10-Q 1 eclipsys2006q110q.htm ECLIPSYS CORPORATION Q1 2006 10Q Eclipsys Corporation Q1 2006 10Q
 





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

________________
 
FORM 10-Q
________________
 

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

COMMISSION FILE NUMBER: 000-24539



ECLIPSYS CORPORATION
(Exact name of registrant as specified in its charter)


DELAWARE
65-0632092
(State of Incorporation)
(IRS Employer Identification Number)


1750 Clint Moore Road
Boca Raton, Florida
33487
(Address of principal executive offices)

561-322-4321
(Telephone number of registrant)




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 for the past 90 days. Yes [ ü ] No [ ]

 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [  ] Accelerated filer [ ü ]  Non-accelerated filer [ ]

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


Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Class
Shares outstanding as of May 1, 2006
Common Stock, $.01 par value
52,209,870



 

 
Part I.
 
Financial Information
 
       
Item 1.
 
Financial Statements - Unaudited
 
       
   
Condensed Consolidated Balance Sheets (unaudited) - As of March 31, 2006
 
   
and December 31, 2005
3
       
   
Condensed Consolidated Statements of Operations (uaudited) - For the Three
 
   
Months ended March 31, 2006 and 2005
4
     
 
   
Condensed Consolidated Statements of Cash Flows (unaudited) - For the Three
 
   
Months ended March 31, 2006 and 2005
5
       
   
Notes to Condensed Consolidated Financial Statements (unaudited)
6
       
Item 2.
 
Mangement's Discussion and Analysis of Financial Condition and Results
 
   
of Operations
13
       
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
22
       
Item 4.
 
Controls and Procedures
23
       
Part II.
 
Other Information
 
       
Item 1.
 
Legal Proceedings
24
       
Item 1A.
 
Risk Factors
24
       
Item 2.
 
Unregistered Sales of Equity Securities
33
       
Item 6.
 
Exhibits
 
       
Signatures
   
34
       
Certifications
   
36


ECLIPSYS CORPORATION AND SUBSIDIARIES
 
Condensed Consolidated Balance Sheets (Unaudited)
 
(In thousands)
 
           
   
March 31,
 
December 31,
 
   
2006
 
2005
 
Assets
             
Current assets:
             
Cash  
 
$
36,214
 
$
76,693
 
Marketable securities 
   
81,979
   
37,455
 
Accounts receivable, net of allowance for doubtful accounts of $6,246 and $5,676 at March 31, 2006 and December 31, 2005, respectively  
   
81,512
   
80,833
 
Inventory  
   
2,157
   
2,289
 
Prepaid expenses  
   
21,263
   
17,909
 
Other current assets  
   
1,204
   
2,184
 
 Total current assets
   
224,329
   
217,363
 
               
Property and equipment, net
   
42,562
   
40,500
 
Capitalized software development costs, net
   
32,765
   
35,690
 
Acquired technology, net
   
508
   
584
 
Intangible assets, net
   
2,727
   
2,940
 
Deferred tax asset
   
4,083
   
4,124
 
Goodwill, net
   
6,669
   
6,624
 
Other assets
   
19,479
   
20,964
 
 Total assets
 
$
333,122
 
$
328,789
 
               
Liabilities and Stockholders’ Equity
             
Current liabilities:
             
Deferred revenue  
 
$
98,040
 
$
107,960
 
Accounts payable  
   
22,490
   
26,103
 
Accrued compensation costs  
   
15,772
   
15,974
 
Deferred tax liability 
   
4,083
   
4,124
 
Other current liabilities  
   
14,749
   
10,413
 
 Total current liabilities
   
155,134
   
164,574
 
               
Deferred revenue
   
14,827
   
16,772
 
Other long-term liabilities
   
169
   
1,252
 
 Total long-term liabilities
   
14,996
   
18,024
 
               
Stockholders’ equity:
             
 Total stockholders’ equity
   
162,992
   
146,191
 
 Total liabilities and stockholders’ equity
 
$
333,122
 
$
328,789
 
               
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
3


 ECLIPSYS CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Operations (Unaudited)
 
 (In thousands, except per share amounts)
 
               
       
 
 
 
 
       
Three Months Ended March 31,
 
       
2006
 
2005
 
Revenues:
                   
Systems and services 
       
$
96,223
 
$
83,128
 
Hardware 
         
4,561
   
1,307
 
Total revenues 
         
100,784
   
84,435
 
                     
Costs and expenses:
                   
Costs of systems and services revenues 
         
56,458
   
52,712
 
Costs of hardware revenues 
         
3,651
   
1,101
 
Sales and marketing 
         
16,269
   
17,729
 
Research and development 
         
16,962
   
12,576
 
General and administrative 
         
5,640
   
4,356
 
Depreciation and amortization 
         
3,802
   
3,683
 
Restructuring charge 
         
7,198
   
-
 
 Total costs and expenses
         
109,980
   
92,157
 
                     
Loss from operations
         
(9,196
)
 
(7,722
)
Interest income, net
         
1,149
   
561
 
Loss before taxes
         
(8,047
)
 
(7,161
)
                     
Provision for income taxes
         
-
   
-
 
Net loss
       
$
(8,047
)
$
(7,161
)
                     
Loss per share
                 
Basic and diluted loss per share
       
$
(0.16
)
$
(0.15
)
                     
Weighted average common shares outstanding
                   
Basic and diluted
         
50,581
   
47,323
 
                     
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
4


 ECLIPSYS CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 (In thousands)
 
               
       
Three Months Ended
 
       
March 31,
 
               
       
2006
 
2005
 
               
Operating activities:
                   
Net loss
       
$
(8,047
)
$
(7,161
)
Adjustments to reconcile net loss to net cash
                   
used in operating activities:
                   
Depreciation and amortization 
         
9,217
   
7,806
 
Provision for bad debts 
         
518
   
450
 
Stock compensation expense 
         
3,774
   
416
 
Changes in operating assets and liabilities:
                   
Accounts receivable
         
(1,197
)
 
5,348
 
Inventory
         
132
   
80
 
Prepaid expenses and other current assets
         
(2,634
)
 
(3,444
)
Other assets
         
647
   
(8,825
)
Deferred revenue
         
(11,864
)
 
2,279
 
 Accounts payable and other current liabilities
         
636
   
(5,683
)
Accrued compensation costs
         
(203
)
 
1,265
 
Other long-term liabilities
         
(1,083
)
 
416
 
 Total adjustments
         
(2,057
)
 
108
 
Net cash used in operating activities
         
(10,104
)
 
(7,053
)
                     
Investing activities:
                   
Purchases of property and equipment 
         
(5,651
)
 
(4,125
)
Purchases of marketable securities 
         
(245,563
)
 
(138,018
)
Proceeds from sales of marketable securities 
         
201,038
   
101,158
 
Capitalized software development costs 
         
(1,576
)
 
(6,427
)
Net cash used in investing activities
         
(51,752
)
 
(47,412
)
                     
Financing activities:
                   
Proceeds from stock options exercised 
         
21,042
   
1,697
 
Net cash provided by financing activities
         
21,042
   
1,697
 
                     
Effect of exchange rates on cash and cash equivalents
         
335
   
81
 
Net decrease in cash and cash equivalents
         
(40,479
)
 
(52,687
)
Cash and cash equivalents, beginning of period
         
76,693
   
122,031
 
Cash and cash equivalents, end of period
       
$
36,214
 
$
69,344
 
                     
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
5

 


ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.  BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Eclipsys Corporation, or the Company, and the notes thereto have been prepared in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and Exchange Commission, or SEC. The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. However, such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of results for the interim periods presented.
 
The results of operations for the three months ended March 31, 2006 are not necessarily indicative of annual results. The Company manages its business as one reportable segment.

The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and the notes thereto that are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005 that was filed with the SEC on March 7, 2006.


2. STOCK-BASED COMPENSATION

Prior to January 1, 2006, we accounted for our stock-based employee compensation arrangements under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), as allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-based Compensation (SFAS No. 123), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (SFAS No. 148). As a result, no expense was recognized for options to purchase our common stock that were granted with an exercise price equal to fair market value at the date of grant and no expense was recognized in connection with purchases under our employee stock purchase plan for the year ended December 31, 2005, nor in the three-month period ended March 31, 2005. In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which amended SFAS No. 123. SFAS No. 123(R) requires measurement of the cost of share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005. Subsequent to the effective date, the pro forma disclosures previously permitted under SFAS No. 123 are no longer an alternative to financial statement recognition. Effective January 1, 2006, we have adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation cost recognized during the three-month period ended March 31, 2006, includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 amortized over the options’ vesting period, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R) amortized on a straight-line basis over the options’ vesting period. The option vesting period ranges from three to five years and all options have a contractual life of ten years. The fair value is estimated at the date of grant using the Black - Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions such as expected term, expected volatility, and risk free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions were based on or determined from external data (for example the risk free interest rate) and other assumptions were derived from our historical experience with share-based payment arrangements (for example, volatility and expected term). The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. Pro forma results for prior periods have not been restated. Implementation of SFAS No. 123(R) contributed $2.9 million to the current quarter loss of $(8.0) million. The adoption of SFAS No. 123(R) had no impact on cash flows from operations or financing activities.

The following table illustrates the effect on net loss and net loss per share had we applied the fair value recognition provisions of SFAS No. 123 to account for our employee stock option plan for the three-month period ended March 31, 2005, because stock-based employee compensation was not accounted for using the fair value recognition method during that period.

6



ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

For purposes of pro forma disclosures, the estimated fair value of the stock awards, as prescribed by SFAS No. 123, is amortized to expense over the vesting period of such awards (in thousands, except per share data):

   
Three Months Ended March 31, 2005
 
   
 
 
   
 
 
Net loss:
       
As reported
 
$
(7,161
)
Add: Stock-based employee compensation expense included
       
in reported net loss, net of related tax effects
   
416
 
Deduct: Total stock-based compensation expense determined
     
under fair value based method for all awards, net of related tax effects
   
(2,416
)
Pro forma Net loss
 
$
(9,161
)
Basic net loss per common share:
       
As reported
 
$
(0.15
)
Pro forma
 
$
(0.19
)
Diluted net loss per common share:
       
As reported
 
$
(0.15
)
Pro forma
 
$
(0.19
)
         
 

The historical pro forma impact of applying the fair value method prescribed by SFAS No. 123 is not representative of the impact that may be expected in the future due to changes resulting from additional grants in future years and changes in assumptions such as volatility, interest rates and expected life used to estimate fair value of the grants in future years.

Note that the above pro forma disclosure was not presented for the three-month period ended March 31, 2006 because stock-based employee compensation has been accounted for using the fair value recognition method under SFAS No. 123(R) for this period.

The following table shows total stock-based employee compensation expense (see Note 8 for types of stock-based employee arrangements) included in the condensed consolidated statement of operations for the three month period ended March 31, 2006 (in thousands):

   
Three Months Ended March 31, 2006
 
       
Costs and expenses:
       
Costs of systems & services revenues
 
$
811
 
Sales and marketing
   
553
 
Research and development
   
239
 
General and administrative
   
1,277
 
         
Total stock-based compensation expense
 
$
2,880
 
         
 
 
7


ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

There was no stock-based employee compensation cost capitalized during the quarter ended March 31, 2006 nor any recognized tax benefit during the quarter ended March 31, 2006. For restricted common stock issued at discounted prices, we recognize compensation expense over the vesting period for the difference between the exercise or purchase price and the fair market value on the measurement date. Compensation expense recognized in our financial statements for stock-based awards for restricted stock was $651,000 and is included in the $2.9 million of stock-based compensation for the three month period ended March 31, 2006. In the quarter ended March 31, 2005, we recorded $416,000 of stock-based compensation for restricted stock.

3. MARKETABLE SECURITIES
 

Marketable securities consist of funds that are highly liquid and are classified as available-for-sale. Marketable securities are recorded at fair value, and unrealized gains and losses are recorded as a component of other comprehensive income.

   
(in thousands)
 
   
March
 
December
 
   
31, 2006
 
31, 2005
 
Security Type
 
 
 
 
 
           
Auction Rate Securities:
             
               
Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies
 
$
13,267
 
$
14,117
 
Debt securities issued by states of the United States and political subdivisions of the states
   
62,489
   
17,084
 
     
75,756
   
31,201
 
Other Securities:
             
               
Government Bonds/Agencies
   
6,165
   
6,206
 
Other debt securities
   
58
   
48
 
Total
 
$
81,979
 
$
37,455
 
               
 

As of March 31, 2006, all marketable securities except for auction rate securities have a maturity of less than 2 years. Auction rate securities of $62.5 million held at March 31, 2006 have an underlying maturity of greater than ten years, but typically have an interest rate reset feature every 30 days pursuant to which we can sell or reset the interest rate on the security. At March 31, 2006, we believe that these investments are considered a part of our working capital and are appropriately classified as current assets.

In an effort to increase our interest income, we moved excess cash from money market investment to marketable securities, which include auction rates securities and government bonds. These funds remain highly liquid.

4. ACCOUNTS RECEIVABLE

Accounts receivable was comprised of the following (in thousands):

           
   
March 31,
 
December 31,
 
   
2006
 
2005
 
Accounts Receivable:
             
Billed accounts receivable, net 
 
$
70,218
 
$
69,772
 
Unbilled accounts receivable, net 
   
11,294
   
11,061
 
 Total accounts receivable, net
 
$
81,512
 
$
80,833
 
               
               
 
 
8

 
ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
5. WARRANTY RESERVE

The agreements that we use to license our software to our customers generally includes a limited warranty. The warranty provides that the product, in its unaltered form, will perform substantially in accordance with the related documentation. Warranty costs are charged to costs of systems of services revenues when they are probable and reasonably estimable. A summary of the activity in our warranty reserve was as follows (in thousands):

           
   
March 31,
 
December 31,
 
   
2006
 
2005
 
           
Beginning Balance
 
$
1,071
 
$
2,057
 
Provision for warranty
   
-
   
-
 
Provision reduction
   
(290
)
 
-
 
Warranty utilized
   
(55
)
 
(986
)
Ending Balance
 
$
726
 
$
1,071
 
               
 

6. GOODWILL AND OTHER INTANGIBLE ASSETS

Acquired technology and intangible assets are amortized over their estimated useful lives generally on a straight-line basis. The carrying values of acquired technology and intangible assets are reviewed if the facts and circumstances suggest that they may be impaired and goodwill is reviewed annually in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”. Testing would be done on a more frequent basis if impairment indicators arise. The test for impairment is based upon a number of factors, including operating results, business plans and projected future cash flows. No impairment has been identified or recorded during the three months ended March 31, 2006 or fiscal 2005.
 
The gross and net amounts for acquired technology, goodwill, and intangible assets consist of the following (in thousands):

   
March 31, 2006
 
December 31, 2005
 
   
Gross Carrying
 
Accumulated Amortization
 
Net Book Value
 
Gross Carrying
 
Accumulated Amortization
 
Net Book Value
 
                           
Amounts subject to amortization:
                                     
Acquired technology 
 
$
914
 
$
406
 
$
508
 
$
914
 
$
330
 
$
584
 
Ongoing customer relationships 
   
4,335
   
1,608
   
2,727
   
4,335
   
1,395
   
2,940
 
 Total
 
$
5,249
 
$
2,014
 
$
3,235
 
$
5,249
 
$
1,725
 
$
3,524
 
Amounts not subject to amortization:
                                     
Goodwill 
 
$
6,669
 
$
-
 
$
6,669
 
$
6,624
 
$
-
 
$
6,624
 
                                       
 

Estimated aggregate amortization expense is:
                           
   
2006
 
2007
 
2008
 
2009
 
2010
 
Total
 
                           
Acquired technology
 
$
229
 
$
279
 
$
-
 
$
-
 
$
-
 
$
508
 
Ongoing customer relationships
   
638
   
851
   
851
   
340
   
47
   
2,727
 
Total amortized expense
 
$
867
 
$
1,130
 
$
851
 
$
340
 
$
47
 
$
3,235
 
                                       
 
 
9

ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
7. OTHER COMPREHENSIVE LOSS

The components of other comprehensive loss were as follows (in thousands):

   
Three Months Ended March 31,
 
   
2006
 
2005
 
           
Net Loss
 
$
(8,047
)
$
(7,161
)
Foreign currency translation adjustment
   
335
   
81
 
Total comprehensive loss
 
$
(7,712
)
$
(7,080
)
               
 
8.  EMPLOYEE BENEFIT PLANS

2005 Stock Incentive Plan
 
At our Annual Meeting of Stockholders held June 29, 2005, our shareholders approved the 2005 Stock Incentive Plan (2005 Plan).  Under the 2005 Plan, no further awards will be granted under our prior Stock Incentive Plans which include our 1996, 1998, 1999 and 2000 plans.  Awards may be made under the 2005 Plan for a number of shares (subject to adjustment in the event of stock splits and other similar events) equal to the sum of (1) 2,000,000 shares of our Voting Common Stock, (2) any shares reserved for issuance under the Amended and Restated 2000 Stock Incentive Plan that remain available for issuance as of the date the 2005 Plan is approved by our stockholders and (3) any shares subject to outstanding awards under our 1996 Stock Plan, the Amended and Restated 1998 Stock Incentive Plan, the Amended and Restated 1999 Stock Incentive Plan and the Amended and Restated 2000 Stock Incentive Plan that expire or are terminated, surrendered or canceled without having been fully exercised, are repurchased or forfeited in whole or part or result in any shares subject to such award not being issued.  As of March 31, 2006, there were 2,416,081 shares available for future issuance under the 2005 Plan.
 
We issued 400,000 stock options and 100,000 shares of restricted stock in the first quarter of 2006 as an inducement grant in accordance with NASD Marketplace Rules. The grant date fair value of the restricted stock was $21.15.

A summary of stock option transactions is as follows during the quarter ended March 31, 2006:

                   
   
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Life
 
Aggregate Intrinsic Value (in thousands)
 
Outstanding at January 1, 2006
   
7,605,609
 
$
12.80
             
Options granted
   
690,000
 
$
22.59
             
Options excercised
   
(2,012,471
)
$
10.46
       
$
24,220
 
Options canceled
   
(334,948
)
$
12.93
             
                           
Outstanding at March 31, 2006
   
5,948,190
 
$
14.73
   
6.56
 
$
54,429
 
                           
Exercisable at March 31, 2006
   
3,242,031
 
$
13.00
   
4.64
 
$
35,668
 
                           
10


ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
 
Non-vested stock award activity including awards granted under NASD Marketplace Rules for the three month period ended March 31, 2006 is summarized as follows:
 

   
Non-vested Number of Shares
 
Weighted Average Grant-Date Fair Value
 
           
Nonvested balance at January 1, 2006
   
623,994
 
$
16.89
 
Granted
   
100,000
   
21.14
 
Vested
   
(71,250
)
 
18.25
 
Forfeited
   
(52,500
)
 
18.91
 
Nonvested balance at March 31, 2006
   
600,244
 
$
17.26
 
               
 
As of March 31, 2006, $34.3 million of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted average period of 3.81 years. As of March 31, 2006, $9.4 million of total unrecognized compensation costs related to nonvested awards is expected to be recognized over a weighted average period of 4.07 years.  The total fair value of shares vested during the quarter ended March 31, 2006 was $1.4 million.
 
The weighted average estimated fair value of our employee stock options granted at grant date market prices was $18.13 per share during the first quarter of fiscal 2006 and $11.69 per share during the first quarter of fiscal 2005. There were 9,926 shares that will be granted under our stock purchase plan as a result of employee participation during the first quarter of 2006. Included in the condensed statement of operations for the three month period ended March 31, 2006 is $2.9 million in stock-based compensation expense related to the amortization of previously valued shares granted under our Stock Incentive Plan.
 
The weighted average fair value of outstanding stock options has been estimated at the date of grant using a Black-Scholes option pricing model. The following are significant weighted average assumptions used for estimating the fair value of the activity under our stock option plans for the quarter ended March 31, 2006:

       
Expected term (in years)
 
6.45
 
Risk free interest rate
   
5.05
%
Expected volatility
   
78
%
Dividend yield
   
0
%
         
 

We have elected to use the simplified method for estimating our expected term equal to the midpoint between the vesting period and the contractual term as allowed by Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment.

We currently estimate volatility by using the weighted average historical volatility of our common stock.

The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term input to the Black-Scholes model.

We estimate forfeitures using a weighted average historical forfeiture rate. Our estimate of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from our estimate.

11

ECLIPSYS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
 
9. BASIC AND DILUTED LOSS PER COMMON SHARE

For all periods presented, basic and diluted loss per common share is presented in accordance with SFAS 128, “Earnings per Share,” which provides for the accounting principles used in the calculation of earnings per share. Basic loss per common share excludes dilution and is calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted loss per common share reflects the potential dilution from assumed conversion of all dilutive securities such as stock options and unvested restricted stock using the treasury stock method. When the effect of the outstanding stock options are anti-dilutive, they are not included in the calculation of diluted earnings per common share. The computation of basic and diluted earnings per common share was as follows (in thousands, except per share data):

   
March 31,
 
   
2006
 
2005
 
Basic and Diluted Loss Per Common Share:
         
Net loss
 
$
(8,047
)
$
(7,161
)
Weighted average common shares outstanding
   
50,581
   
47,323
 
Loss per common share
 
$
(0.16
)
$
(0.15
)
               
 
10.  RESTRUCTURING

In January 2006, we effected a restructuring of our operations which included a reduction in headcount of approximately 100 individuals and the reorganization of our senior management team. This initiative resulted in a restructuring charge of approximately $7.2 million in the first quarter of 2006 which has been recorded in our statements of operations as “restructuring charge” and is part of total costs and expenses. At March 31, 2006, the remaining unpaid liability was $3.9 million.  We expect to incur additional restructuring charges of $2.0 million during the second quarter of 2006. In connection with these initiatives, we have invested a portion of the anticipated cost reductions into client-related activities including client support and professional services.
 
11.  NEW ACCOUNTING PRONOUNCEMENTS

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Corrections” which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 also provides guidance on the accounting for and reporting of error corrections. This statement is applicable for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
 
12. LEGAL ACTION

The Company and its subsidiaries are from time to time parties to legal proceedings, lawsuits and other claims incident to their business activities. Such matters may include, among other things, assertions of contract breach or intellectual property infringement, claims for indemnity arising in the course of our business and claims by persons whose employment with us has been terminated. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance or recoverable from third parties, or the financial impact with respect to these matters as of the date of this report. However, based on our knowledge at the time of this report, management believes that the final resolution of such matters pending at the time of this report, individually and in the aggregate, will not have a material adverse effect upon our consolidated financial position, results of operations or cash flows.

 

12




ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS


This report contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about our company and our industry. When used in this report, the words “may”, “will”, “should”, “predict”, “continue”, “plans”, “expects”, “anticipates”, “estimates”, “intends”, “believe”, and “could”, and similar expressions are intended to identify forward-looking statements. These statements may include, but are not limited to, statements concerning our anticipated performance, including revenue, margin, cash flow, balance sheet and profit expectations; development and implementation of our software; duration, size, scope and revenue expectations associated with client contracts; benefits provided by Eclipsys software, outsourcing and consulting services; business mix; sales and growth in our client base; market opportunities; industry conditions; and our accounting, including its effects and potential changes in accounting.

Actual results might differ materially from the results projected due to a number of risks and uncertainties. Software development may take longer and cost more than expected, and incorporation of anticipated features and functionality may be delayed, due to various factors including programming and integration challenges and resource constraints. We may change our product strategy in response to client requirements, market factors, resource availability, and other factors. Implementation of some of our software is complex and time consuming. Clients’ circumstances vary and may include unforeseen issues that make it more difficult or costly than anticipated to implement or derive benefit from software, outsourcing or consulting services. The success and timeliness of our services often depends at least in part upon client involvement, which can be difficult to control. We are required to meet specified performance standards, and contracts can be terminated or their scope reduced under certain circumstances. Competition is vigorous, and competitors may develop more compelling offerings or offer more aggressive pricing. New business is not assured and existing clients may migrate to competing offerings. Financial performance targets might not be achieved due to various risks, including slower-than-expected business development or new account implementation, or higher-than-expected costs to develop products, meet service commitments or sign new contracts. Our cash consumption may exceed expected levels if profitability does not meet expectations or strategic opportunities require cash investments. These and other risks and uncertainties are described in this report under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in our other filings made from time to time with the Securities and Exchange Commission. The cautionary statements made in this report should be read as being applicable to all related forward-looking statements wherever they appear. These statements are only predictions. We cannot guarantee future results, levels of activity, performance or achievements. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. We nonetheless reserve the right to make such updates from time to time without the need for specific reference to this report. No such update shall be deemed to indicate that other statements not addressed by such updates remain correct or create an obligation to provide any other updates.


Executive Overview
 
The following should be read in conjunction with our condensed consolidated financial statements, including the notes thereto, which are included elsewhere in this document.
 

Eclipsys is a healthcare information technology (HIT) company and a leading provider of advanced clinical, financial and management information software and service solutions. We develop and license proprietary software and content that is designed for use in connection with many of the key clinical, administrative and financial functions that hospitals and other healthcare organizations require. Among other things, our software enables physicians, nurses and other clinicians to order tests, treatment and medications and record, access and share information about patients. Our software also facilitates many administrative and financial functions, including patient admissions, scheduling, records maintenance, invoicing, inventory control, cost accounting, and assessment of the profitability of specific medical procedures and personnel.  Our content, which is integrated with our software, provides practice guidelines in context at the point of care for use by physicians, nurses and other clinicians.
 
We also provide services related to our software.  These services include software and hardware maintenance, outsourcing, remote hosting of our software as well as third-party HIT applications, network services, and training and consulting.
 

13


We believe that one of the key differentiators of our software is its open, flexible and modular architecture.  This allows our software to be installed one application at a time or all at once, and to integrate easily with software developed by other vendors or the client. This enables our clients to install our software without the disruption and expense of replacing their existing software systems to gain additional functionality.
 
We market our software to small, stand-alone hospitals, large multi-entity healthcare systems, academic medical centers and community hospitals. We have one or more of our software applications installed in, or licensed to be installed at approximately 1,500 facilities. All 16 of the top-ranked U.S. hospitals named to the Honor Roll of “America’s Best Hospitals” in the July 18, 2005 issue of U.S. News & World Report use one or more of our solutions.
 
Our Web site address is www.eclipsys.com.  We make available free of charge, on or through our Web site, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.
 
Background
 
We were founded in December 1995 to commercialize an integrated clinical and financial information software system for use by hospitals. Historically, hospitals kept records in paper form. This has been associated with patient safety concerns, including avoidable medical errors, duplicative and unnecessary procedures, inefficient use of limited resources, and a limited ability to track, bill and collect for services rendered. Our software is designed to address these issues by turning data into information that can be easily used, accessed by or provided to the right person, at the right time, in the right place. This enables hospital employees to redesign business processes, deliver higher quality care at lower cost, and receive expedited payment for services rendered. Our software also helps to improve collaboration among physicians, nurses and other healthcare workers across all venues of care.
 
Software Development
 
In June 1999, we began re-expressing the intellectual property we had acquired through acquisitions on a common platform to provide integrated software to our clients. In 1999, we announced the general availability of Sunrise Clinical Manager (SCM), the first version of our SunriseTM suite of software. SCM provides advanced knowledge-based clinical decision-support capabilities including computerized physician order entry.
 
In 2001, we announced our SunriseXATM strategy. This strategy was to migrate our Sunrise suite of software to an open architecture and platform. SunriseXA’s architecture is built on Microsoft’s .NET Framework, Microsoft SQL Server and the Microsoft Windows family of operating systems. In 2002 and 2003, we announced the general availability of certain components of our SunriseXA software offerings.
 
In October 2003, we identified and announced certain response time issues within components of the version of our next-generation clinical software that we were developing at that time. Although some of our software components had been implemented in and were working at some client sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. To address the issue, we implemented a strategy that was designed to allow SunriseXA clients to continue their deployment of SunriseXA, and at the same time allow us to continue the development of advanced SunriseXA solutions. This strategy was to replace the affected SunriseXA components with certain components from our SCM software, which is our prior generation, core clinical software. The response time issue resulted in a software delivery delay for some of our advanced SunriseXA functionality. The announcement of these issues also impacted the implementation schedules for a number of our clients. 
 
In connection with this issue, we recorded a $1.2 million write-down of capitalized software development costs to net realizable value for some SunriseXA components in the third quarter of 2003. The write-down was included in the costs of systems and services revenues. Also, we believe that the correction of the response time issue and related issues is covered by the warranties that we provide to our clients.  We intend to continue to remediate the problem for our clients. Accordingly, we recorded provisions related to warranty costs of $4.6 million to date.  These provisions reflect our estimate of warranty-related costs that includes among other things, implementation and third-party costs for affected clients. Warranty costs are charged to costs of systems and services revenues when they are probable and reasonably estimable.  Through March 31, 2006, we had expended approximately $3.9 million in warranty costs related to remediation of the response time issue and related issues.  As of March 31, 2006, the warranty reserve balance was $726,000.   Professional services revenues have been, and we believe will continue to be negatively affected as we utilize resources to fulfill these obligations.
 
On June 30, 2004, we released Sunrise Clinical Manager Release 3.5 XA.  This new release contained significant additional functionality for core clinical, ambulatory and emergency department settings, as well as enhancements to patient management

14


functions.  Additionally, the new release extended support for physicians through the inclusion of advanced functionality for clinical decision support, structured notes, medical necessity checking, prescription writing and medication management configuration.

In November 2004, we announced the general availability of Sunrise ED Manager 3.6 XA and Sunrise Ambulatory Care Manager 3.6 XA.  In the first quarter of 2005, we released Sunrise Clinical Manager Release 4.0 XA, which contained new features and enhancements in several key areas including incremental functionality related to ambulatory, emergency department, critical care, medication management and nursing.   Additionally, we released Remote Access Services (RAS) 4.0 XATM and Pocket SunriseTM 4.0 XA, which enhanced users’ ability to access our applications from remote locations.  Furthermore, in November 2005 we announced the release of Sunrise Radiology Information System (RIS), which automates radiology workflow.
 
In January 2006, we released Sunrise Clinical Manager Release 4.5 XA (SCM 4.5XA).  This release contained approximately 1,500 incremental functions which continued to enhance the capabilities of our offering in all major clinical areas including ambulatory, emergency department, critical care and nursing.  Additionally, this release included integrated end-to-end medication management capabilities and builds upon recent enhancements to our Sunrise Patient Financial Manager and Sunrise Decision Support Manager solutions.  The general availability of these releases fulfilled key deliverables expected by our clients in connection with the 2003 response time issue.
 
Competitive Environment and Other Challenges for 2006
 
During the fourth quarter of 2004 and much of 2005, we experienced a slow-down in closing new sales transactions related to increasing competition, issues associated with our previously discussed software delay and our CEO transition.  Additionally, we hired a new CEO during the fourth quarter of 2005 and implemented a restructuring of senior management and our operations during January 2006.   Our releases of  SCM 4.0 XA in March 2005 and SCM 4.5 XA in January 2006 included significant new functionality, and we are implementing this new software with a signficant number of clients.   In the event our new software does not continue to achieve market acceptance, we experience any significant delays in implementing these new releases or experience disruptions in our operations as a result of the restructuring activities, our results of operations could be negatively affected, including a delay or loss in closing future new sales transactions.
 
Critical Accounting Policies
 
We believe there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amount of revenue and other significant areas involving management’s judgments and estimates. On an ongoing basis, management evaluates and adjusts its estimates and judgments, if necessary. These significant accounting policies relate to revenue recognition, stock-based compensation, allowance for doubtful accounts, capitalized software development costs and our warranty reserve. Please refer to Note 2 of the audited consolidated financial statements for further discussion of our accounting policies in our 10-K for the year ended December 31, 2005 filed with the SEC on March 7, 2006.
 
Revenue Recognition
 
We generally contract under multiple element arrangements, which include software license fees, hardware and services including consulting, implementation, and software maintenance, for periods of 3 to 10 years. We evaluate revenue recognition on a contract-by-contract basis as the terms of each arrangement vary. The evaluation of our contractual arrangements often requires judgments and estimates that affect the timing of revenue recognized in our statements of operations. Specifically, we may be required to make judgments about:
 
 
·
whether the fees associated with our software and services are fixed or determinable;
 
 
·
whether collection of our fees is reasonably assured;
 
 
·
whether professional services are essential to the functionality of the related software;
 
 
·
whether we have the ability to make reasonably dependable estimates in the application of the percentage-of-completion method; and
 
 
·
whether we have verifiable objective evidence of fair value for our software and services.
 

15


 
We recognize revenues in accordance with the provisions of Statement of Position, No. 97-2, “Software Revenue Recognition,” (SOP 97-2) as amended by SOP 98-9, “Modification of SOP 97-2, With Respect to Certain Transactions”, (SOP No. 98-9) Staff Accounting Bulletin 104 “Revenue Recognition” (SAB 104) and Emerging Issues Task Force, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). SOP 97-2 and SAB 104, as amended, require among other matters, that there be a signed contract evidencing an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable.
 
 
Many of our contracts with our clients are multiple element arrangements which may provide for multiple software modules including the rights to future versions and releases we may offer within the software suites the client purchases or rights to software versions that support different hardware or operating platforms, and that do not qualify as exchange rights.  We refer to these arrangements as subscription contracts.  Additionally, we sometimes enter into multiple element arrangements that do not include these rights to future software or platform protection rights.  We refer to these arrangements as traditional software contracts.  Finally, we offer much of our software and services on a stand-alone basis. Revenue under each of these arrangements is recognized as follows:
 
Subscription Contracts
 
Our subscription contracts typically include the following deliverables:
 
 
 
·
Software license fees;
 
 
·
Maintenance;
 
 
·
Professional services; and
 
 
·
Third party hardware or remote hosting services.
 
Software license fees are recognized ratably over the term of the contract, commencing upon the delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. The value of the software is determined using the residual method pursuant to SOP 98-9. These contracts contain the rights to unspecified future software within the suite purchased and/or unspecified platform transfer rights that do not qualify for exchange accounting. Accordingly, these arrangements are accounted for pursuant to paragraphs 48 and 49 of SOP 97-2. Under certain arrangements, we capitalize related direct costs consisting of third party software costs and direct software implementation costs. These costs are amortized over the term of the arrangement.
 
In the case of maintenance revenues, vendor-specific objective evidence, or VSOE of fair value is based on substantive renewal prices, and the revenues are recognized ratably over the maintenance period.
 
In the case of professional services revenues, VSOE is based on prices from stand-alone sale transactions, and the revenues are recognized as services are performed pursuant to paragraph 65 of SOP 97-2.
 
Third party hardware revenues are recognized upon delivery, pursuant to SAB 104.
 
In the case of remote hosting services, VSOE is based upon consistent pricing charged to clients based on volumes and performance requirements on a stand-alone basis and substantive renewal terms, and the revenues are recognized ratably over the contract term as the services are performed. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the client at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly the related set-up fees are recognized ratably over the term of the contract.
 
We consider the applicability of EITF 00-3, “Application of AICPA SOP 97-2 to Arrangements That Include the Right to Use Software Stored On Another Entity’s Hardware,” to our remote hosting services arrangements on a contract-by-contract basis. If we determine that the client has the contractual right to take possession of our software at any time during the hosting period without significant penalty, and can feasibly run the software on its own hardware or enter into another arrangement with a third party to host the software, a software element covered by SOP 97-2 exists. When a software element exists in a remote hosting services arrangement, we recognize the license, professional services and remote hosting services revenues pursuant to SOP 97-2, whereby the fair value of the remote hosting service is recognized as revenue ratably over the term of the remote hosting contract. If we determine that a software element covered by SOP 97-2 is not present in a remote hosting services arrangement; we recognize revenue for the remote hosting services arrangement, ratably over the term of the remote hosting contract pursuant to SAB 104.

16


 
Traditional Software Contracts
 
We enter into traditional multiple-element arrangements that include the following elements:
 
 
 
·
Software license;
 
 
·
Maintenance;
 
 
·
Professional services; and
 
 
·
Third party hardware or remote hosting services.
 
  
Revenue for each of the elements is recognized as follows:
 
Software license fees are recognized upon delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. For those arrangements in which the fee is not considered fixed or determinable, the software license revenue is recognized as the payments become due. For arrangements where VSOE only exists for the undelivered elements, we account for the delivered elements (software license revenue) using the residual method in accordance with SOP 98-9.
 
In addition to the software license fees, these contracts may also contain maintenance, professional services and hardware or remote hosting services. VSOE and revenue recognition for these elements is determined using the same methodology as noted above for subscription contracts.
 
Software Contracts Requiring Contract Accounting
 
We enter into certain multiple element arrangements containing milestone provisions in which the professional services are considered essential to the functionality of the software. Under these arrangements, software license fees and professional service revenues are recognized using the percentage-of-completion method over the implementation period which generally ranges from 12 to 24 months. Under the percentage-of-completion method, revenue and profit are recognized throughout the term of the implementation based upon estimates of total labor hours incurred and revenues to be generated over the term of the implementation. Changes in estimates of total labor hours and the related effect on the timing of revenues and profits are recognized in the period in which they are determinable. Accordingly, changes in these estimates could occur and have a material effect on our operating results in the period of change.
 
Stand-Alone Software and Service
 
We also market certain software and services on a stand-alone basis, including the following:
 
 
 
·
Outsourcing;
 
 
·
Software license;
 
 
·
Maintenance;
 
 
·
Professional services;
 
 
·
Hardware;
 
 
·
Network services; and
 
 
·
Remote Hosting services.
 
Revenues related to such software and services are recognized as follows:
 
Software license fees and maintenance are marketed on a stand-alone basis may be licensed either under traditional contracts or under subscription arrangements. Software license fees under traditional contracts are recognized pursuant to SOP 97-2 upon delivery of the

17


software, persuasive evidence of an arrangement exists, the fee is fixed or determinable and collectibility is probable. Under subscription agreements for stand-alone software, license fees are recognized ratably over the term of the contract. With respect to maintenance, VSOE is determined based on substantive renewal prices contained in the contracts. Maintenance is recognized ratably over the term of the contract.
 
Professional services represent incremental services marketed to clients including implementation and consulting services. Professional services revenues, where VSOE is based on prices from stand-alone transactions are recognized as services are performed.
 
Hardware is recognized upon delivery pursuant to SAB 104.
 
Network service arrangements include the assessment, assembly and delivery of a wireless network which may include wireless carts or other wireless equipment to the client. Our network services arrangements are sold to a client for a fixed fee. All services are performed prior to the delivery of the equipment. These contracts are typically 60 to 90 days in length and are recognized pursuant to SAB 104, upon the delivery of the network to the client.
 
Remote hosting contracts that are sold on a stand alone basis are recognized ratably over the contract term pursuant to SAB 104. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the client at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly we recognize the related set-up fees ratably over the term of the contract.
 
We provide outsourcing services to our clients. Under these arrangements we assume all responsibilities for a healthcare organization’s IT operations using our employees. Our outsourcing services include facilities management, network outsourcing and transition management. These arrangements typically range from five to ten years in duration. Revenues from these arrangements are recognized when services are performed.
 
We record reimbursable out-of-pocket expenses in both systems and services revenues and as a direct cost of systems and services revenues in accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred (“EITF 01-14”). EITF 01-14 requires reimbursable out-of-pocket expenses incurred to be characterized as revenue in the statement of operations. In the quarter ended March 31, 2006 and 2005, reimbursable out-of-pocket expenses were $1.9 and $1.7 million respectively. 

In accordance with EITF Issue No. 00-10, Accounting for Shipping and Handling Fees, we have classified the re-imbursement by clients of shipping and handling costs as revenue and the associated cost as a component of costs of systems and services revenues.
 
If other judgments or assumptions were used in the evaluation of our revenue arrangements, the timing and amounts of revenue recognized may have been significantly different.
 
Stock - Based Compensation

Prior to January 1, 2006, we accounted for our stock-based employee compensation arrangements under the intrinsic value method prescribed by APB No. 25, as allowed by SFAS No. 123, as amended by SFAS No. 148. As a result, no expense was recognized for options to purchase our common stock that were granted with an exercise price equal to fair market value at the date of grant and no expense was recognized in connection with purchases under our employee stock purchase plan for the year ended December 31, 2005, nor in the three-month period ended March 31, 2005. In December 2004, FASB issued SFAS No. 123(R), which amended SFAS No. 123. SFAS No. 123(R) requires measurement of the cost of share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005. Subsequent to the effective date, the pro forma disclosures previously permitted under SFAS No. 123 are no longer an alternative to financial statement recognition. Effective January 1, 2006, we have adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation cost recognized during the three-month period ended March 31, 2006, includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 amortized over the options’ vesting period, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R) amortized on a straight-line basis over the options’ vesting period. The fair value is estimated at the date of grant using the Black - Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions such as expected term, expected volatility, and risk-free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of

18


the assumptions were based on or determined from external data (for example the risk free interest rate) and other assumptions were derived from our historical experience with share-based payment arrangements (for example, volatility and expected term). The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. Pro forma results for prior periods have not been restated. Implementation of SFAS No. 123(R) contributed $2.9 million to the current quarter loss of $(8.0) million The adoption of SFAS No. 123(R) had no impact on cash flows from operations or financing activities.

Allowance for Doubtful Accounts
 
In evaluating the collectibility of our accounts receivable, we assess a number of factors, including a specific client’s ability to meet its financial obligations to us, as well as general factors such as the length of time the receivables are past due and historical collection experience. Based on these assessments, we record a reserve for specific account balances as well as a reserve based on our historical experience for bad debt to reduce the related receivables to the amount we ultimately expect to collect from clients. If circumstances related to specific clients change, or economic conditions deteriorate such that our past collection experience is no longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in the consolidated financial statements.
 
Capitalized Software Development Costs
 
We capitalize software development costs in accordance with FASB Statement No. 86 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” We capitalize software development costs incurred subsequent to establishing technological feasibility of the software being developed. These costs include salaries, benefits, consulting and other directly related costs incurred in connection with coding and testing software. Capitalization ceases when the software is generally released for sale to clients, at which time amortization of the capitalized costs begins. At each balance sheet date, we perform a detailed assessment of our capitalized software development costs which includes a review of, among other factors, projected revenues, client demand requirements, software lifecycle, changes in software and hardware technologies, and software development plans. Based on this analysis we record adjustments, when appropriate, to reflect the net realizable value of our capitalized software development costs. The estimates of expected future revenues generated by the software, the remaining economic life of the software, or both, could change, materially affecting the carrying value of capitalized software development costs, as well as our consolidated operating results in the period of change.
 
Warranty Reserve
 
The agreements that we use to license our software include a limited warranty providing that our software, in its unaltered form, will perform substantially in accordance with the related documentation. Warranty costs are charged to costs of systems and services revenues when they are probable and reasonably estimable. In determining this warranty reserve, we used significant judgments and estimates for the additional professional service hours and third party costs that will be necessary to remedy this issue on a client-by-client basis. The timing and amount of our warranty reserve could have been different if we had used other judgments or assumptions in our evaluation.
 
19


THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005 (In thousands)

                           
   
Three Months Ended March 31, 2006
 
Three Months Ended March 31, 2005
         
                           
   
2006
 
% of Total Revenues
 
2005
 
% of Total Revenues
 
Change $
 
Change %
 
Revenues
                                     
Systems and services 
 
$
96,223
   
95.5
%
$
83,128
   
98.5
%
$
13,095
   
15.8
%
Hardware 
   
4,561
   
4.5
%
 
1,307
   
1.5
%
 
3,254
   
249.0
%
 Total revenues
   
100,784
   
100.0
%
 
84,435
   
100.0
%
 
16,349
   
19.4
%
                                       
Costs and expenses:
                                     
Costs of systems and services 
   
56,458
   
56.0
%
 
52,712
   
62.4
%
 
3,746
   
7.1
%
Costs of hardware revenues 
   
3,651
   
3.6
%
 
1,101
   
1.3
%
 
2,550
   
231.6
%
Sales and marketing 
   
16,269
   
16.1
%
 
17,729
   
21.0
%
 
(1,460
)
 
-8.2
%
Research and development 
   
16,962
   
16.8
%
 
12,576
   
14.9
%
 
4,386
   
34.9
%
General and administrative 
   
5,640
   
5.6
%
 
4,356
   
5.2
%
 
1,284
   
29.5
%
Depreciation and amortization 
   
3,802
   
3.8
%
 
3,683
   
4.4
%
 
119
   
3.2
%
Restructuring charge  
   
7,198
   
7.1
%
 
-
   
0.0
%
 
7,198
     
 Total costs and expenses
   
109,980
   
109.1
%
 
92,157
   
109.1
%
 
17,823
   
19.3
%
                                       
Loss from operations
   
(9,196
)
 
-9.1
%
 
(7,722
)
 
-9.1
%
 
(1,474
)
     
Interest income, net
   
1,149
   
1.1
%
 
561
   
0.7
%
 
588
   
104.8
%
Loss before income taxes
   
(8,047
)
 
-8.0
%
 
(7,161
)
 
-8.5
%
 
(886
)
     
                                       
Provision for income taxes
   
-
   
0.0
%
 
-
   
0.0
%
 
-
     
Net loss
 
$
(8,047
)
 
-8.0
%
$
(7,161
)
 
-8.5
%
$
(886
)
 
-12.4
%
 
                                     
Basic and diluted loss per common share
 
$
(0.16
)
     
$
(0.15
)
     
$
(0.01
)
     
                                       
 


RESULTS OF OPERATIONS

Total revenues increased $16.3 million, or 19.4%, to $100.8 million for the quarter ended March 31, 2006, compared with $84.4 million for the first quarter of 2005.

Systems and services revenues increased $13.1 million, or 15.8%, to $96.2 million for the quarter ended March 31, 2006, compared with $83.1 million for the first quarter of 2005. The increase in systems and services revenues was primarily a result of an increase in revenues associated with revenues recognized on a monthly basis including software, maintenance, outsourcing and remote hosting which increased $7.5 million or 12.5% over the prior year. Additionally, professional services revenues which include implementation and consulting related services were $23.6 million, an increase of $7.5 million or 46.0% over the prior year. Revenues related to software and networking services were $5.5 million, a decrease of $1.8 million over the prior year.

The increase in revenues from software, maintenance, outsourcing and remote hosting was primarily related to higher sales volumes in the second half of 2005. The higher sales volumes were associated with successful sales of our advanced clinical systems as well as outsourcing and remote hosting related services which is the result of an ongoing industry-wide trend in the adoption of such systems. The increase in professional services was related to heightened activity with customer implementations of our software solutions. These activities are expected to remain at higher levels in 2006 as nearly 100 customers are in the process of upgrading their software applications. Additionally, we have experienced a trend of a higher volume of professional services being purchased by our customers as they implement our applications. The decrease in software and networking services was primarily due to a lower volume of these transactions in 2006.

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Hardware revenues increased $3.3 million, or 249.0%, to $4.6 million for the quarter ended March 31, 2006, compared with $1.3 million for the first quarter of 2005. We expect hardware and networking services revenue to continue to fluctuate on a quarterly basis. During the next several years we expect to enhance our marketing effort around remote hosting to expand this portion of our business.

The adoption of SFAS No. 123(R) on January 1, 2006, which resulted in the expensing of stock based compensation during the current quarter, impacted costs and expenses discussed in more detail below as follows (in thousands):

   
Three Months Ended March 31, 2006
 
       
Costs of systems & services revenues
 
$
811
 
Sales and marketing
   
553
 
Research and development
   
239
 
General and administrative
   
1,277
 
Total stock-based compensation expense
 
$
2,880
 
         
 

Costs of systems and services revenues increased $3.7 million, or 7.1%, to $56.5 million, for the quarter ended March 31, 2006, compared to $52.7 million for the first quarter of 2005. The increase in costs of systems and services revenues was as a result of the increase in higher volumes of outsourcing, remote hosting and the delivery of professional services, the impact of adopting 123(R) as well as an increase in amortization of capitalized software development costs, discussed in further detail below. Gross margins on systems and services revenue were 41.3% for the quarter ended March 31, 2006 compared to 36.6% for the first quarter of 2005. The increase in gross margins was primarily a result of an improvement in revenue mix.

Costs of hardware revenues increased $2.6 million, or 231.6%, to $3.7 million for the quarter ended March 31, 2006, compared to $1.1 million for the first quarter of 2005. The increase in the cost of hardware revenues was attributable to the increase in hardware revenues discussed above. Gross margins on hardware revenue were 20.0% in the first quarter of 2006 compared to 15.8% in first quarter 2005.

Sales and marketing expenses decreased $1.5 million, or 8.2%, to $16.3 million for the quarter ended March 31, 2006, compared to $17.7 million for the first quarter of 2005. The decrease in sales and marketing expenses was primarily related to lower expenditures in the quarter related to trade shows and other marketing events. The current quarter restructuring initiative also had a positive impact on sales and marketing expenditures during the current quarter. We do not expect sales and marketing expense to continue at these lower levels for the rest of 2006.

Research and development expenses increased $4.4 million, or 34.9%, to $17.0 million, for the quarter ended March 31, 2006, compared to $12.6 million for the first quarter of 2005. The increase in research and development expense was primarily related to a decrease in capitalized software development costs of $4.9 million from $6.5 million in the quarter ended March 31, 2005, to $1.6 million for the quarter ended March 31, 2006. Gross research and development costs were $18.3 million in the quarter, compared to $19.0 million in the first quarter of 2005. The decrease in capitalized software was due to a lower level of costs associated with coding and development as a result of the release of SunriseXA 4.5 in January 2006 and the release of SunriseXA 4.0 in March 2005. We also made a concentrated effort in the current quarter to dedicate research and development resource on reducing our backlog of open customer support cases as part of our focus on customer service. Amortization of capitalized software development costs, which is included as a component of cost of systems and services revenues, increased by approximately $1.2 million, to $4.5 million for the three months ended March 31, 2006, compared to $3.3 million for the first quarter of 2005. We expect capitalized software development costs to increase during the remainder of 2006 as we begin to focus more heavily on new development initiatives. For the year, we expect capitalized software development costs to approximate 20% of gross research and development expenditures, with amortization of capitalized software development costs slightly exceeding capitalization. Ultimately, we expect the effect of amortization and capitalization to be approximately neutral over a calendar year, although not necessarily in individual quarters.

General and administrative expenses increased $1.3 million, or 29.5%, to $5.6 million, for the quarter ended March 31, 2006, compared to $4.4 million for the first quarter of 2005. The increase in expenses was primarily related to stock based compensation costs of $1.3 million as a result of the adoption of SFAS 123(R) as described previously.

21


Depreciation and amortization increased $119,000, or 3.2%, to $3.8 million for the quarter ended March 31, 2006, compared to $3.7 million, for the first quarter of 2005. The increase was primarily the result of higher depreciation related to fixed assets to increase capacity at our Technology Solutions Center.

In the quarter ended March 31, 2006, we recorded a restructuring charge of $7.2 million as a result of a reduction in headcount of approximately 100 individuals and the reorganization of our senior management team. This initiative was undertaken to better align our organization, reduce costs and to re-invest some of the cost savings into client-related activities including client support and professional services. At March 31, 2006, the remaining unpaid liability was $3.9 million which we expect to pay out during 2006.  We expect to incur additional restructuring related charges of approximately $2.0 million which will impact the second quarter of 2006.

Interest income increased $588,000, or 104.8%, to $1.1 million for the quarter ended March 31, 2006, compared to $561,000 for the first quarter of 2005. The increase was due to an improvement in yields related to higher interest rates in the quarter on higher cash balances.

As a result of these factors, we had a net loss of $(8.0) million for the quarter ended March 31, 2006, compared to a net loss of $(7.2) million for the first quarter in 2005.
 
LIQUIDITY AND CAPITAL RESOURCES

During the quarter ended March 31, 2006, operations used $10.1 million of cash, primarily related to the payment of year-end bonuses and commissions, and costs associated with the restructuring initiative. Investing activities used $51.8 million of cash, consisting of a net $44.5 million of purchases of marketable securities, $5.7 million for the purchase of property and equipment and $1.6 million for the funding of capitalized software development costs. The purchases of property and equipment was related to our continued investment in the infrastructure of our Technology Solutions Center for the expansion of our remote hosting services as well as our Oracle ERP implementation. Financing activities provided $21.0 million of cash from the exercise of stock options. Stock option exercises were higher than usual in the quarter because option holders whose employment was terminated in connection with our restructuring exercised their options.

As of March 31, 2006, our principal source of liquidity is our combined cash and marketable securities balance of $118.2 million. Our future liquidity requirements will depend on a number of factors including, among other things, the timing and level of our new sales volumes, the cost of our development efforts related to SunriseXA, the success and market acceptance of our future product releases, and other related items. As of March 31, 2006, we had approximately $840,000 in commitments for expenditures related to the Oracle ERP implementation. We believe that our current cash and marketable securities balances, combined with our anticipated cash collections from customers will be adequate to meet our liquidity requirements through 2006.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not currently use derivative financial instruments. We generally invest in high quality debt instruments with relatively short maturities. Based upon the nature of our investments, we do not expect any material loss from our investments.
 
22

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates. A hypothetical 10% increase or decrease in interest rates, however, would not have a material adverse effect on our financial condition. 
 
The following table illustrates potential fluctuation in annualized interest income based upon hypothetical values for blended interest rates and cash and marketable securities account balances. 

   
Combined cash and cash equivalents and
 
   
marketable securities balances (in thousands)
 Hypothetical Interest Rate
 
$
100,000
 
$
110,000
 
$
120,000
 
1.5%
   
1,500
   
1,650
   
1,800
 
2.0%
   
2,000
   
2,200
   
2,400
 
2.5%
   
2,500
   
2,750
   
3,000
 
3.0%
   
3,000
   
3,300
   
3,600
 
3.5%
   
3,500
   
3,850
   
4,200
 
4.0%
   
4,000
   
4,400
   
4,800
 
                     
* This sensitivity analysis is not a forecast of future interest income.
                     
 
We account for cash equivalents and marketable securities in accordance with SFAS No. 115. “Accounting for Certain Investments in Debt and Equity Securities.” Cash equivalents are short-term highly liquid investments with original maturity dates of three months or less. Cash equivalents are carried at cost, which approximates fair market value.
 
We do not currently enter into foreign currency hedge transactions. Through March 31, 2006, foreign currency fluctuations have not had a material impact on our financial position or results of operations.

ITEM 4. CONTROLS AND PROCEDURES
 
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) as of March 31, 2006.  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives of ensuring that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  There is no assurance that our disclosure controls and procedures will operate effectively under all circumstances.  Based upon the evaluation described above our chief executive officer and chief financial officer concluded that, as of March 31, 2006, our disclosure controls and procedures were effective at the reasonable assurance level.
 
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The Company is in the process of implementing an Oracle ERP system which is expected to go live during the second quarter of fiscal 2006. As a result of the implementation, it is anticipated that there will be changes to the design of our internal controls over financial reporting.

23

PART II.

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are from time to time parties to legal proceedings, lawsuits and other claims incident to their business activities. Such matters may include, among other things, assertions of contract breach or intellectual property infringement, claims for indemnity arising in the course of our business and claims by persons whose employment with us has been terminated. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance or recoverable from third parties, or the financial impact with respect to these matters as of the date of this report. However, based on our knowledge at the time of this report, management believes that the final resolution of such matters pending at the time of this report, individually and in the aggregate, will not have a material adverse effect upon our consolidated financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS

Many risks affect our business.  These risks include, but are not limited to, those described below, each of which may be relevant to decisions regarding ownership of our stock.  We have attempted to organize the description of these risks into logical groupings to enhance readability, but many of the risks interrelate or could be grouped in other ways, so no special significance should be attributed to these groupings.  Any of these risks could have a significant adverse effect on our business, financial condition or results of operations.
 
Risks relating to development and operation of our software
 
Since October 2003, we have worked to overcome the effects of technical issues we experienced at that time, and the success of our recent software releases, particularly Sunrise Clinical Manager 4.5 XA, is critical. 
 
 In October 2003, we announced the existence of response time issues within some components of the version of our next-generation core clinical software that we were developing at that time. We concluded that this was attributable to the technical design of the software, which did not adequately support the throughput required in the highly interactive patient care environment.   These issues harmed our reputation in the marketplace and set back our software development plans.  In addition, they resulted in significant expense associated with re-development and warranty claims.  Our 2003 operating results include a $1.2 million write-down of capitalized software development costs for some of our software components, and to date we have recorded provisions related to warranty costs of $4.6 million. We still have warranty and related issues with clients associated with the October 2003 problem.  Our sales bookings, market position, and financial performance have suffered as a result.
 
We took steps to address these issues, and our subsequent releases of Sunrise Clinical Manager 3.5 XA (3.5) in June 2004 and Sunrise Clinical Manager 4.0 XA (4.0) in March 2005 to date have not manifested these same throughput shortcomings.  Combined, these versions have been installed in approximately 60 locations; we believe they have performed well and achieved market acceptance.  However, they are still relatively recent releases and issues may appear in the future.  Due to our recent history, the marketplace can be expected to be particularly sensitive to any future technical issues we may encounter with our software, so any serious issues associated with 3.5 or 4.0 that may emerge could seriously impair our reputation, sales, client relationships and results of operations.
 
We believe that Sunrise Clinical Manager 4.5 XA (4.5), which we released in January 2006, largely completes the development objectives that we had envisioned before October 2003.  Many clients, investors and market observers have anticipated the 4.5 release as an important milestone in the evolution of our software offering and our market position.  However, 4.5 has not yet been widely implemented in clinical environments, so it is too early to assess its operational performance.  It is an ambitious software release that incorporates a large number of new features and functions and was completed relatively quickly.  As is typical with new software releases in general, 4.5 may require additional work to add functionality and to address issues that may be discovered as the software comes into use in our client base.  If these issues are significant, our reputation, sales, client relationships and results of operations could be significantly impaired.
 
Our software may not operate properly, which could damage our reputation and impair our sales. 
 
Software development is time consuming, expensive and complex.  Unforeseen difficulties can arise. We may encounter technical obstacles, and it is possible that we could discover additional problems that prevent our software from operating properly. If our software contains errors or does not function consistent with product specifications or client expectations, clients could assert liability claims against us and/or attempt to cancel their contracts with us.  It is also possible that future releases of our software, which would typically include additional features for our software, may be delayed. This could damage our reputation and impair our sales.
 
Our software development efforts may not meet the needs of our clients, which could adversely affect our results of operations.
 
We continuously strive to develop new software, and improve our existing software to add new features and functionality. We schedule and prioritize these development efforts according to a variety of factors, including our perceptions of market trends, client requirements, and resource availability. Our software is complex and requires a significant investment of time and resources to develop, test and introduce into use. Sometimes this takes longer than we expect. Sometimes we encounter unanticipated difficulties that require us to re-direct or scale-back our efforts. Sometimes we change our plans in response to changes in client requirements, market demands, resource availability, regulatory requirements, or other factors. All of this can result in acceleration of some initiatives and delay of others.  If we make the wrong choices or do not manage our development efforts well, we may fail to produce software that responds appropriately to our clients’ needs or fails to meet client expectations regarding new or enhanced features and

24


functionality.  If we fail to deliver software within the timeframes and with the features and functionality as described in our product specifications, we could be subject to significant contractual damages.
 
Market changes or mistaken development decisions could decrease the demand for our software, which could harm our business and decrease our revenues.
 
The healthcare information technology market is characterized by rapidly changing technologies, evolving industry standards and new software introductions and enhancements that may render existing software obsolete or less competitive. Our position in the market could erode rapidly due to the development of regulatory or industry standards that our software may not fully meet, or due to changes in the features and functions of competing software, as well as the pricing models for such software.  Our future success will depend in part upon our ability to enhance our existing software and services, and to develop and introduce competing new software and services that are appropriately priced to meet changing client and market requirements. The process of developing software and services such as those we offer is extremely complex and is expected to become more complex and expensive in the future as new technologies are introduced.  As we evolve our offering in an attempt to anticipate and meet market demand, clients and potential clients may find our software and services less appealing.  If software development for the healthcare information technology market becomes significantly more expensive due to changes in regulatory requirements or healthcare industry practices, or other factors, we may find ourselves at a disadvantage to larger competitors with more financial resources to devote to development.  If we are unable to enhance our existing software or develop new software to meet changing client requirements, demand for our software could suffer.
 
Our software strategy is dependent on the continued development and support by Microsoft of its .NET Framework and other technologies.
 
Our software strategy is substantially dependent upon Microsoft’s .NET Framework and other Microsoft technologies. The .NET Framework, in particular, is a relatively new and evolving technology. If Microsoft were to cease actively supporting .NET or other technologies, fail to update and enhance them to keep pace with changing industry standards, encounter technical difficulties in the continuing development of these technologies or make them unavailable to us, we could be required to invest significant resources in re-engineering our software. This could lead to lost or delayed sales, client costs associated with platform changes, unanticipated development expenses and harm to our reputation, and would cause our financial results and business to suffer.
 
Any failure by us to protect our intellectual property, or any misappropriation of it, could enable our competitors to market software with similar features, which could reduce demand for our software.
 
We are dependent upon our proprietary information and technology. Our means of protecting our proprietary rights may not be adequate to prevent misappropriation. The laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the United States. Also, despite the steps we have taken to protect our proprietary rights, it may be possible for unauthorized third parties to copy aspects of our software, reverse engineer our software or otherwise obtain and use information that we regard as proprietary. In some limited instances, clients can access source-code versions of our software, subject to contractual limitations on the permitted use of the source code. Furthermore, it may be possible for our competitors to copy or gain access to our content. Although our license agreements with clients attempt to prevent misuse of the source code or trade secrets, the possession of our source code or trade secrets by third parties increases the ease and likelihood of potential misappropriation of our software. Furthermore, others could independently develop technologies similar or superior to our technology or design around our proprietary rights.
 
Failure of security features of our software could expose us to significant expense and reputational harm.
 
Clients use our systems to store and transmit highly confidential patient health information.  Because of the sensitivity of this information, security features of our software are very important.  If, notwithstanding our efforts, our software security features do not function properly, or client systems using our software are compromised, we could face damages for contract breach, penalties for violation of applicable laws or regulations, significant costs for remediation and re-engineering to prevent future occurrences, and serious harm to our reputation.
 
Risks related to sales and implementation of our software
 
The length of our sales and implementation cycles may adversely affect our future operating results.
 
We have experienced long sales and implementation cycles. How and when to implement, replace, expand or substantially modify an information system, or modify or add business processes, are major decisions for hospitals, our target client market. Furthermore, our software generally requires significant capital expenditures by our clients. The sales cycle for our software ranges from 6 to 18 months

25


or more from initial contact to contract execution.  Our implementation cycle has generally ranged from 6 to 36 months from contract execution to completion of implementation. During the sales and implementation cycles, we will expend substantial time, effort and resources preparing contract proposals, negotiating the contract and implementing the software. We may not realize any revenues to offset these expenditures and, if we do, accounting principles may not allow us to recognize the revenues during corresponding periods. Additionally, any decision by our clients to delay purchasing or implementing our software may adversely affect our revenues.
 
We may experience implementation delays that could harm our reputation and violate contractual commitments.
 
Some of our software is complex and requires a lengthy and expensive implementation process.  Each client’s situation is different, and unanticipated difficulties and delays may arise as a result of failures by us or the client to meet our respective implementation responsibilities.  Because of the complexity of the implementation process, delays are sometimes difficult to attribute solely to us or the client.  Implementation delays could motivate clients to delay payments or attempt to cancel their contracts with us or seek other remedies from us. Any inability or perceived inability to implement consistent with a client’s schedule may be a competitive disadvantage for us as we pursue new business.  Implementation also requires our clients to make a substantial commitment of their own time and resources and to make significant organizational and process changes, and if our clients are unable to fulfill their implementation responsibilities in a timely fashion our projects may be delayed or become less profitable.
 
Implementation costs may exceed expectations, which can negatively affect our operating results.
 
Each client’s circumstances may include unforeseen issues that make it more difficult or costly than anticipated to implement our software. We may fail to project, price or manage our implementation services correctly.  If we do not have sufficient qualified personnel to fulfill our implementation commitments in a timely fashion, related revenue may be delayed, and if we must supplement our capabilities with expensive third-party consultants, our costs will increase.
 
Risks related to our outsourcing services
 
Various risks could interrupt clients’ access to their data residing in our service center, exposing us to significant costs.
 
We provide remote hosting services that involve running our software and third- party vendor’s software for clients in our Technology Solutions Center (TSC).  The ability to access the systems and the data the TSC hosts and supports on demand is critical to our clients.  Our operations and facilities are vulnerable to interruption and/or damage from a number of sources, many of which are beyond our control, including, without limitation: (i) power loss and telecommunications failures; (ii) fire, flood, hurricane and other natural disasters; (iii) software and hardware errors, failures or crashes, and (iv) computer viruses, hacking and similar disruptive problems.  We attempt to mitigate these risk through various means including redundant infrastructure, disaster recovery plans, separate test systems and change control and system security measures, but our precautions  may not protect against all problems.  If clients’ access is interrupted because of problems in the operation of our facilities, we could be exposed to significant claims by clients or their patients, particularly if the access interruption is associated with problems in the timely delivery of medical care.  We must maintain disaster recovery and business continuity plans that rely upon third-party providers of related services, and if those vendors fail us at a time that our center is not operating correctly, we could incur a loss of revenue and liability for failure to fulfill our contractual service commitments.  Any significant instances of system downtime could negatively affect our reputation and ability to sell our remote hosting services.
 
Any breach of confidentiality of client or patient data in our service center could expose us to significant expense and reputational harm.
 
We must maintain facility and systems security measures to preserve the confidentiality of data belonging to our clients and their patients that resides on computer equipment in our TSC.  Notwithstanding the efforts we undertake to protect data, our measures can be vulnerable to infiltration as well as unintentional lapse, and if confidential information is compromised we could face damages for contract breach, penalties for violation of applicable laws or regulations, significant costs for remediation and re-engineering to prevent future occurrences, and serious harm to our reputation.
 
 
Recruiting challenges and higher than anticipated costs in outsourcing our client’s IT operations may adversely affect our profitability.
 
We provide outsourcing services that involve operating clients’ IT departments using our employees.  At the initiation of these relationships, clients often require us to hire, at substantially the same compensation, the entire IT staff that had been performing the

26


services we take on.  In these circumstances our costs may be higher than we target unless and until we are able to transition the workforce, methods and systems to a more scalable model.  Various factors can make this difficult, including geographic dispersion of client facilities and variation in client needs, IT environments, and system configurations.  Also, under some circumstances we may incur unanticipated costs as a successor employer by inheriting unforeseen liabilities that the client had to these employees.  Further, facilities management contracts require us to provide the IT services specified by contract, and in some places it can be difficult to recruit qualified IT personnel.  Changes in circumstances or failure to assess the client’s environment and scope our services accurately can mean we must hire more staff than we anticipated in order to meet our responsibilities.  If we have to increase salaries or relocate personnel, or hire more people than we anticipated, our costs may increase under fixed fee contracts.
 
Inability to obtain consents needed from third parties could impair our ability to provide remote outsourcing services.
 
We and our clients need consent from some third-party software providers as a condition to running their software in our data center, or to allowing our employees who work in client locations under facilities management arrangements to have access to their software.  Vendors’ refusal to give such consents, or insistence upon unreasonable conditions to such consents, could reduce our revenue opportunities and make our outsourcing services less viable for some clients.
 
Risks related to the healthcare IT industry and market
 
We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do.
 
We face intense competition in the marketplace. We are confronted by rapidly changing technology, evolving user needs and the frequent introduction of new software to meet the needs of our current and future clients. Our principal competitors in our software business include Cerner Corporation, Epic Systems Corporation, Meditech, GE Medical Systems (which recently acquired IDX Systems Corporation, formerly a separate competitor), McKesson Corporation, QuadraMed Corporation and Siemens AG. Other software competitors include providers of practice management, general decision support and database systems, as well as segment-specific applications and healthcare technology consultants.  Our services business competes with large consulting firms such as Deloitte & Touche and Cap Gemini, as well as independent providers of technology implementation and other services.  Our outsourcing business competes with large national providers of technology solutions such as International Business Machines Corporation (IBM), Computer Sciences Corp. (CSC), Perot Systems Corporation, as well as smaller firms.  Several of our existing and potential competitors are better established, benefit from greater name recognition and have significantly more financial, technical and marketing resources than we do.  Some competitors, particularly those with a more diversified revenue base or that are privately held, may have greater flexibility than we do to compete aggressively on the basis of price.  We expect that competition will continue to increase, which could lead to a loss of market share or pressure on our prices and could make it more difficult to grow our business profitably.
 
The principal factors that affect competition within our market include software functionality, performance, flexibility and features, use of open industry standards, speed and quality of implementation and client service and support, company reputation, price and total cost of ownership.  We anticipate that competition will increase as a result of continued consolidation in both the information technology and healthcare industries.  We expect large integrated technology companies to become more active in our markets, both through acquisition and internal investment.  There is a finite number of hospitals and other healthcare providers in our target market.  As costs fall, technology improves, and market factors continue to compel investment by healthcare organizations in software and services like ours, market saturation may change the competitive landscape in favor of larger competitors with greater scale.
 
Clients that use our legacy software are vulnerable to competition.
 
A significant part of our revenue comes from relatively high-margin legacy software that was installed by our clients many years ago. We attempt to convert these clients to our newer generation software, but such conversions require significant investments of time and resources by clients. This reduces our advantage as the incumbent vendor and has allowed our competitors to target these clients, with some success.  If we are not successful in retaining a large portion of these clients by continuing to support legacy software - which is increasingly expensive to maintain - or by converting them to our newer software, our results of operations will be negatively affected.
 
The healthcare industry faces financial constraints that could adversely affect the demand for our software and services.
 
The healthcare industry faces significant financial constraints. For example, the shift to managed healthcare in the 1990’s put pressure on healthcare organizations to reduce costs, and the Balanced Budget Act of 1997 dramatically reduced Medicare reimbursement to healthcare organizations. Our software often involves a significant financial commitment by our clients. Our ability to grow our

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business is largely dependent on our clients’ information technology budgets.  If healthcare information technology spending declines or increases more slowly than we anticipate, demand for our software could be adversely affected.
 
Healthcare industry consolidation could impose pressure on our software prices, reduce our potential client base and reduce demand for our software.
 
Many hospitals have consolidated to create larger healthcare enterprises with greater market power. If this consolidation trend continues, it could reduce the size of our target market and give the resulting enterprises greater bargaining power, which may lead to erosion of the prices for our software. In addition, when hospitals combine they often consolidate infrastructure including IT systems, and acquisition of our clients could erode our revenue base.
  
Potential changes in standards applicable to our software could require us to incur substantial additional development costs.
 
Integration and interoperability of the software and systems provided by various vendors are important issues in the healthcare industry.  Market forces or regulatory authorities could cause emergence of software standards applicable to us, and if our software is not consistent with those standards we could be forced to incur substantial additional development costs to conform.  If our software is not consistent with emerging standards, our market position and sales could be impaired.
 
Risks related to our operating results, accounting controls and finances
 
We have a history of operating losses and we cannot predict future profitability.
 
During the current quarter, we had a net loss of $8.0 million. We had a profit of $485,000 in 2005 although we had a loss from operations of $2.6 million. We had a net loss of $32.6 million for the year ended December 31, 2004. We also had net losses of $56.0 million in 2003, $29.8 million in 2002 and $34.0 million in 2000. In 2001, we had net income of $4.4 million, although we had a loss from operations of $1.6 million.  It is not certain that we will achieve sustained or increasing profitability.  We may incur net losses in the future.
 
Our operating results may fluctuate significantly and may cause our stock price to decline.
 
We have experienced significant variations in revenues and operating results from quarter to quarter. Our operating results may continue to fluctuate due to a number of factors, including:

 
·
the performance of our software and our ability to promptly and efficiently address software performance shortcomings or warranty issues;
 
·
the cost, timeliness and outcomes of our software development and implementation efforts;
 
·
the timing, size and complexity of our software sales and implementations;
 
·
overall demand for healthcare information technology;
 
·
the financial condition of our clients and potential clients;
 
·
market acceptance of new services, software and software enhancements by us and our competitors;
 
·
client decisions regarding renewal or termination of their contracts;
 
·
software and price competition;
 
·
the relative proportions of revenues we derive from software, services and hardware;
 
·
the timing and size of future acquisitions;
 
·
personnel changes;
 
·
significant judgments and estimates made by management in the application of generally accepted accounting principles;
 
·
healthcare reform measures and healthcare regulation in general; and
 
·
fluctuations in general economic and financial market conditions, including interest rates.
 
It is difficult to predict the timing of revenues that we receive from software sales, because the sales cycle can vary depending upon several factors. These include the size and terms of the transaction, the changing business plans of the client, the effectiveness of the client’s management, general economic conditions and the regulatory environment. In addition, the timing of our revenue recognition could vary considerably depending upon whether our clients license our software under our subscription model or our traditional licensing arrangements. Because a significant percentage of our expenses are relatively fixed, a variation in the timing of sales and implementations could cause significant variations in operating results from quarter to quarter. We believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful. Investors should not rely on these comparisons as indicators of future performance.

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Early termination of client contracts could adversely affect results of operations.
 
Client contracts can change or terminate early for a variety of reasons.  Change of control, financial issues, or other changes in client circumstances may cause us or the client to seek to modify or terminate a contract.  Further, either we or the client may generally terminate a contract for material uncured breach by the other.  If we breach a contract, we may be required to refund money previously paid to us by the client, or to pay other damages.  Even if we have not breached, we may deal with various situations from time to time for the reasons described above which may result in the amendment of a contract.  These steps can result in significant current period charges and/or reductions in future revenue.
 
Because in many cases we recognize revenues for our software monthly over the term of a client contract, downturns or upturns in sales will not be fully reflected in our operating results until future periods.
 
We recognize a significant portion of our revenues from clients monthly over the terms of their agreements, which are typically 5-7 years and can be up to 10 years. As a result, much of the revenue that we report each quarter is attributable to agreements executed during prior quarters. Consequently, a decline in sales, client renewals, or market acceptance of our software in one quarter will not necessarily be reflected in lower revenues in that quarter, and may negatively affect our revenues and profitability in future quarters. In addition, we may be unable to adjust our cost structure to compensate for these reduced revenues. This monthly revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as a significant portion of revenues from new clients must generally be recognized over the applicable agreement term.
 
Payment defaults by large customers could have significant negative impact on our liquidity and overall financial condition.
 
During the fiscal year ended December 31, 2005, approximately 40.2 % of our revenues were attributable to our 20 largest clients.  In addition, approximately 51.7% of our accounts receivable as of December 31, 2005 were attributable to 20 clients. Significant payment defaults by these clients could have a significant negative impact on our liquidity and overall financial condition.  
  
Impairment of intangible assets could increase our expenses.
 
A significant portion of our assets consists of intangible assets, including capitalized development costs, goodwill and other intangibles acquired in connection with acquisitions.  Current accounting standards require us to evaluate goodwill on an annual basis and other intangibles if certain triggering events occur, and adjust the carrying value of these assets to net realizable value when such testing reveals impairment of the assets.  Various factors, including regulatory or competitive changes, could affect the value of our intangible assets.  If we are required to write-down the value of our intangible assets due to impairment, our reported expenses will increase, resulting in a corresponding decrease in our reported profit.
 
Failure to maintain effective internal controls could adversely affect our operating results and the market price of our common stock.
 
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we maintain internal control over financial reporting that meets applicable standards.  If we fail to maintain effective internal controls and procedures in accordance with the requirements of Section 404, as such standards may be modified, supplemented or amended, we may be required to disclose our deficiencies.  If we are unable, or are perceived as unable, to produce reliable financial reports due to internal controls deficiencies, investors could lose confidence in our reported financial information and our operating results and the market price of our common stock could be adversely affected. 
 
Inability to obtain additional financing could limit our ability to conduct necessary development activities and make strategic investments.
 
While our available cash and cash equivalents and the cash we anticipate generating from operations appear at this time to be adequate to meet our foreseeable needs, we could incur significant expenses as a result of unanticipated events in our business or competitive, regulatory, or other changes in our market.  As a result, we may in the future need to obtain additional financing.  If additional financing is not available on acceptable terms, we may not be able to respond adequately to these changes, which could adversely affect our operating results and the market price of our common stock.  




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Risk of liability to third parties
 
Our software and content are used to assist clinical decision-making and provide information about patient medical histories and treatment plans. If our software fails to provide accurate and timely information or is associated with faulty clinical decisions or treatment, clients, clinicians or their patients could assert claims against us that could result in substantial cost to us, harm our reputation in the industry and cause demand for our software to decline.
 
We provide software and content that provides practice guidelines and potential treatment methodologies, and other information and tools for use in clinical decision-making, provides access to patient medical histories and assists in creating patient treatment plans. If our software fails to provide accurate and timely information, or if our content or any other element of our software is associated with faulty clinical decisions or treatment, we could have liability to clients, clinicians or patients. The assertion of such claims, whether or not valid and ensuing litigation, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations and decrease market acceptance of our software. We attempt to limit by contract our liability for damages and to require that our clients assume responsibility for medical care and approve all system rules and protocols. Despite these precautions, the allocations of responsibility and limitations of liability set forth in our contracts may not be enforceable, may not be binding upon patients, or may not otherwise protect us from liability for damages. We maintain general liability and errors and omissions insurance coverage, but this coverage may not continue to be available on acceptable terms or may not be available in sufficient amounts to cover one or more large claims against us. In addition, the insurer might disclaim coverage as to any future claim. One or more large claims could exceed our available insurance coverage.
 
Complex software such as ours may contain errors or failures that are not detected until after the software is introduced or updates and new versions are released. It is challenging for us to envision and test our software for all potential problems because it is difficult to simulate the wide variety of computing environments or treatment methodologies that our clients may deploy or rely upon. Despite extensive testing by us and clients, from time to time we have discovered defects or errors in our software, and such defects or errors can be expected to appear in the future.  Defects and errors that are not timely detected and remedied could expose us to risk of liability to clients, clinicians and patients and cause delays in software introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or client satisfaction with our software.
 
Our software and our vendors’ software that we include in our offering could infringe third-party intellectual property rights, exposing us to costs that could be significant.
 
Infringement or invalidity claims or claims for indemnification resulting from infringement claims could be asserted or prosecuted against us based upon design or use of software we provide to clients, including software we develop as well as software provided to us by vendors. Regardless of the validity of any claims, defending against these claims could result in significant costs and diversion of our resources, and vendor indemnity might not be available. The assertion of infringement claims could result in injunctions preventing us from distributing our software, or require us to obtain a license to the disputed intellectual property rights, which might not be available on reasonable terms or at all.  We might also be required to indemnify our clients at significant expense.
 
Risks related to our strategic relationships and initiatives
 
We depend on licenses from third parties for rights to some technology we use, and if we are unable to continue these relationships and maintain our rights to this technology, our business could suffer.
 
We depend upon licenses for some of the technology used in our software from a number of third-party vendors. Most of these licenses expire within one to five years, can be renewed only by mutual consent and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. We may not be able to continue using the technology made available to us under these licenses on commercially reasonable terms or at all. As a result, we may have to discontinue, delay or reduce software shipments until we obtain equivalent technology, which could hurt our business. Most of our third-party licenses are non-exclusive. Our competitors may obtain the right to use any of the technology covered by these licenses and use the technology to compete directly with us. In addition, if our vendors choose to discontinue support of the licensed technology in the future or are unsuccessful in their continued research and development efforts, particularly with regard to Microsoft, we may not be able to modify or adapt our own software.
 



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Our offering often includes software modules provided by third parties, and if these third parties do not meet their commitments, our relationships with our clients could be impaired.
 
Some of the software modules we offer to clients are provided by third parties.  We often rely upon these third parties to produce software that meets clients’ needs and to implement and maintain that software.  If these third parties fail to fulfill their responsibilities, our relationships with affected clients could be impaired, and we could be responsible to clients for the failures.  We might not be able to recover from these third parties for all of the costs we incur as a result of their failures.
 
If we undertake additional acquisitions, they may be disruptive to our business and could have an adverse effect on our future operations and the market price of our common stock.
 
An important element of our business strategy has been expansion through acquisitions. Since 1997, we have completed ten acquisitions.  While there is no assurance that we will complete any future acquisitions, any future acquisitions would involve a number of risks, including the following:

 
·
The anticipated benefits from any acquisition may not be achieved. The integration of acquired businesses requires substantial attention from management. The diversion of management’s attention and any difficulties encountered in the transition process could hurt our business.
 
·
In future acquisitions, we could issue additional shares of our capital stock, incur additional indebtedness or pay consideration in excess of book value, which could have dilutive effect on future net income, if any, per share.
 
·
New business acquisitions must be accounted for under the purchase method of accounting. These acquisitions may generate significant intangible assets and result in substantial related amortization charges to us.

Risks related to industry regulation
 
Potential regulation by the U.S. Food and Drug Administration of our software and content as medical devices could impose increased costs, delay the introduction of new software and hurt our business.
 
The U.S. Food and Drug Administration, or FDA, is likely to become increasingly active in regulating computer software or content intended for use in the healthcare setting. The FDA has increasingly focused on the regulation of computer software and computer-assisted products as medical devices under the Food, Drug, and Cosmetic Act, or the FDC Act. If the FDA chooses to regulate any of our software, or third party software that we resell, as medical devices, it could impose extensive requirements upon us, including the following:

 
·
requiring us to seek FDA clearance of pre-market notification submission demonstrating substantial equivalence to a device already legally marketed, or to obtain FDA approval of a pre-market approval application establishing the safety and effectiveness of the software;
 
·
requiring us to comply with rigorous regulations governing the pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and
 
·
requiring us to comply with rigorous regulations governing the pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and
 
·
requiring us to comply with the FDC Act regarding general controls including establishment registration, device listing, compliance with good manufacturing practices, reporting of specified device malfunctions and adverse device events.
 
If we fail to comply with applicable requirements, the FDA could respond by imposing fines, injunctions or civil penalties, requiring recalls or software corrections, suspending production, refusing to grant pre-market clearance or approval of software, withdrawing clearances and approvals, and initiating criminal prosecution. Any FDA policy governing computer products or content, may increase the cost and time to market of new or existing software or may prevent us from marketing our software.
 
Changes in federal and state regulations relating to patient data could depress the demand for our software and impose significant software redesign costs on us.
 
Clients use our systems to store and transmit highly confidential patient health information and data.  State and federal laws and regulations and their foreign equivalents govern the collection, use, transmission and other disclosures of health information. These laws and regulations may change rapidly and may be unclear or difficult to apply.
 

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Federal regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, impose national health data standards on healthcare providers that conduct electronic health transactions, healthcare clearinghouses that convert health data between HIPAA-compliant and non-compliant formats and health plans. Collectively, these groups are known as covered entities. The HIPAA standards prescribe transaction formats and code sets for electronic health transactions; protect individual privacy by limiting the uses and disclosures of individually identifiable health information; and require covered entities to implement administrative, physical and technological safeguards to ensure the confidentiality, integrity, availability and security of individually identifiable health information in electronic form. Though we are not a covered entity, most of our clients are and require that our software and services adhere to HIPAA standards. Any failure or perception of failure of our software or services to meet HIPAA standards could adversely affect demand for our software and services and force us to expend significant capital, research and development and other resources to modify our software or services to address the privacy and security requirements of our clients.
 
States and foreign jurisdictions in which we or our clients operate have adopted, or may adopt, privacy standards that are similar to or more stringent than the federal HIPAA privacy standards. This may lead to different restrictions for handling individually identifiable health information. As a result, our clients may demand information technology solutions and services that are adaptable to reflect different and changing regulatory requirements which could increase our development costs. In the future, federal or state governmental authorities may impose new data security standards or additional restrictions on the collection, use, transmission and other disclosures of health information. We cannot predict the potential impact that these future rules, may have on our business. However, the demand for our software and services may decrease if we are not able to develop and offer software and services that can address the regulatory challenges and compliance obligations facing our clients.
 
Risks related to our personnel and organization
 
Recent changes in our executive team could distract management and cause uncertainty that could result in delayed or lost sales.
 
From April until November 2005, our Chairman, Eugene V. Fife, served as our President and Chief Executive Officer on an interim basis, pending a search for a new, long-term Chief Executive Officer.  In November 2005, R. Andrew Eckert replaced Mr. Fife as CEO and President.  Including Mr. Eckert, five of our executive officers have joined the Company or assumed their current roles within the past year.  In January, 2006, we announced a headcount reduction of approximately 100 persons, including seven senior executives, and reorganization of our management structure.  These changes may disrupt continuity in our organization, disrupt established relationships with clients, prospects and vendors, divert our management’s time and attention from the operation of our business, delay important operational initiatives, and cause some level of uncertainty among our clients and potential clients that could lead to delays in closing new business or ultimately in lost sales.
 
If we fail to attract, motivate and retain highly qualified technical, marketing, sales and management personnel, our ability to execute our business strategy could be impaired.
 
Our success depends, in significant part, upon the continued services of our key technical, marketing, sales and management personnel, and on our ability to continue to attract, motivate and retain highly qualified employees. Competition for these employees is intense and we maintain at-will employment terms with our employees, meaning that they are free to leave at any time.  Further, while we do utilize non-compete agreements with some employees, such agreements may not be enforceable, or we may choose for various reasons not to attempt to enforce them. In addition, the process of recruiting personnel with the combination of skills and attributes required to execute our business strategy can be difficult, time-consuming and expensive. We believe that our ability to implement our strategic goals depends to a considerable degree on our senior management team. The loss of any member of that team could hurt our business.
 
Provisions of our charter documents and Delaware law may inhibit potential acquisition bids that a stockholder may believe is desirable, and the market price of our common stock may be lower as a result.
 
Our board of directors has the authority to issue up to 4,900,000 shares of preferred stock. The board of directors can fix the price, rights, preferences, privileges and restrictions of the preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may discourage, delay or prevent a merger or acquisition of our company. The issuance of preferred stock may result in the loss of voting control to other stockholders. We have no current plans to issue any shares of preferred stock. In August 2000, our board of directors adopted a shareholder rights plan under which we issued preferred stock purchase rights that would adversely affect the economic and voting interests of a person or group that seeks to acquire us or a 15% or more interest in our common stock without negotiations with our board of directors.
 


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Our charter documents contain additional anti-takeover devices including:
 
 
·
only one of the three classes of directors is elected each year;
 
·
the ability of our stockholders to remove directors without cause is limited;
 
·
the right of stockholders to act by written consent has been eliminated;
 
·
the right of stockholders to call a special meeting of stockholders has been eliminated; and
 
·
advance notice must be given to nominate directors or submit proposals for consideration at stockholders meetings.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES

In January 2006, we hired John E. Deady as Executive Vice President Client Solutions. Mr. Deady’s compensation includes 100,000 restricted shares of Eclipsys common stock and non-qualified options to purchase up to 400,000 shares of Eclipsys common stock, which were issued to Mr. Deady during the quarter, ended March 31, 2006. The restricted stock has a purchase price of $.01 per share, is subject to contractual restrictions on transfer until vested, and vests over five years, with the first 26.666% vesting on June 1, 2007, and an additional 10% of the total number of shares vesting on each December 1 and June 1 thereafter, with the final 3.334% vesting on June 1, 2011.  The stock options were issued to Mr. Deady in partial consideration of his employment, have a 10-year term and an exercise price per share equal to the fair market value of Eclipsys common stock on the date of grant, and vest over five years, with the first 20 percent vesting on February 1, 2007, and the remaining 80 percent vesting in 48 equal consecutive monthly installments thereafter.  Vesting of the restricted stock and stock options is contingent upon continued employment and is subject to acceleration under certain circumstances. These issuances were made as inducement grants pursuant to Section 4350(i)(1)(A)(iv) of the NASD Marketplace Rules, and were exempt from registration under the Securities Act of 1933 under Section 4(2) of that Act, because they did not involve any public offering.


ITEM 6. EXHIBITS

See Index to exhibits.
 
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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.

Date: May 9, 2006                         /S/ Robert J. Colletti  
                        Robert J. Colletti
Senior Vice President, Chief Financial Officer and Chief Accounting Officer



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ECLIPSYS CORPORATION
EXHIBIT INDEX


Exhibit
Number
Description
3.1 (1)
Third Amended and Restated Certificate of Incorporation of Eclipsys Corporation
3.2 (3)
Certificate of Designation of Series A Junior Participating Preferred
3.3 (2)
Amended and Restated Bylaws of Eclipsys Corporation
4.1 (3)
Rights Agreement dated July 26, 2000 by and between Eclipsys Corporation and Fleet National Bank, as Rights Agent, which includes as Exhibit A, the Form of Certificate of Designation, as Exhibit B, the form of Rights Certificate, and as Exhibit C, the Summary of Rights to Purchase Preferred Stock.
31.1
Rule 13a-14(a) Certification of R. Andrew Eckert
31.2
Rule 13a-14(a) Certification of Robert J. Colletti
32.1
Rule 13a-14(b) Certification of R. Andrew Eckert (pursuant to 18 U.S.C. Section 1350)
32.2
Rule 13a-14(b) Certification of Robert J. Colletti (pursuant to 18 U.S.C. Section 1350)

(1) Previously filed with the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 000-24539 and incorporated herein by reference.

(2) Previously filed with the Registrant’s Registration Statement on Form S-1, as amended (Registration No. 333-50781) and incorporated herein by reference.

(3)  Previously filed with the Company’s Current Report on Form 8-K filed August 8, 2000 and incorporated herein by reference.
 
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