivable, net and one client that accounted for more than 15% of accounts receivable, net as of March 31, 2012. One client accounted for 15% of accounts receivable, net as of December 31, 2011.

 

The Company’s revenue is derived primarily from clients in the healthcare industry (e.g., pharmaceutical companies, managed care companies and market research firms) within the U.S. For the quarter ended March 31, 2012, one client accounted for approximately 12% of total revenues, net. For the quarter ended March 31, 2011, no single client accounted for more than 10% of total revenues, net.

 

Software Development Costs

 

Software development costs incurred in conjunction with product development are charged to research and development expense until technological feasibility is established. Thereafter, until the product is released for sale, software development costs are capitalized and reported at the lower of unamortized cost or net realizable value of the related product. The Company does not consider a product in development to have passed the technological feasibility milestone until the Company has completed a model of the product that contains essentially all the functionality and features of the final product and has tested the model to ensure that it works as expected.  The Company previously capitalized software development costs upon technical feasibility for the electronic health record (“EHR”) solution until it announced its decision to discontinue the EHR business. Capitalized costs of $0.3 million incurred in the first quarter of 2012 up until the date of the announcement were reclassified to loss from discontinued operations in the Company’s condensed consolidated statements of comprehensive loss.

 

Internal Use Software and Website Development Costs

 

With regard to software developed for internal use and website development costs, the Company expenses all costs incurred that relate to planning and post-implementation phases of development. Costs incurred in the development phase are capitalized and amortized over the product’s estimated useful life which is generally three years. For the three months ended March 31, 2012 and 2011, the

 

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Company capitalized $0.7 million and $0.8 million, respectively, of software development costs related to software for internal use and website development costs. Internal software development costs are generally amortized on a straight-line basis over three years beginning with the date the software is placed into service. Amortization of software developed for internal use was $0.4 million for the three months ended March 31, 2012 and $0.5 million for the three months ended March 31, 2011. Amortization of internal use software is reflected in cost of revenue. Costs associated with minor enhancement and maintenance of the Company’s website are expensed as incurred.

 

Facilities Exit Costs

 

The Company vacated the East Windsor, New Jersey office in the first quarter of 2011 and relocated its New Jersey operations to Ewing, New Jersey. The Company had entered into a non-cancellable lease with the landlord which does not expire until the end of fiscal year 2012. The Company was, therefore, liable to make monthly lease payments under the contract until the termination of the lease. The liability recorded at fair value is based on the present value of the remaining lease rentals and is reduced for the estimated sublease rentals that could be reasonably obtained for the property. The Company recorded a charge of approximately $0.6 million in the three months ended March 31, 2011 relating to the East Windsor facility exit costs.

 

Segment Information

 

Previously, the Company had two reportable segments: Subscriptions and Interactive Services, and EHR. On February 24, 2012, the Audit Committee of the Board of Directors of the Company, as authorized by the Board of Directors, approved the discontinuation of Epocrates’ EHR business. Upon the approval, the Company qualified for discontinued operations presentation under GAAP, and at such time, the EHR reportable segment results were reported in loss from discontinued operations on the Company’s condensed consolidated statements of comprehensive loss. Prior period amounts have been revised in order to conform to the current period presentation. Substantially all of the Company’s revenues and all of the Company’s long-lived assets are located in the U.S.

 

Recent Accounting Pronouncements

 

In May 2011, the FASB issued new accounting guidance that amends some fair value measurement principles and disclosure requirements. The new guidance states that the concepts of highest and best use and valuation premise are only relevant when measuring the fair value of non-financial assets and prohibits the grouping of financial instruments for purposes of determining their fair values when the unit of account is specified in other guidance. Early application is not permitted for public companies. The Company adopted this guidance in the first quarter of 2012. The adoption of this guidance did not have an effect on the Company’s condensed consolidated financial statements.

 

In June 2011, the FASB issued new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. In December 2011, the FASB issued revised accounting guidance, which deferred the guidance relating to the presentation of reclassification adjustments. All other requirements of the previously issued guidance were not affected by the issuance of this revised guidance. The amendments to the guidance should be applied retrospectively. For public entities, the amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted. The Company adopted this guidance in the first quarter of 2012. The adoption of this guidance did not have a material financial effect on the Company’s consolidated financial statements.

 

In September 2011, the FASB issued new accounting guidance intended to simplify goodwill impairment testing. Entities will be allowed to perform a qualitative assessment on goodwill impairment to determine whether a quantitative assessment is necessary. This guidance is effective for the Company’s interim and annual periods beginning January 1, 2012. Early adoption of the standard is permitted. The Company adopted this guidance in the first quarter of 2012. The adoption of this guidance did not have a material financial effect on the Company’s condensed consolidated financial statements.

 

3. Net Income (Loss) Per Share

 

In February 2011, all of the Company’s outstanding convertible preferred stock converted into common stock in connection with the IPO. Prior to the conversion, holders of Series A and Series C convertible preferred stock were entitled to receive 8% per annum non-cumulative dividends. Holders of Series B preferred stock were entitled to receive 8% per annum cumulative dividends.

 

In 2011, basic and diluted net loss per share attributable to common stockholders was presented in conformity with the “two-class method” required for participating securities. Under the two-class method, basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the sum of the weighted average number of common shares outstanding during the period, net of shares subject to repurchase. Net income (loss) attributable to common stockholders is calculated as net

 

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income (loss) less the preferred stock dividend for the period. Due to the Company’s presentation of the EHR results in discontinued operations, a similar calculation was performed for the 2011 per share income from continuing operations. Basic income from continuing operations per share is computed by subtracting the preferred stock dividend for the period from income from continuing operations and dividing that amount by the weighted average number of common shares outstanding.

 

Diluted net loss per share gives effect to the impact of potentially dilutive securities, which consist of convertible preferred stock, stock options, RSUs and warrants. The dilutive effect of outstanding stock options, warrants and RSUs is computed using the treasury stock method. The computation of diluted net loss per share does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on earnings.

 

The following table presents the calculations of basic and diluted net loss per share (in thousands, except per share data):

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Numerator:

 

 

 

 

 

Income from continuing operations

 

$

1,403

 

$

201

 

Loss from discontinued operations, net of tax

 

(2,841

)

(1,326

)

Net loss

 

$

(1,438

)

$

(1,125

)

Less: Accrued dividend on Series B mandatorily redeemable convertible preferred stock plus an 8% non-cumulative dividend on Series A and Series C mandatorily redeemable convertible preferred stock

 

 

294

 

Net loss attributable to common stockholders

 

$

(1,438

)

$

(1,419

)

Denominator:

 

 

 

 

 

Weighted average number of common shares outstanding – basic

 

24,775

 

17,839

 

Weighted average number of common shares outstanding – diluted

 

25,258

 

20,146

 

Net income (loss) per share – basic and diluted

 

 

 

 

 

Continuing operations

 

$

0.06

 

$

(0.01

)

Discontinued operations

 

(0.12

)

(0.07

)

Net loss per share attributable to common stockholders

 

$

(0.06

)

$

(0.08

)

 

For the three months ended March 31, 2012, anti-dilutive securities were not included in the calculation of fully diluted per share loss from discontinued operations and net loss, and for the three months ended March 31, 2011, anti-dilutive securities were not included in the calculation of fully diluted per share income from continuing operations, loss from discontinued operations and net loss, as the effect would have been anti-dilutive. The table that follows outlines securities that were anti-dilutive for the three months ended March 31, 2012 and 2011 (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Weighted average common stock warrants

 

17

 

17

 

Weighted average outstanding unexercised options and RSUs

 

3,881

 

6,340

 

Weighted average mandatorily redeemable convertible preferred stock

 

 

3,943

 

Total weighted average anti-dilutive shares

 

3,898

 

10,300

 

 

4. Fair Value Measurements

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (the “exit price”) in an orderly transaction between market participants at the measurement date. A three level hierarchy is applied to prioritize the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

 

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The fair value hierarchy prioritizes the inputs into three broad levels:

 

Level 1 – Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2 – Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

 

Level 3 – Inputs are unobservable inputs based on the Company’s assumptions.

 

The following table represents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 and the basis of that measurement (in thousands):

 

As of March 31, 2012

 

Total Fair
Value

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Money market funds

 

$

11,338

 

$

11,338

 

$

 

$

 

Short-term investments (See Note 5):

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

5,867

 

5,867

 

 

 

Obligations of U.S. corporations

 

1,962

 

 

1,962

 

 

Obligations of Non-U.S. corporations

 

1,049

 

 

1,049

 

 

Total short-term investments

 

8,878

 

5,867

 

3,011

 

 

TOTAL FINANCIAL ASSETS

 

$

20,216

 

$

17,205

 

$

3,011

 

$

 

 

As of December 31, 2011

 

Total Fair
Value

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Money market funds

 

$

10,310

 

$

10,035

 

$

275

 

$

 

Short-term investments (See Note 5):

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

6,219

 

6,219

 

 

 

Obligations of U.S. corporations

 

2,630

 

 

2,630

 

 

Obligations of Non-U.S. corporations

 

1,048

 

 

1,048

 

 

Total short-term investments

 

9,897

 

6,219

 

3,678

 

 

TOTAL FINANCIAL ASSETS

 

$

20,207

 

$

16,254

 

$

3,953

 

$

 

 

The Company’s financial instruments, including cash equivalents, accounts receivable and accounts payable, are carried at cost, which approximates fair value due to the short-term nature of those instruments.

 

Money market funds are considered Level 1 investments under the GAAP fair value hierarchy because fair value inputs are unadjusted quoted prices in active markets for identical assets or liabilities. As of March 31, 2012, obligations of U.S. government agencies are also considered Level 1 investments. The remainder of the Company’s short-term investments are considered Level 2 investments under the GAAP fair value hierarchy because the fair value inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

 

During the first quarter of 2012, the Company corrected the classification of its U.S. government agency obligations, reported as Level 2 investments for the year ended December 31, 2011, and began reporting such obligations as Level 1 in order to conform to current period presentation. The Company concluded that the classification and disclosure of these investments as Level 1 is appropriate. Other than disclosed above, during the quarters ended March 31, 2012 and December 31, 2011, there were no material transfers between Level 1 and Level 2 fair value instruments.

 

5. Short-Term Investments

 

Marketable securities are classified as available-for-sale. These securities are reported at fair value with any changes in market value reported as a part of comprehensive income. Premiums (discounts) are amortized (accreted) to interest income over the life of the investment. Marketable securities are classified as short-term investments if the remaining maturity from the date of purchase is in excess of 90 days.

 

The Company determines the fair value amounts by using available market information. As of March 31, 2012 and December 31, 2011, the average contractual maturity was less than one year and the contractual maturity of any single investment did not exceed 12 months.

 

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As of March 31, 2012 and December 31, 2011, unrealized gains and losses on available-for-sale securities can be summarized as follows (in thousands):

 

March 31, 2012

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

Cash, Cash Equivalents and Available-for-Sale Securities

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

5,869

 

$

 

$

(2

)

$

5,867

 

Obligations of U.S. corporations

 

1,962

 

1

 

(1

)

1,962

 

Obligations of Non-U.S. corporations

 

1,049

 

 

 

1,049

 

Money market funds

 

11,338

 

 

 

11,338

 

Cash

 

61,427

 

 

 

61,427

 

 

 

$

81,645

 

$

1

 

$

(3

)

$

81,643

 

Amounts included in cash and cash equivalents

 

$

72,765

 

$

 

$

 

$

72,765

 

Amounts included in short-term investments

 

8,880

 

1

 

(3

)

8,878

 

 

 

$

81,645

 

$

1

 

$

(3

)

$

81,643

 

 

December 31, 2011

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

Cash, Cash Equivalents and Available-for-Sale Securities

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

6,494

 

$

1

 

$

(1

)

$

6,494

 

Obligations of U.S. corporations

 

2,633

 

 

(3

)

2,630

 

Obligations of Non-U.S. corporations

 

1,048

 

 

 

1,048

 

Money market funds

 

10,035

 

 

 

10,035

 

Cash

 

65,016

 

 

 

65,016

 

 

 

$

85,226

 

$

1

 

$

(4

)

$

85,223

 

Amounts included in cash and cash equivalents

 

$

75,326

 

$

 

$

 

$

75,326

 

Amounts included in short-term investments

 

9,900

 

1

 

(4

)

9,897

 

 

 

$

85,226

 

$

1

 

$

(4

)

$

85,223

 

 

As of March 31, 2012 and December 31, 2011, the Company’s cash equivalents were primarily in the form of money market funds, and the Company had no significant unrealized gains or losses on any of these investments. Cash equivalents were $11.3 million and $10.3 million as of March 31, 2012 and December 31, 2011, respectively.

 

6. Acquisitions

 

Caretools, Inc. — In connection with the acquisition of Caretools, Inc. on June 23, 2009, the Company recorded contingent consideration of $1.3 million on the acquisition date. This contingent consideration was based on an estimate of revenues to be generated from sales of products developed incorporating Caretools’ technology.

 

As a result of the Company’s decision to pursue strategic alternatives for the EHR business, the Company recorded an impairment charge to write down the carrying value of the contingent consideration liability associated with the EHR business to an estimated fair value of zero during the fourth quarter of 2011. The change in the fair value of the contingent consideration was primarily due to revised estimates of revenues to be derived from the acquired technologies of Caretools, Inc. As of December 31, 2011, the fair value of the contingent consideration liability was zero due to forecasted revenues of zero for the EHR business.

 

MedCafe Inc. — In connection with the acquisition of MedCafe on February 1, 2010, the Company recorded contingent consideration of $14.8 million on the acquisition date. This contingent consideration was based on an estimate of revenues to be generated from sales of products developed incorporating MedCafe technology. In 2011, the Company recorded a decrease in the contingent consideration liability resulting in a gain of approximately $5.9 million for the year ended December 31, 2011. The change in the fair value of the contingent consideration was due primarily to an agreement with the sellers in the second quarter of 2011 to settle the liability for $6.4 million.

 

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7. Intangible Assets

 

Intangible assets excluding goodwill consisted of the following (in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Gross

 

 

 

Net

 

Gross

 

 

 

 

 

Net

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Carrying

 

Accumulated

 

 

 

Carrying

 

 

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Impairment

 

Amount

 

Technology

 

$

11,332

 

$

5,953

 

$

5,379

 

$

11,780

 

$

5,015

 

$

448

 

$

6,317

 

Client relationships

 

34

 

34

 

 

60

 

34

 

26

 

 

Trademarks and trade name

 

41

 

36

 

5

 

50

 

31

 

9

 

10

 

Non-compete agreement

 

867

 

488

 

379

 

870

 

423

 

3

 

444

 

 

 

$

12,274

 

$

6,511

 

$

5,763

 

$

12,760

 

$

5,503

 

$

486

 

$

6,771

 

 

Amortization of intangible assets was $1.0 million for both the three months ended March 31, 2012 and 2011, respectively. Amortization of the acquired intangible assets is reflected in cost of revenues. Amortization for the years ending December 31, 2012 and 2013 is expected to be approximately $4.0 million and $2.8 million, respectively.

 

8. Income Taxes

 

For the three months ended March 31, 2012, the Company recorded an income tax benefit of approximately $0.8 million, of which $0.1 million was allocated to continuing operations, with the balance of $0.7 million allocated to discontinued operations. For the three months ended March 31, 2011, the Company recorded an income tax benefit of $0.8 million, which was comprised of a tax provision of approximately $0.2 million allocated to continuing operations and a tax benefit of $1.0 million allocated to discontinued operations. The income tax benefit during the three months ended March 31, 2012 represented the federal and state statutory rates adjusted for non-deductible stock compensation expense. The income tax provision during the three months ended March 31, 2011 represented the federal and state statutory tax rates adjusted for non-deductible stock compensation expense partially offset by research and development credits.

 

As of March 31, 2012, the amount of interest and penalties associated with the unrecognized tax benefits were insignificant.  The Company does not expect any significant increases or decreases to its unrecognized tax benefits in the next 12 months.

 

9. Commitments and Contingencies

 

Operating Leases

 

Rent expense for the three months ended March 31, 2012 and 2011 was $0.6 and $0.7 million, respectively.

 

The Company leases two office spaces in New Jersey, one in San Mateo, California, and one in Durham, North Carolina under non-cancellable operating leases which expire in December 2012, March 2014, December 2014 and December 2014, respectively. Future minimum lease payments under these leases as of March 31, 2012 are as follows (in thousands):

 

 

 

Operating

 

Years Ending December 31,

 

Leases

 

2012 (remaining 9 months)

 

$

2,146

 

2013

 

2,565

 

2014

 

1,938

 

 

 

$

6,649

 

 

Minimum Royalty and Content License Fee Commitments

 

The Company’s royalty and license fee expenses consist of fees that the Company pays to branded content owners for the use of their intellectual property. Royalty and license fee expenses are expensed as incurred.

 

Typically, the terms of the Company’s royalty agreements call for the Company to pay the content owner either a percentage of sales of subscription products that use such content or are based upon the number of users of subscription products that use such content. However, certain royalty agreements require payment to content owners only after funds are received from the Company’s customers. Payments are due within 30-45 days of the designated royalty period, which is typically either three or six months. Royalty agreements require the Company to report subscription sales data as well as data regarding the number of users for subscription products that use such data. Royalty agreements may initially be signed for multi-year terms, typically two to four years, but convert to automatically renewable one-year agreements after the initial contract term expires.

 

The Company’s contracts with some licensors include minimum guaranteed royalty payments, which are payable regardless of the ultimate sales of subscriptions. Because significant performance remains with the content owner, including the obligation on the part

 

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of the content owner to keep its content accurate and up to date, the Company records royalty payments as a liability when incurred, rather than upon execution of the agreement.

 

Actual royalty expense under such agreements was $1.1 million for both the three months ended March 31, 2012 and 2011. Future minimum payments under various royalty and license fee agreements with vendors as of March 31, 2012 are as follows (in thousands):

 

Years Ending December 31,

 

Royalty and
Content License
Fee Commitments

 

2012 (remaining 9 months)

 

$

3,466

 

2013

 

2,642

 

2014

 

1,318

 

 

 

$

7,426

 

 

Other Commitments

 

The Company has contracts with individuals and firms to provide product development and content development work and other consulting services. The contracts are terminable without cause by Epocrates subject to 15 days prior notice, and therefore the Company’s obligation under these contracts is limited to estimated fees, as outlined in each contract, for 15 days. Epocrates’ obligation under these commitments was $.02 million as of March 31, 2012. The Company expects to pay such fees during the second quarter of 2012.

 

Subscription Cancellation Reserve

 

If a paid user is unsatisfied for any reason during the first 30 days of the subscription and wishes to cancel the subscription, the Company will provide a full refund. Refunds made by the Company under this obligation have not been material during the periods presented and have been within management’s expectations. The Company maintains a reserve for estimated future returns based on historical data. The provision for estimated future returns is included in other accrued liabilities.

 

Legal Matters

 

On February 25, 2011, the Company received a letter from the SEC informing it that the SEC was conducting an investigation and attaching a subpoena for certain information and documents related to the Company’s expert network services, including its relationship with Hudson Street Services, a Goldman, Sachs & Co. business. On January 5, 2012, the Company received a letter from the SEC notifying the Company that the SEC had terminated its inquiry regarding Epocrates’ expert network services and that no enforcement action has been recommended.

 

From time to time, the Company 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, the Company records 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, rulings, 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 or if a loss becomes probable and estimable, there exists the possibility of a material adverse impact on the Company’s results of operations, balance sheet or cash flows.

 

Indemnification

 

The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to the agreements, each party may indemnify, defend and hold the other party harmless with respect to such claim, suit or proceeding brought against it by a third party alleging that the indemnifying party’s intellectual property infringes upon the intellectual property of the third party, or results from a breach of the indemnifying party’s representations and warranties or covenants, or that results from any acts of negligence or willful misconduct. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, the Company has not been obligated to make significant payments for these obligations and no liabilities have been recorded for these obligations on the condensed consolidated balance sheets as of March 31, 2012 or December 31, 2011.

 

The Company also indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer is or was serving at the Company’s request in such capacity. The maximum amount of potential future indemnification is unlimited;

 

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however, the Company has a Director and Officer Insurance Policy that limits its exposure and enables the Company to recover a portion of any future amounts paid. Historically, the Company has not been obligated to make any payments for these obligations and no liabilities have been recorded for these obligations on the balance sheet as of March 31, 2012 or December 31, 2011.

 

Other Contingencies

 

The Company is subject to claims and assessments from time to time in the ordinary course of business. The Company’s management does not believe that any such matters, individually or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

10. Equity Award Plans and Stock-Based Compensation

 

In August 1999, the Company’s Board of Directors adopted and the stockholders approved, the 1999 Stock Option Plan (“1999 Plan”). In May 2009, the Board of Directors adopted and the stockholders approved, an amendment and restatement of the 1999 Plan, the 2008 Equity Incentive Plan (“2008 Plan”). In July 2010, the Company’s Board of Directors adopted the 2010 Equity Incentive Plan (“2010 Plan” and together with the 1999 Plan and the 2008 Plan, the “Plans”). The 2010 Plan was most recently amended by the Board of Directors on December 22, 2010 and was approved by the Company’s stockholders on January 5, 2011. The 2010 Plan became effective upon the completion of the IPO. Awards granted after May 2009 but before the adoption of the 2010 Incentive Plan continue to be governed by the 2008 Plan. All outstanding stock awards granted prior to May 2009 continue to be governed by the terms of the Company’s 1999 Plan.

 

The 2010 Plan provides for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock awards, RSU awards, performance stock awards and other stock awards. In addition, the 2010 Plan provides for the grant of performance cash awards. The Company may issue incentive stock options (“ISOs”) only to its employees. Non-qualified stock options (“NQSOs”) and all other awards may be granted to employees, directors and consultants. ISOs and NQSOs are granted to employees with an exercise price equal to the market price of the Company’s common stock at the date of grant, as determined by the Company’s Board of Directors. Stock options granted to employees generally have a contractual term of 10 years and vest over five years of continuous service, with 25 percent of the stock options vesting on the one-year anniversary of the date of grant and the remaining 75 percent vesting in equal monthly installments over the 48-month period thereafter.

 

The number of shares of the Company’s common stock reserved for issuance under the 2010 Plan will automatically be increased annually on January 1st of each year, starting on January 1, 2012 and continuing through January 1, 2014, by the lesser of (a) four percent (4%) of the total number of shares of common stock outstanding on the last day of the preceding calendar year, (b) 1,965,000 shares of common stock or (c) a number determined by the Company’s Board of Directors that is less than (a) or (b).

 

A summary of activity under the Plans is as follows (in thousands, except weighted average exercise price): 

 

 

 

Options Outstanding

 

 

 

 

 

 

 

 

 

Weighted

 

Weighted

 

 

 

 

 

Number

 

Average

 

Average

 

Aggregate

 

 

 

of

 

Exercise

 

Contractual

 

Intrinsic

 

 

 

Options

 

Price

 

Term (Years)

 

Value

 

 

 

 

 

 

 

 

 

 

 

Balances, January 1, 2012

 

4,684

 

$

10.85

 

5.32

 

$

4,318

 

Granted

 

1,271

 

9.03

 

 

 

 

 

Forfeited, cancelled or expired

 

(562

)

10.73

 

 

 

 

 

Exercised

 

(247

)

3.82

 

 

 

 

 

Balances, March 31, 2012

 

5,146

 

$

10.75

 

6.75

 

$

3,538

 

 

 

 

 

 

 

 

 

 

 

Options vested and expected to vest at March 31, 2012

 

4,679

 

$

10.77

 

6.48

 

$

3,511

 

Options exercisable at March 31, 2012

 

2,848

 

$

10.39

 

4.80

 

$

3,439

 

 

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The following table summarizes all RSU activity for the three months ended March 31, 2012 (in thousands):

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

 

 

 

 

Number of

 

Remaining

 

Aggregate

 

 

 

RSUs

 

Contractual

 

Intrinsic

 

 

 

Outstanding

 

Life (in years)

 

Value

 

 

 

 

 

 

 

 

 

Balances at January 1, 2012

 

137

 

1.74

 

$

1,072

 

Awarded

 

 

 

 

 

 

Released

 

(10

)

 

 

 

 

Forfeited or cancelled

 

(7

)

 

 

 

 

Balances at March 31, 2012

 

120

 

1.76

 

$

1,032

 

 

 

 

 

 

 

 

 

RSUs vested and expected to vest at March 31, 2012

 

100

 

1.76

 

$

694

 

 

The following table summarizes all stock-based compensation charges for the three months ended March 31, 2012 and 2011 (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Stock-based compensation expense

 

$

1,449

 

$

2,295

 

Stock-based compensation associated with outstanding repriced options

 

20

 

512

 

Total stock-based compensation

 

$

1,469

 

$

2,807

 

 

Stock-based compensation expense for the three months ended March 31, 2011 includes a charge of approximately $0.5 million relating to modification of the terms of the stock options held by certain directors who resigned from the Board of Directors during the three months ended March 31, 2011.

 

The Company uses the Black-Scholes option pricing model to estimate the fair value of options and RSUs. This model requires the input of highly subjective assumptions including the expected term of the option, expected stock price volatility and expected forfeitures. The Company used the following assumptions:

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Dividend yield

 

 

 

Expected volatility

 

58

%

50

%

Risk-free interest rate

 

0.81% - 1.09

%

1.97% - 2.14

%

Expected life of options (in years)

 

4.5

 

4.75

 

Weighted-average grant date fair value

 

$

4.28

 

$

9.65

 

 

11. Stockholders’ Equity

 

Common Stock

 

In February 2011, the Company completed its IPO, whereby it sold 5,360,000 shares of common stock (including exercise of the overallotment option) at a public offering price of $16.00 per share. As a result of the IPO and the exercise of the overallotment option, the Company received net proceeds of approximately $62.2 million, after underwriting discounts and commissions of $4.9 million and other offering expenses of approximately $3.0 million.

 

After the completion of the IPO on February 7, 2011, the Company amended its certificate of incorporation to increase its authorized number of shares of common stock to 100,000,000, reduce the authorized number of shares of preferred stock to 10,000,000 and establish the par value of each share of common and preferred stock to be $0.001 per share.

 

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An Amended and Restated Certificate of Incorporation for a 1-for-0.786 reverse split approved by the Company’s Board of Directors on November 18, 2010 was filed with the Delaware Secretary of State on January 28, 2011 and was effected upon the closing of the IPO. All information related to common stock, stock options, RSUs and earnings per share, as well as all references to preferred stock or preferred stock warrants as converted into common stock, has been retroactively adjusted to give effect to the reverse split.

 

Preferred Stock

 

Prior to the closing of the IPO, the Company had three outstanding series of convertible preferred stock. Upon the consummation of the IPO, the outstanding shares of preferred stock were converted into an aggregate of 11,089,201 shares of common stock. At March 31, 2012 and 2011, the Company had no preferred shares outstanding. From the proceeds of the IPO, aggregate cumulative dividends of approximately $29.6 million were paid in full to the holders of the Company’s Series B preferred stock.

 

In June 2000, the Company had issued a warrant to purchase 18,214 shares of Series B stock at $5.71 per share. Outstanding warrants were classified as liabilities, which were adjusted to fair value at each reporting period until the earlier of their exercise or expiration or the completion of a liquidation event, including the completion of an IPO. Upon the consummation of the IPO, the preferred stock warrant was automatically converted to a warrant to purchase shares of common stock in accordance with the terms of the warrant agreement and the warrant was reclassified to stockholders’ equity.

 

12. Related Party Transactions

 

The Company recorded revenue from two advertising agencies whose parent company’s Chief Executive Officer is a member of the Company’s Board of Directors. The Company recorded revenue from these entities of approximately $0.8 million and $1.1 million for the three months ended March 31, 2012 and 2011, respectively. There were accounts receivable from these entities of approximately $1.0 million as of both March 31, 2012 and December 31, 2011.

 

Item 2.  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 in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2011, or fiscal year 2011, included in our Annual Report on Form 10-K for fiscal year 2011, or 2011 Annual Report on Form 10-K. References to “Epocrates,” “we,” “our” and “us” are to Epocrates, Inc. unless otherwise specified or the context otherwise requires.

 

This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Terminology such as “believe,” “may,” “might,” “objective,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “predict,” “potential” or the negative of these terms or other similar expressions is intended to identify forward-looking statements.

 

We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in “Part II — Item 1A. Risk Factors” below, and those discussed in the sections titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as filed with the Securities and Exchange Commission, or SEC, on March 19, 2012. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

 

Business Overview

 

Epocrates is a leading physician platform for essential clinical content, practice tools and health industry engagement at the point of care. Our user network consists of over one million healthcare professionals, including approximately 330,000, or over 50% of, U.S. physicians. Epocrates’ portfolio features top-ranked medical applications, including the industry’s #1 used mobile drug reference, which provides convenient, point-of-care access to information such as dosing, drug interactions, pricing and insurance coverage for

 

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thousands of brand, generic and over-the-counter drugs. The features available through our unique physician platform are referenced multiple times per day and help healthcare professionals make more informed prescribing decisions, improve workflow and enhance patient safety. We offer our products on major U.S. mobile platforms including Apple, Android and BlackBerry.

 

Recent Developments

 

In early 2012, management determined that the forecasted revenues from and the projected subscribers for the Epocrates Electronic Health Record, or EHR, product had not materialized and that the costs to develop, continue to enhance and support the EHR product had a significant adverse effect on our operating margin in 2011 and would likely continue to have such an adverse effect for the foreseeable future. On February 24, 2012, the Audit Committee of the Board of Directors of Epocrates, as authorized by the Board of Directors, approved the discontinuation of Epocrates’ EHR business. The Board of Directors made this determination in order to focus Epocrates’ efforts on its core business, Subscriptions and Interactive Services, and due to the future uncertainty and ongoing investment required for the EHR product. Epocrates is exploring strategic alternatives for the EHR product. In connection with this decision, Epocrates recorded an impairment charge of approximately $8.5 million in its fourth fiscal quarter of 2011, which represents the write-down of the carrying value of the goodwill, intangible and other long-lived assets related to the EHR product to their estimated fair value of zero. This charge was recorded in Impairment of Long-lived Assets and Goodwill in our consolidated statements of operations for the year ended December 31, 2011.

 

Upon the approval, we met the requirements for reporting the EHR segment as discontinued operations, and the results of this segment are recorded in Loss from Discontinued Operations, net of tax on our Condensed Consolidated Statements of Comprehensive Loss. Prior period results have been revised to conform to the current period presentation.

 

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 three months ended March 31, 2012, we recorded total revenues, net of $27.5 million, a decrease of $1.6 million, or 6%, from the three months ended March 31, 2011.

 

Our users pay for one or two year subscriptions of our premium products upfront. This amount is deferred and recognized ratably over the term of the subscription. Typically, interactive services clients are billed a portion of the contracted fee upon signing of the contract with the balance billed upon one or more future milestones. The amounts collected are deferred and recognized as services are delivered.

 

Our client base is located almost entirely within the U.S. For the quarter ended March 31, 2012, we had one client that accounted for approximately 12% of total revenues, net. For the quarter ended March 31, 2011, no single client accounted for more than 10% of total revenues, net. There was one client that accounted for more than 10% of accounts receivable, net and one client that accounted for more than 15% of accounts receivable, net at March 31, 2012. One client accounted for 15% of accounts receivable, net as of December 31, 2011.

 

We invested significant development and marketing resources during 2011 to develop and deliver new products. Specifically, we recorded $2.5 million in sales and marketing and research and development expenses related to the EHR product during the three months ended March 31, 2011. This investment of resources had an adverse effect on our operating margin for the quarter ended March 31, 2011. As mentioned above, our Board of Directors, through its Audit Committee, has since approved the discontinuation of our EHR offering and the results of our EHR operating segment are classified as discontinued operations for the three months ended March 31, 2012. Prior period results have been revised to conform to the current period presentation.

 

Our operating margin was 4.6% for the three months ended March 31, 2012 and 1.1% for the three months ended March 31, 2011. These calculations exclude the results of the EHR segment, which is now reported as discontinued operations. Our operating margin, prior to the EHR segment classification as discontinued operations, calculated using amounts disclosed in our quarterly report on Form 10-Q for the three months ended March 31, 2011, was (6.8)%.

 

Total cash, cash equivalents and short-term investments at March 31, 2012 were $81.6 million, a decrease of $3.6 million, or 4%, compared to December 31, 2011.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S., or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and

 

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liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. Our critical accounting policies are those that affect our historical financial statements materially and involve difficult, subjective or complex judgments by management.

 

There have been no significant changes in our critical accounting policies during the quarter ended March 31, 2012 compared to those previously disclosed in “Critical Accounting Policies and Estimates” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2011 Annual Report on Form 10-K.

 

Results of Operations

 

The following table summarizes our results of operations for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 (in thousands, except percentages):

 

 

 

Three Months Ended
March 31,

 

Increase/
(Decrease)

 

Increase/
(Decrease)

 

 

 

2012

 

2011

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Total revenues, net

 

$

27,531

 

$

29,177

 

$

(1,646

)

(6

)%

Total cost of revenues

 

10,287

 

9,390

 

897

 

10

%

Gross profit

 

17,244

 

19,787

 

(2,543

)

(13

)%

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

6,082

 

7,121

 

(1,039

)

(15

)%

Research and development

 

4,921

 

5,020

 

(99

)

(2

)%

General and administrative

 

4,986

 

6,257

 

(1,271

)

(20

)%

Facilities exit costs

 

 

560

 

(560

)

*

 

Change in fair value of contingent consideration

 

 

506

 

(506

)

*

 

Total operating expenses

 

15,989

 

19,464

 

(3,475

)

(18

)%

Income from operations

 

1,255

 

323

 

932

 

*

 

Interest income

 

6

 

28

 

(22

)

(79

)%

Other income, net

 

1

 

2

 

(1

)

(50

)%

Income before income taxes

 

1,262

 

353

 

(909

)

*

 

Benefit from (provision for) income taxes

 

141

 

(152

)

293

 

*

 

Income from continuing operations

 

1,403

 

201

 

1,202

 

*

 

Loss from discontinued operations, net of tax

 

(2,841

)

(1,326

)

(1,515

)

*

 

Net loss

 

$

(1,438

)

$

(1,125

)

$

(313

)

28

%

 


*  Changed by 100% or more.

 

In 2011, we had two reportable segments: Subscriptions and Interactive Services and EHR. On February 24, 2012, the Audit Committee of our Board of Directors, as authorized by the Board of Directors, approved the discontinuation of Epocrates’ EHR product. In the first quarter of 2012, we qualified for discontinued operations presentation under GAAP, and at such time, the EHR operating segment results were reported in loss from discontinued operations on our condensed consolidated statements of comprehensive loss. Prior period amounts have been revised in order to conform to the current period presentation.

 

Revenues

 

We generate revenue by providing healthcare companies with interactive services to engage with our network of users and through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals. Revenues from our Subscriptions and Interactive Services for the three months ended March 31, 2012 and 2011 were as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

Decrease

 

Decrease

 

 

 

2012

 

2011

 

$

 

%

 

Subscriptions

 

$

4,676

 

$

6,209

 

$

(1,533

)

(25

)%

Interactive Services

 

22,855

 

22,968

 

(113

)

%

 

 

$

27,531

 

$

29,177

 

$

(1,646

)

(6

)%

 

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Subscriptions. The decrease in subscriptions revenue of $1.5 million was primarily due to recognition of additional revenue of $1.1 for unused license codes upon expiration of contracts in the first quarter of 2011 which did not occur in the first quarter of 2012, as well as a $0.2 million decrease in iTunes App Store sales. We expect the percentage of users who pay for a subscription to remain unchanged or even decrease over time. As a result, we expect subscription revenue from our premium products to decrease and to decrease as a percentage of total revenue in the future.

 

Interactive Services.  Interactive services revenue remained relatively unchanged from the same period in the prior year, as a $0.4 million increase in market research services was offset by decreases of $0.3 million in formulary hosting services and $0.2 million in pharmaceutical revenues. The $0.2 million decrease in pharmaceutical revenues is largely attributable to a decline of $0.3 million in EssentialPoints revenue due to a reduced number of activities in the first quarter of 2012 compared with the first quarter of 2011.

 

Cost of revenues

 

Cost of revenues consists of the costs related to providing services to clients which include salaries and related personnel expenses, stock-based compensation, service support costs, payments to participants for market research surveys we conduct for our clients, third-party royalties and allocated overhead. Third-party royalties consist of fees paid to branded content owners for the use of their intellectual property in our premium drug and reference products. Allocated overhead represents expenses such as rent, occupancy charges and information technology costs that we allocate to all departments based on headcount. We also allocate depreciation and amortization expense to cost of revenues.

 

The following is a breakdown of cost of revenues related to subscriptions and interactive services for the three months ended March 31, 2012 and 2011 (in thousands):

 

 

 

Three Months Ended
March 31,

 

Increase/
(Decrease)

 

Increase/
(Decrease)

 

 

 

2012

 

2011

 

$

 

%

 

Subscriptions

 

$

1,949

 

$

2,043

 

$

(94

)

(5

)%

Interactive Services

 

8,338

 

7,347

 

991

 

13

%

 

 

$

10,287

 

$

9,390

 

$

897

 

10

%

 

Subscriptions. Cost of subscriptions revenue decreased by an insignificant amount for the three months ended March 31, 2012 versus the same period in 2011. As a percentage of subscriptions revenue, cost of subscriptions revenues was 42% for the quarter ended March 31, 2012 versus 33% for the quarter ended March 31, 2011. The increase in cost of subscriptions revenues as a percentage of subscriptions revenue is due to the decline in subscriptions revenue from the same period in the prior year as a result of the recognition of revenue on an unusually high number of unused license code expirations during the first quarter of 2011.

 

Interactive Services. Cost of interactive services revenue increased approximately $1.0 million for the three months ended March 31, 2012 compared to the same period in 2011, primarily due to increases of $0.4 million in fulfillment and research services associated with our mSampling and DocAlert product offerings, $0.3 million in increased co-location consulting costs and employee-related expenses as a result of hiring three new members of management and $0.3 million in honoraria expenses as a result of higher market research activity in the first quarter of 2012. Cost of interactive services revenue as a percentage of interactive services revenue was 36% and 32% for the three months ended March 31, 2012 and 2011, respectively.

 

Sales and marketing expense

 

Sales and marketing expense primarily consists of salaries and related personnel expenses, sales commissions, stock-based compensation, trade show expenses, promotional expenses, public relations expenses and allocated overhead.

 

Sales and marketing expense decreased approximately $1.0 million, or 15%, for the three months ended March 31, 2012 versus the same period in 2011. This decrease was primarily due to a $0.6 million reduction in sales commissions as a result of lower sales and a $0.5 million reduction in stock compensation expense. Sales and marketing expense as a percentage of total revenues, net declined from 24% for the three months ended March 31, 2011 to 22% for the three months ended March 31, 2012.

 

Research and development expense

 

Research and development expense primarily consists 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.

 

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Research and development expense decreased approximately $0.1 million, or 2%, for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This decrease was primarily due to decreased consulting and temporary professional fees of $0.3 million offset by increased salary and other employee-related compensation of $0.2 million. As a percentage of total revenues, net, research and development expense for the three months ended March 31, 2012 and 2011 was 18% and 17%, respectively.

 

General and administrative expense

 

General and administrative expense primarily consists 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 decreased $1.3 million, or 20%, for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This decrease was primarily due to a decrease in employee compensation of $0.8 million (which includes stock-based compensation of $0.6 million) and a decrease of $0.2 million in recruiting and other employee-related expenses.  The $0.6 million decrease in stock-based compensation was primarily due to additional stock compensation expense in the three months ended March 31, 2011 that was recorded in connection with the modification of the terms of the stock options held by certain directors who resigned from the Board of Directors during the first quarter of 2011 and the change in the fair value of outstanding repriced stock options, which are subject to variable accounting.

 

General and administrative expense as a percentage of total revenues, net for the three months ended March 31, 2012 and 2011 was 18% and 21%, respectively.

 

Facilities exit costs

 

We recorded a charge of approximately $0.6 million in the three months ended March 31, 2011 relating to facilities exit costs. We vacated our East Windsor, New Jersey office in the first quarter of 2011 and relocated our New Jersey operations to Ewing, New Jersey. We had signed a non-cancellable lease with the landlord, which does not expire until the end of fiscal 2012 and therefore we will be liable to make monthly lease rentals under the contract. The liability recorded at fair value is based on the present value of the remaining lease rentals and is reduced for the estimated sub-lease rentals that could be reasonably obtained for the property.

 

Change in fair value of contingent consideration

 

The decrease in the change in fair value of contingent consideration for the three months ended March 31, 2012 as compared to March 31, 2011 is due to the absence of contingent consideration as a result of the agreement reached with the sellers of MedCafe Inc. in the second quarter of 2011 and as a result of the EHR-related impairment charge recorded for Caretools, Inc. in the fourth quarter of 2011.

 

Benefit from (provision for) income taxes

 

For the three months ended March 31, 2012, we recorded an income tax benefit of approximately $0.8 million, of which $0.1 million was allocated to continuing operations, with the balance of $0.7 million allocated to discontinued operations. For the three months ended March 31, 2011, we recorded an income tax benefit of $0.8 million, which was comprised of a tax provision of approximately $0.2 million allocated to continuing operations and a tax benefit of $1.0 million allocated to discontinued operations. The income tax benefit during the three months ended March 31, 2012 represented the federal and state statutory rates adjusted for non-deductible stock compensation expense. The income tax provision during the three months ended March 31, 2011 represented the federal and state statutory tax rates adjusted for non-deductible stock compensation expense partially offset by research and development credits.

 

At March 31, 2012, our estimated annual effective tax rate was approximately 28%. We determine our interim tax benefit from (provision for) income taxes using an estimated annual effective tax rate methodology. Our annual effective tax rate is affected by our forecasted net income, research tax credits, stock compensation expense related to Incentive Stock Options, or ISOs, and the expected level of other tax benefits. Our annual effective tax rate is difficult to predict because it will be impacted by any disqualifying dispositions of ISOs by our employees. Disqualifying dispositions occur when an employee sells stock that was acquired through the exercise of an ISO within two years of the ISO grant date or one year of the ISO exercise date. Our estimated annual effective tax rate could materially change if there are a significant number of disqualifying dispositions of ISOs during the period.

 

Non-GAAP Financial Measures

 

Adjusted EBITDA is an unaudited number and represents net income before income and expenses unrelated to core business activities, such as interest income, other income, net and (benefit from) provision for income taxes; non-recurring income and

 

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expenses, such as change in fair value of contingent consideration; and non-cash charges, such as depreciation and amortization expense (including intangible assets) related to the core business, stock-based compensation and other expenses.

 

Adjusted EBITDA is not a measure of operating performance or liquidity calculated in accordance with GAAP and should be viewed as a supplement to, and not a substitute for, our results of operations presented on a GAAP basis. Adjusted EBITDA does not purport to represent cash flow provided by, or used in, operating activities as defined by GAAP. Our consolidated statements of cash flows present 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 income or 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.

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Net loss, as reported

 

$

(1,438

)

$

(1,125

)

Loss from discontinued operations, net of tax

 

(2,841

)

(1,326

)

Net income from continuing operations

 

$

1,403

 

$

201

 

 

 

 

 

 

 

Add: (Income) expenses unrelated to core business activities

 

 

 

 

 

Interest income

 

(6

)

(28

)

Other (income) expense, net

 

(1

)

(2

)

(Benefit from) provision for income taxes

 

(141

)

152

 

 

 

 

 

 

 

Add: Non-recurring and non-cash charges (income)

 

 

 

 

 

Depreciation and amortization expense (including intangible assets) related to core business

 

1,956

 

2,018

 

Stock-based compensation

 

1,458

 

2,807

 

Change in fair value of contingent consideration (1)

 

 

506

 

Facilities exit costs

 

 

560

 

Other

 

 

112

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

4,669

 

$

6,326

 

 


(1)          For the three months ended March 31, 2011, represents an expense of $506 from the write-down of the contingent consideration liability related to an earn-out agreement with the sellers of Caretools, Inc., a company that Epocrates acquired in 2010.

 

Note: prior period amounts have been revised to conform to the current period presentation.

 

The decrease in adjusted EBITDA for the first quarter of 2012 was primarily attributable to decreased revenue coupled with an increase in cost of revenue, offset by lower operating expenses compared to the first quarter of 2011.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity as of March 31, 2012 consisted of cash, cash equivalents and short-term investments of $81.6 million compared to $85.2 million at December 31, 2011. We believe that 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. Our future liquidity and capital requirements will depend upon numerous factors, including retention of clients 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 clients and us.

 

Operating activities

 

Cash used in operating activities was $2.8 million for the three months ended March 31, 2012 compared with cash provided by operating activities of $6.3 million for the three months ended March 31, 2011. The decrease in operating cash flows for the three months ended March 31, 2012 was primarily driven by decreases of $4.6 million in deferred revenue due to higher billings in the first quarter of 2011 which were a result of contracts that were signed in late 2010 and $2.3 million in other accrued liabilities and payables, largely due to bonuses that were accrued at December 31, 2011 but were paid out during the first quarter of 2012. In the prior year, the bonus accrual was recorded during the first quarter of 2011.

 

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Investing activities

 

We had net cash used in investing activities of $0.7 million for the three months ended March 31, 2012 versus net cash provided by investing activities of $0.2 million for the comparable period in 2011. The decrease in cash flows from investing activities is primarily due to a net decrease of $1.9 million in available-for-sale investment activity, which was partially offset by a $1.0 million increase due to lower purchases of property and equipment. The net decrease in available-for-sale investments is attributed to a decrease of $5.9 million as a result of decreased maturities and sales of short-term investments, which was partially offset by a cash inflow of $4.0 million due to lower purchases of investments.

 

The following table summarizes our investments in cash, cash equivalents and short-term investments as of March 31, 2012 and 2011 (in thousands):

 

 

 

March 31,

 

 

 

2012

 

2011

 

Cash

 

$

61,427

 

$

48,348

 

Cash equivalents

 

11,338

 

29,071

 

Short-term investments

 

8,878

 

15,756

 

Total cash, cash equivalents and short-term investments

 

$

81,643

 

$

93,175

 

Unrealized loss on available-for-sale securities

 

$

(2

)

$

 

 

Capital expenditures and capitalized internal use software were $1.7 million and $2.7 million for the three months ended March 31, 2012 and 2011, respectively.

 

Financing activities

 

Cash provided by financing activities was $0.9 million in the three months ended March 31, 2012 compared to $34.9 million of cash provided by financing activities in the three months ended March 31, 2011. The $34.0 million decrease in cash provided by financing activities in the three months ended March 31, 2012 was primarily a result of a net cash inflow of $34.6 million in the three months ended March 31, 2011 due to $64.2 million of proceeds from the issuance of common stock under our IPO, partially offset by the payment of $29.6 million of aggregate cumulative dividends to the holders of our Series B preferred stock.

 

Contractual Obligations

 

Our contractual obligations at March 31, 2012 and the effects that such obligations are expected to have on future liquidity and cash flows have not changed significantly since December 31, 2011.

 

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.

 

Indemnification

 

See Note 9 to the Condensed Consolidated Financial Statements of this quarterly report on Form 10-Q.

 

Recent Accounting Pronouncements

 

For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, see Note 2 to the Condensed Consolidated Financial Statements of this quarterly report on Form 10-Q.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

There are no material changes in market risk from the information presented in Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk,” in our 2011 Annual Report on Form 10-K.

 

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Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2012. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2012, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

On February 25, 2011, we received a letter from the SEC informing us that the SEC was conducting an investigation and attaching a subpoena for certain information and documents related to our expert network services, including our relationship with Hudson Street Services, a Goldman, Sachs & Co. business. On January 5, 2012, the Company received a letter from the SEC notifying the Company that the SEC had terminated its inquiry regarding Epocrates’ expert network services and that no enforcement action has been recommended.

 

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. We are not currently involved in any material legal proceedings.

 

Item 1A. Risk Factors

 

Our risk factors have not changed materially from those set forth in our 2011 Annual Report on Form 10-K filed with the SEC on March 19, 2012.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Unregistered Sales of Equity Securities

 

None.

 

Use of Proceeds

 

On February 1, 2011, our registration statement on Form S-1 (File No. 333-168176) was declared effective for our IPO. As a result of our IPO and the exercise of the overallotment option on February 3, 2011, both of which closed on February 7, 2011, we received net proceeds of approximately $62.2 million after underwriting discounts and commissions of $4.9 million. In addition, we incurred other expenses associated with our IPO of approximately $3.0 million. The net proceeds were used to pay aggregate cumulative dividends due to the holders of our Series B preferred stock totaling $29.6 million, with the balance being used for general corporate purposes.

 

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There has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC pursuant to Rule 424(b).

 

Item 5. Other Information

 

As previously disclosed, as a result of Peter Brandt’s appointment as Interim President and Chief Executive Officer and departure from the Audit Committee, we were not in compliance with the Audit Committee composition requirements of NASDAQ Listing Rule 5605(c)(2)(A), which requires at least three independent members of the Board of Directors to serve on the Audit Committee. In order to not be delisted from NASDAQ, we were required to cure this deficiency on or before May 14, 2012, six months from when Mr. Brandt became the Interim President and Chief Executive Officer and stepped down from the Audit Committee. Effective as of May 1, 2012, Mark A. Wan was appointed to the Audit Committee. After review of all relevant identified transactions or relationships between Mr. Wan, or any of his family members, and Epocrates, its senior management and its independent auditors, our Board of Directors has affirmatively determined that Mr. Wan is an independent director within the meaning of the applicable NASDAQ listing standards. Therefore, as of May 1, 2012, the Audit Committee is comprised of at least three independent members of the Board of Directors, in compliance with the Audit Committee composition requirements of NASDAQ Listing Rule 5605(c)(2)(A).

 

Item 6. Exhibits

 

See the Exhibit Index which follows the signature page of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Epocrates, Inc.

 

By:

/s/ ANDREW HURD

 

By:

/s/ PATRICK D. SPANGLER

 

ANDREW HURD,

 

 

PATRICK D. SPANGLER,

 

President and Chief Executive Officer

 

 

Chief Financial Officer

 

(Principal Executive Officer)

 

 

(Principal Financial and Accounting Officer)

 

Date: May 11, 2012

 

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Table of Contents

 

Exhibit Index

 

Exhibit
Number

 

Description of Document

3.1(1)

 

Amended and Restated Certificate of Incorporation dated February 7, 2011.

 

 

 

3.2(2)

 

Amended and Restated Bylaws.

 

 

 

4.1(3)

 

Specimen common stock certificate.

 

 

 

4.2(3)

 

Form of Warrant to purchase Series B convertible preferred stock.

 

 

 

10.1(4)

 

Offer Letter, dated March 22, 2012, by and between Registrant and Andrew Hurd.

 

 

 

10.2(5)

 

2012 Bonus Plan.

 

 

 

31.1

 

Certification of Principal Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Principal Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Taxonomy Instance Document.

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document.

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

101.LAB

 

XBRL Taxonomy Extension Labels Linkbase Document.

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.


(1)

Filed as Exhibit 3.1 to our Annual Report on Form 10-K (Reg. No. 001-35062) with the SEC on March 31, 2011, and incorporated herein by reference.

 

 

(2)

Filed as Exhibit 3.4 to our Registration Statement on Form S-1, as amended (Reg. No. 333-168176), and incorporated herein by reference.

 

 

(3)

Filed as the like-described exhibit to our Registration Statement on Form S-1, as amended (Reg. No. 333-168176), and incorporated herein by reference.

 

 

(4)

Filed as the Exhibit 10.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 26, 2012 (Reg. No. 001-35062), and incorporated herein by reference.

 

 

(5)

As described in Item 5.02 of our Current Report on Form 8-K filed with the Securities and Exchange Commission on April 27, 2012 (Reg. No. 001-35062), and incorporated herein by reference.

 

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