10-Q 1 form10q.htm ECLIPSYS CORPORATION 10Q Q3 2005 Eclipsys Corporation 10Q Q3 2005
 


 

 
 
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 SEPTEMBER 30, 2005

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. Yesþ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yesþ No o

     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 October 31, 2005
 
 
  
Common Stock, $.01 par value
 
48,917,589

 
 


 
 








 


ECLIPSYS CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2005

INDEX
 
 
 
 
 
 
 
 
 
 
 
Page
PART I.
 
Financial Information
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
Condensed Consolidated Balance Sheets (Unaudited) - As of September 30, 2005 and December 30, 2004
 
 
2
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Operations (Unaudited) - For the Three and Nine Months ended September 30, 2005 and 2004
 
 
3
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited) - For the Three and Nine Months ended September 30, 2005 and 2004
 
 
4
 
 
 
 
 
 
 
 
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
5
 
 
 
 
 
 
 
 
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
11
 
 
 
 
 
 
 
 
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
 
27
 
 
 
 
 
 
 
 
Item 4.
 
Controls and Procedures
 
 
27
 
 
 
 
 
 
 
 
PART II.
 
Other Information
 
 
 
 
 
Item 1.
  
 
Legal Proceedings
   
 
28
  
 
Item 2.
 
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
28
 
 
Item 6.
 
 
Exhibits
 
 
 
29
 
 
 
 
 
 
 
 
Signatures
 
 
 
 
30
 
 
 
 
 
 
 
 
             



PART I

ITEM 1.
ECLIPSYS CORPORATION
Condensed Consolidated Balance Sheets - (Unaudited)
(In thousands, except share and per share data)

 
           
   
September 30,
  
December 31,
 
   
2005
  
2004
 
               
Assets
              
Current assets:
              
Cash and cash equivalents 
  
$
23,439
  
$
122,031
  
Marketable securities 
    
83,643
   
-
 
Accounts receivable, net of allowance for doubtful accounts of $4,821 and $4,952 
            
at September 30, 2005 and December 31, 2004 
    
75,195
   
64,862
 
Prepaid and other current assets 
    
18,373
   
15,586
 
Inventory 
    
2,134
   
1,644
 
 Total current assets
    
202,784
   
204,123
 
               
Property and equipment, net
    
37,578
   
35,002
 
Capitalized software development costs, net
    
33,551
   
29,819
 
Goodwill
   
4,371
   
2,863
 
Acquired technology and intangible assets, net
    
3,813
   
4,690
 
Other assets
    
22,397
   
14,923
 
 Total assets
  
$
304,494
  
$
291,420
  
               
               
Liabilities and Stockholders' Equity
              
Current liabilities:
              
 Deferred revenue
 
$
106,453
  
$
106,804
  
 Other current liabilities
    
33,187
   
32,587
 
 Accrued compensation
    
14,386
   
12,738
 
 Total current liabilities
    
154,026
   
152,129
 
               
Deferred revenue
    
17,809
   
15,892
 
               
Other long-term liabilities
    
1,258
   
122
 
               
Stockholders' Equity
    
131,401
   
123,277
 
               
   
$
304,494
  
$
291,420
  
               
               
               
               
 
              
               
               

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
- 2 -
 
ECLIPSYS CORPORATION
Condensed Consolidated Statements of Operations - (Unaudited)
(In thousands, except share amounts)

   
THREE MONTHS
  
NINE MONTHS
  
   
ENDED SEPTEMBER 30,
 
ENDED SEPTEMBER 30,
  
   
2005
  
2004
 
2005
  
2004
  
REVENUES
                          
Systems and services
  
$
94,806
  
$
71,352
  
$
269,491
  
$
201,756
  
Hardware
    
3,046
   
8,463
   
8,660
   
20,086
 
                           
TOTAL REVENUES
    
97,852
   
79,815
   
278,151
   
221,842
 
                           
COSTS AND EXPENSES
                        
Costs of systems and services revenues
    
56,776
   
42,694
   
165,601
   
124,079
 
Costs of hardware revenues
    
2,575
   
7,311
   
7,233
   
17,282
 
Sales and marketing
    
14,076
   
15,207
   
47,136
   
46,356
 
Research and development
    
12,726
   
15,032
   
39,276
   
44,306
 
General and administrative
    
3,840
   
3,281
   
14,707
   
10,856
 
Depreciation and amortization
    
3,625
   
3,355
   
10,891
   
9,731
 
                           
TOTAL COSTS AND EXPENSES
    
93,618
   
86,880
   
284,844
   
252,610
 
                           
INCOME (LOSS) FROM OPERATIONS
    
4,234
   
(7,065
)
  
(6,693
)
  
(30,768
)
Interest income, net
    
865
   
415
   
2,146
   
1,094
 
                           
INCOME (LOSS) BEFORE INCOME TAXES
    
5,099
   
(6,650
)
  
(4,547
)
  
(29,674
)
                           
Provision for income taxes
    
-
   
-
   
-
   
-
 
                           
NET INCOME (LOSS)
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
                           
BASIC NET INCOME (LOSS) PER COMMON SHARE
  
$
0.11
  
$
(0.14
)
$
(0.10
)
$
(0.64
)
                           
DILUTED NET INCOME (LOSS) PER COMMON SHARE
  
$
0.10
  
$
(0.14
)
$
(0.10
)
$
(0.64
)
                           
BASIC WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
    
48,304
   
46,671
   
47,751
   
46,459
  
                           
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
    
51,316
   
46,671
   
47,751
   
46,459
  
                           
                           
                           
 
                          
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 
- 3 -

ECLIPSYS CORPORATION
Condensed Consolidated Statements of Cash Flows - (Unaudited)
(In thousands)

   
THREE MONTHS ENDED
  
NINE MONTHS ENDED
  
   
SEPTEMBER 30,
  
SEPTEMBER 30,
  
   
2005
  
2004
  
2005
  
2004
  
OPERATING ACTIVITIES
                          
Net Income (loss)
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
Adjustments to reconcile net income (loss) to net cash provided by
                         
(used in) operating activities:
                          
Depreciation and amortization
    
8,319
   
7,468
   
24,425
   
19,719
 
Provision for bad debts
    
450
   
350
   
1,500
   
1,350
 
Stock compensation expense
    
570
   
132
   
1,720
   
293
 
Changes in operating assets and liabilities:
                      
Accounts receivable
    
(10,697
)
  
(8,195
)
  
(11,832
)
  
(8,301
)
Inventory
    
(462
)
  
(247
)
  
(490
)
  
(1,395
)
Other current assets
    
(450
)
  
(1,705
)
  
(2,787
)
  
1,434
 
Other assets
    
38
   
(350
)
  
(9,882
)
  
(2,800
)
Deferred revenue
    
3,322
   
13,550
   
1,567
   
13,819
 
Accrued compensation costs
    
(1,765
)
  
(2,790
)
  
1,998
   
(4,297
)
Other current liabilities
    
4,345
   
521
   
600
   
(480
)
Other long-term liabilities
    
(8
)
  
(12
)
  
1,135
   
(549
)
 Total adjustments to reconcile net income (loss)
                          
 to net cash provided by (used in) operating activities
    
3,662
   
8,722
   
7,954
   
18,793
 
 NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    
8,761
   
2,072
   
3,407
   
(10,881
)
                           
INVESTING ACTIVITIES
                          
Purchases of property and equipment
    
(6,493
)
  
(3,854
)
  
(12,809
)
  
(10,649
)
Purchases of marketable securities
   
(182,060
)
  
(10,867
)
  
(341,906
)
  
(175,866
)
Proceeds from sales of marketable securities
   
135,570
   
10,748
   
258,282
   
134,929
 
Capitalized software development costs
    
(5,003
)
  
(2,084
)
  
(14,637
)
  
(10,603
)
Cash paid for acquisitions
    
(926
)
  
-
   
(946
)
  
(2,500
)
 NET CASH USED IN INVESTING ACTIVITIES
    
(58,912
)
  
(6,057
)
  
(112,016
)
  
(64,689
)
                           
FINANCING ACTIVITIES
                          
Exercise of stock options
    
2,296
   
1,278
   
9,919
   
4,192
 
Proceeds from employee stock purchase plan
    
-
   
-
   
-
   
1,664
 
 NET CASH PROVIDED BY FINANCING ACTIVITIES
    
2,296
   
1,278
   
9,919
   
5,856
 
                           
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
    
29
   
106
   
117
   
86
 
                           
NET DECREASE IN CASH AND CASH EQUIVALENTS
    
(47,826
)
  
(2,601
)
  
(98,573
)
  
(69,628
)
                           
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
71,265
   
84,656
   
122,031
   
151,683
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
  
$
23,439
  
$
82,055
  
$
23,458
  
$
82,055
  
                           
SUPPLEMENTAL DISCLOSURE
                          
Non-cash investing activities:
                          
Issuance of shares for acquisition
  
$
-
  
$
-
  
$
-
  
$
2,500
  
Contingent purchase price of eSys and CPMRC
  
$
913
  
$
-
  
$
1,275
  
$
-
  
 

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

- 4 -
ECLIPSYS CORPORATION
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. 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 nine months ended September 30, 2005 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, 2004 that was filed with the SEC on March 16, 2005.


2. ACQUISITIONS
 
    In March 2004, we acquired CPM Resource Center, Ltd., or CPMRC. CPMRC provides consulting services and clinical content designed principally to improve and enhance the care process primarily related to the workflow of nurses and interdisciplinary healthcare professionals. At closing, we paid $2.5 million in cash and issued 184,202 shares of common stock for CPMRC, for a total initial consideration of $5.0 million. The transaction provided for additional earn-out payments to the prior owner of CPMRC through 2008 based on future operating results. The earn-out consideration is payable half in cash and half in shares of our common stock. The number of shares of the common stock to be issued, if any, will be based upon the average of the last reported sale prices of our common stock on the NASDAQ National Market for the five consecutive trading days ending on the trading day that is one day prior to the date on which the earn-out consideration is paid. The operating results of CPMRC have been combined with those of Eclipsys since the date of acquisition. We did not present unaudited pro forma results of operations of Eclipsys and CPMRC for the nine months ended September 30, 2004 because our pro forma results for this period would not be materially different from our actual results.
 
    As a result of the CPMRC acquisition, we originally recorded approximately $1.7 million in non-amortizable goodwill and $3.2 million in amortizable intangible assets. Since the date of acquisition we have recorded an additional $1.4 million in non-amortizable goodwill related to the earn-out provisions of the agreement. The first such earn-out payment, totaling $723,000 was paid in the quarter ended September 30, 2005. Amortizable intangible assets include customer relationships and acquired technology, and are being amortized over seven- and five-year periods, respectively, which we believe reflects the estimated expected utility of these assets. The non-amortizable goodwill is not tax deductible. The increase in non-amortizable goodwill recorded during the period ended September 30, 2005 reflects approximately $700,000 of incremental consideration that the prior owner earned in the third quarter of 2005 as part of the earn-out provisions of the agreement. All consideration paid under the earn-out provisions of the agreement will be recorded as non-amortizable goodwill.
 
    In December of 2004, we acquired eSys Medical Inc. (eSys). eSys develops and markets radiology information systems (RIS). We paid $2.3 million in cash consideration for the eSys acquisition. The transaction provided for two additional payments to the prior owners of eSys related to certain milestones in connection with future development efforts of the acquired technology. The first payment, totaling $750,000 and payable 25% in cash and 75% in our common stock, was earned during the quarter ended September 30, 2005. The second payment, which is worth $1.75 million to the former owners of eSys and also payable 25% in cash and 75% in our common stock, is pending based on attainment of the defined milestone in the purchase agreement between Eclipsys and the former owners. As of September 30, 2005, this milestone has not been met. Additionally, the agreement contains an earn-out provision in which the prior owners can earn up to an additional $5.0 million in future consideration based on sales of the acquired technology through 2008, payable in shares of our common stock. Since the date of acquisition, the prior owners of eSys have earned approximately $58,000, paid in cash, related to sales of the acquired technology. The number of shares of our common stock issued as earn-out consideration will be based on the average closing prices of our common stock on the NASDAQ National Market for the calendar quarter preceding the payment of the earn-out consideration.
 
    As a result of the eSys acquisition, we originally recorded approximately $2.0 million in amortizable intangible assets. These amortizable intangible assets include customer relationships ($1.1 million) and acquired technology ($914,000), which are being amortized over five- and three-year periods, respectively. We believe these amortization periods reflect the estimated expected utility of these assets. The operating results of eSys have been combined with those of Eclipsys since the date of acquisition. We did not present unaudited pro forma results of operations of Eclipsys and eSys for the three and nine months ended September 30, 2004 because our pro forma results for this period would not be materially different from our actual results. The majority of future consideration, if earned, will be recorded as non-amortizable goodwill.
 
    With respect to the acquisitions of CPMRC and eSys, we assigned the total purchase price to the net assets and liabilities of the businesses, with any remaining amount assigned to goodwill. The value assigned to the identifiable intangible assets was based on an analysis as of the date of acquisitions.

- 5 -
3. STOCK-BASED COMPENSATION
 
    The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations. Under this method, compensation cost for stock options is measured as the excess, if any, of the estimated market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. Accordingly, the Company provides the additional disclosures required under Statement of Financial Accounting Standards, or SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure.”
 
    The Company has adopted the disclosure-only provision of SFAS 123. Had compensation cost for the Company’s stock option grants described above been determined based on the fair value at the grant date of the respective awards, consistent with the provisions of SFAS 123, the Company’s net income (loss) and earnings (loss) per share would have been the pro forma amounts indicated below for the three month and nine month periods ended September 30, (in thousands, except per share data):
 
 
 Three Months Ended September 30,
  
Nine Months Ended September 30,
  
 
 
2005
  
2004
  
2005
  
2004
  
                   
Net Income (Loss): 
                          
 As reported
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
 Add: Stock-based employee compensation expense included
                          
 in reported net income (loss), net of related tax effects
    
570
    
132
    
1720
    
293
 
 Deduct: Total stock-based compensation expense determined
                          
 under fair value based method for all awards, net of related tax effects
    
(2,331
)
  
(2,147
)
  
(8,142
)
  
(7,627
)
 Pro forma
    
3,338
   
(8,665
)
  
(10,969
)
  
(37,008
)
Basic net income (loss) per share: 
                          
 As reported
    
0.11
   
(0.14
)
  
(0.10
)
  
(0.64
)
 Pro forma
    
0.07
   
(0.19
)
  
(0.23
)
  
(0.80
)
Diluted net income (loss) per share: 
                          
 As reported
    
0.10
   
(0.14
)
  
(0.10
)
  
(0.64
)
 Pro forma
    
0.07
   
(0.19
)
  
(0.23
)
  
(0.80
)
                           
4. MARKETABLE SECURITIES

Security Type
  
September
  
December
  
(in thousands)
  
30, 2005
  
31, 2004
  
   
 
  
 
  
Auction Rate Securities:
              
Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies
  
$
46,577
  
$
-
  
Debt securities issued by states of the United States and political subdivisions of the states
    
23,280
   
-
 
     
69,857
   
-
 
Other Securities:
              
Government Bonds/Agencies
    
5,999
   
-
 
Other debt securities
    
7,787
   
-
 
Total
  
$
83,643
  
$
-
  
 
    Marketable securities consist of funds that are highly liquid and are classified as available-for-sale. Marketable securities are recorded at a fair value, and unrealized gains and losses are recorded as a component of other comprehensive income.
 
    As of September 30, 2005, all marketable securities except for auction rate securities have a maturity of less than 2 years. Auction rate securities of $69.9 million held at September 30, 2005 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 September 30, 2005, we believe that these investments are considered a part our working capital and are appropriately classified as current assets.
 
- 6 -
    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. We do not foresee any additional risks and the funds remain highly liquid.
 
    For the three and nine months ended September 30, 2004, we revised our statements of cash flows to reflect the maturities and purchases of marketable securities in cash flows from investing activities for the three and nine months ended September 30, 2004 as follows (in thousands):

               
Three months ended September 30, 2004
              
   
Previously
      
As
 
   
Reported
  
Reclass
  
Reclassified
  
Maturities of short-term investments securities
 
$
-
  
$
10,748
  
$
10,748
  
Purchases of short-term investments securities
    
(119
)
$
(10,748
)
$
(10,867
)
Net change
  
$
(119
)
$
-
  
$
(119
)
                     
Nine months ended September 30, 2004
                    
 
 
 
Previously 
          
As
 
 
 
 
Reported 
    
Reclass
    
Reclassified
  
Maturities of short-term investments securities
 
$
-
  
$
134,929
  
$
134,929
  
Purchases of short-term investments securities
    
(40,937
)
$
(134,929
)
$
(175,866
)
Net change
  
$
(40,937
)
$
-
  
$
(40,937
)
 
5. ACCOUNTS RECEIVABLE

Unbilled Accounts Receivable and Deferred Revenue
 
    The timing of revenue recognition and contractual billing terms under certain multiple element arrangements may not precisely coincide, resulting in the recording of unbilled accounts receivable or deferred revenue. Customer payments are due under these arrangements in varying amounts upon the achievement of certain contractual milestones throughout the implementation periods, which generally range from 12 to 24 months. The current portion of unbilled accounts receivable is included in accounts receivable.
 
    In addition, we maintain certain long-term contracts used to finance a portion of certain customer hardware and software fees owed. These arrangements generally provide for payment terms that range from 3 to 5 years and carry interest rates that range from 7% to 10%. Such amounts are recorded as non-current unbilled accounts receivable. The non-current portion of amounts due related to these arrangements was $1.2 million and $1.1 million as of September 30, 2005 and December 31, 2004, respectively, and is included in other assets in the accompanying financial statements. The current portion of amounts due related to these arrangements is included in accounts receivable in the accompanying financial statements. Accounts receivable was composed of the following (in thousands):


           
   
September 30, 2005
  
December 31, 2004
  
Accounts Receivable:
              
Billed accounts receivable, net  
  
$
62,803
  
$
53,698
  
Total unbilled accounts receivable, net  
    
12,392
    
11,164
  
 Total accounts receivable, net
 
$
75,195
  
$
64,862
  
               

- 7 -
6. WARRANTY RESERVE
 
The agreements that we use to license our software to our customers generally include a limited warranty providing that the product, in its unaltered form, will perform substantially in accordance with the related documentation. Through September 30, 2003, Eclipsys had not incurred any material warranty costs related to its products. Due to the response time issues that we identified during the fourth quarter of 2003, we recorded provisions related to warranty costs of $4.6 million to date. Warranty costs are charged to cost of systems and services revenues when they are probable and reasonably estimable. A summary of the activity in our warranty reserve was as follows (in thousands):
 

           
   
2005
  
2004
  
           
Beginning Balance, January 1,
 
$ 2,057
 
$ 4,400
 
Provision for warranty
    
-
   
450
 
Provision reduction
    
-
   
(252
)
Warranty utilized
    
(742
)
  
(2,222
)
Ending Balance September 30,
  
$
1,315
  
$
2,376
  
               
 
7. GOODWILL AND OTHER INTANGIBLE ASSETS

The components of goodwill and other intangible assets were as follows (in thousands):


   
As of September 30, 2005
  
As of December 31, 2004
  
   
Gross Carrying
 
Accumulated
      
Gross Carrying
 
Accumulated
      
   
Amount
  
Amortization
  
Net Balance
  
Amount
  
Amortization
  
Net Balance
  
                           
Amortized intangible assets:
                              
Customer relationships 
  
$
4,335
  
$
(1,182
)
$
3,153
  
$
4,335
  
$
(531
)
$
3,804
  
Acquired technology
    
914
   
(254
)
  
660
   
914
   
(28
)
  
886
 
 Subtotal
  
$
5,249
  
$
(1,436
)
$
3,813
  
$
5,249
  
$
(559
)
$
4,690
  
                                       
 Unamortized intangible assets:
                                      
Goodwill 
  
$
2,863
  
$
-
  
$
2,863
  
$
454
  
$
-
  
$
454
  
Goodwill acquired during the period 
    
1,508
   
-
   
1,508
   
2,409
   
-
   
2,409
 
 Subtotal
  
$
4,371
  
$
-
  
$
4,371
  
$
2,863
  
$
-
  
$
2,863
  
                                       
Total goodwill and other intangibles
  
$
9,620
  
$
(1,436
)
$
8,184
  
$
8,112
  
$
(559
)
$
7,553
  
                                       
                                       
                                       
 The estimated amortization for the next five fiscal years is as follows (in thousands):
                    
                                       
 
    
For the year ending December 31, 
                          
     
2005
            
$
289
              
     
2006
              
1,155
             
     
2007
              
1,130
             
     
2008
              
851
             
     
2009
              
340
             
 
     Thereafter             
48
             
                     
$
3,813
              
                                       
 
    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 at least annually. This review indicates whether assets will be recoverable based on future expected cash flows. We perform our review for impairment of our intangible assets including goodwill during the fourth quarter of each fiscal year. Such a review was performed in the fourth quarter of 2004 and no impairment related issues were noted.

- 8 -

 
8. OTHER COMPREHENSIVE LOSS
 
The components of other comprehensive loss were as follows (in thousands):
 

   
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
   
2005
  
2004
  
2005
  
2004
  
                   
Net Income (Loss)
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
Foreign currency translation adjustment
    
29
   
106
   
117
   
86
 
Total comprehensive income (loss)
  
$
5,128
  
$
(6,544
)
$
(4,430
)
$
(29,588
)
                           

9. NET INCOME (LOSS) PER COMMON SHARE
 
    Net income (loss) per share is computed in accordance with SFAS No. 128, "Earnings Per Share."  We compute basic net income (loss) per share by dividing net income (loss) by the weighted average number of common shares outstanding for each period.  Diluted net income (loss) per share is based upon the addition of the effect of common stock equivalents (stock options and restricted stocks) to the denominator of the basic net income (loss) per share calculation using the treasury stock method, if their effect is dilutive.  The computation of net income (loss) per share for the three and nine months ended September 30, 2005 and 2004 is as follows (in thousands, except per share data):
 

   
Three Months Ended
  
Nine months Ended
  
   
September 30,
  
September 30,
  
   
2005
  
2004
  
2005
  
2004
  
     
Basic earnings (loss) per share:
                          
Income (loss) from continuing operations
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
Amount allocated to participating preferred stockholders
    
-
   
-
   
-
   
-
 
Income (loss) available to common stockholders - basic
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
                           
Weighted average common shares outstanding
    
48,304
   
46,671
   
47,751
   
46,459
 
Basic earnings (loss) from continuing operations per share
    
0.11
   
(0.14
)
  
(0.10
)
  
(0.64
)
                           
Diluted earnings (loss) per share:
                          
Income (loss) from continuing operations
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
Amount allocated to participating preferred stockholders
    
-
   
-
   
-
   
-
 
Income (loss) available to common stockholders - diluted
  
$
5,099
  
$
(6,650
)
$
(4,547
)
$
(29,674
)
                           
Weighted average common shares outstanding
    
48,304
   
46,671
   
47,751
   
46,459
 
Weighted average effect of common stock equivalents:
                          
Stock options outstanding
    
2,490
   
-
   
-
   
-
 
Restricted stock outstanding
    
522
   
-
   
-
   
-
 
Weighted average diluted shares outstanding
   
51,316
   
46,671
   
47,751
   
46,459
 
Diluted earnings (loss) from continuing operations per share 
 
$
0.10
  
$
(0.14
)
$
(0.10
)
$
(0.64
)
 
 
10. NEW ACCOUNTING PRONOUNCEMENTS
 
    On December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”, (SFAS 123R) which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Statement 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. SFAS 123R requires all share-based payments to employees to be recognized in the income statement over the corresponding service period based on their grant date fair values and also requires an estimation of forfeitures when calculating compensation expense. We must adopt SFAS 123R no later than January 1, 2006. SFAS 123R permits public companies to adopt its requirements using one of three methods. We have not yet determined which adoption method we will utilize, but we believe it will have an impact on our results of operations (footnote 3).

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    In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”) which supersedes APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS No. 154 changes the requirements for accounting for and reporting of changes in accounting principle. The statement requires the retroactive application to prior periods' financial statements of changes in accounting principles, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS No. 154 does not change the guidance for reporting the correction of an error in previously issued financial statements or the change in accounting estimate. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not believe SFAS No. 154 will have a significant impact on our consolidated financial position or results of operations.

11. LITIGATION
 
    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. MANAGEMENT TRANSITION
 
    On April 29, 2005, we announced that Eugene V. Fife, our Chairman of the Board of Directors, had been named interim Chief Executive Officer (CEO) and President, replacing our prior CEO and President who had left the company. In connection with the transition of our prior CEO, we recorded severance and other transition related costs of approximately $2.2 million in the nine months-ended September 30, 2005.
 
    On October 20, 2005, we announced that the Board of Directors has appointed R. Andrew Eckert to replace Mr. Fife as CEO and President, effective as of November 14, 2005. Mr. Fife will continue as Chairman of the Board. Mr. Eckert’s employment commenced on October 24, 2005. He has entered into an employment agreement with the Company pursuant to which he is entitled to an annual salary of $650,000, a guaranteed bonus of $400,000 for 2006, and a performance-based bonus in subsequent years with a target payment of $400,000. In addition, Mr. Eckert’s compensation includes 150,000 restricted shares of Eclipsys common stock and non-qualified options to purchase up to 525,000 shares of Eclipsys common stock, all to be granted to him on November 14, 2005. 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 20 percent vesting on December 1, 2006, and an additional 10 percent vesting each June 1 and December 1 thereafter for the following four years. The stock options have a 10-year term, 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 December 1, 2006, 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.


- 10 -



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
 
    Eclipsys is a healthcare information technology company. We develop and license our proprietary software and content to hospitals and other healthcare organizations. Our software allows the organizations to automate many of the key clinical, administrative and financial functions that they require. Our software is designed to improve patient care and patient satisfaction for our customers, and allow them to reduce their operating costs and enhance their revenues. Our content provides practice guidelines for use in hospitals and other healthcare organizations.
 
    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 and initially grew through a series of strategic acquisitions completed in 1999. Our acquisitions were focused on acquiring strong customer bases and advanced software for the healthcare industry.
 
    In addition to these acquisitions, in 1996 we licensed certain intellectual property on an exclusive basis from Partners HealthCare System, Inc., or Partners. This intellectual property related to clinical workflows including order management and clinical decision support. The Partners technology has been incorporated within our product offerings.
 
    In March 2004, we acquired CPM Resource Center, Ltd., or CPMRC. CPMRC provides consulting services and clinical content designed principally to improve and enhance the care process primarily related to the workflow of nurses and interdisciplinary healthcare professionals who provide the majority of hands-on care at the point of service.

- 11 -
 
    In December of 2004, we acquired eSys Medical Inc. or eSys. eSys develops and markets radiology information systems, or RIS. We believe eSys’ RIS will enhance our diagnostic imaging solution and extend our clinical workflow solutions in radiology.

Product Development
 
    In June 1999, we began re-expressing the intellectual property that we acquired through acquisitions on a common platform to provide integrated software to our customers. In 1999, we announced the general availability of Sunrise Clinical Manager, or SCM, the first version of our Sunrise™ suite of software products. SCM provides advanced knowledge-based clinical decision-support capabilities including computerized physician order entry.
 
    In 2001, we announced our SunriseXA™ strategy. This strategy was to migrate our Sunrise suite of products to an open architecture and platform. Sunrise XA’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 product offerings.
 
    In October 2003, we identified and announced response time issues within some components of the version of our next-generation core clinical software that we were developing at that time. Although some of the software components had been implemented in and were working at some customer sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. The response time issue resulted in a product delivery delay for some of our advanced clinical software functionality and also adversely affected the implementation schedules for a number of our customers. As previously disclosed, this announcement had an adverse effect on our sales for 2004.
 
    In June 2004, we released Sunrise Clinical Manager 3.5 XA and in March 2005 we released Sunrise Clinical Manager 4.0 XA. The general availability of these releases fulfilled key deliverables expected by our customers in connection with the earlier response time issue. These releases were consistent with our strategy and contained enhanced functionality as planned. Sunrise Clinical Manager 4.5 XA is scheduled for release in December 2005 - January 2006.

Operational Initiatives
 
    During 2001, our management made two strategic decisions that significantly impacted our operating results. First, we substantially increased our gross research and development spending, which includes research and development expenses and capitalized software development costs. This decision was made to enable us to bring components of our SunriseXA product line to market more rapidly. Second, we invested heavily in sales and marketing to enhance market awareness surrounding Eclipsys and its products and services. We did this to capitalize on perceived market demand for our products and services. Additionally, in 2002, we moved aggressively to change our contracting model, offering our customers payment terms which are more evenly distributed over the term of the contract compared to the traditional licensing model we used previously, in which software license fees were paid in advance. We did this to meet the needs of our customers, by matching the timing of their payments to the value that we deliver to them. We believe that this contracting model makes purchasing decisions easier for our customers.
 
    The change in our contracting model has had a material affect on our business. Most notably, our revenues, gross margins, and cash flows have been affected by our adoption of this approach. Because the payments from our customers for software license fees are more evenly distributed over the term of the contract, our revenue from a particular transaction is recognized over a longer period of time compared to the traditional licensing model, while a significant portion of our operating expenses remain relatively fixed and are recognized early in the contract term. In some periods, our gross margins, operating margins, and cash flow from operating activities were negatively affected by lower upfront software payments. However, we believe that this contracting model provides for more predictable revenues on a year-over-year basis.
 
    During the quarter-ended June 30, 2005, we announced that Eugene V. Fife our Chairman of the Board of Directors had been named interim Chief Executive Officer and President. On October 20, 2005, we announced that the Board of Directors has appointed R. Andrew Eckert to replace Mr. Fife as CEO and President, effective as of November 14, 2005. Mr. Fife will continue in his role as Chairman of the Board of Directors of Eclipsys.
 
    We consumed cash in 2003, 2004 and the first three quarters of 2005, primarily because cash collections from new contract signings were not sufficient to offset our higher operating expenses. To fund our business, we used a portion of our cash on hand.

Operational Environment and Other Challenges for 2005
 
    During the fourth quarter of 2004, we experienced a slow down in sales transactions as a result of increasing competition within our sector, and this continued through the first half of 2005.  In particular, second quarter sales were disappointing.  Third quarter sales showed improvement over second quarter levels and fourth quarter prospects appear promising, but second half sales in the aggregate are unlikely to compensate fully for below-target sales in the second quarter.  Because new sales in 2005 are the primary source of

- 12 -

revenue growth for 2006, we anticipate that our revenues for 2006 will be somewhat less than our prior expectations.   Additionally, we have a significant number of customers scheduled to activate one or more modules of our software applications in the next several months. The successful implementation of these customers will be critical to our success. We are scheduled to release Sunrise Clinical Manager 4.5 XA, our newest version of our core clinical software, in December 2005 - January 2006.

 
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, allowance for doubtful accounts, capitalized software development costs and our warranty reserve.

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 products 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 product;

· 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 products and services.
 
    We recognize revenues in accordance with the provisions of Statement of Position, or SOP, No. 97-2, “Software Revenue Recognition” as amended by SOP No. 98-9, Staff Accounting Bulletin, or SAB, 104, “Revenue Recognition” and Emerging Issues Task Force, or EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” SOP 97-2 and SAB 104, as amended, require, among other things, that there be a signed contract evidencing that an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable.
 
    Many of our contracts with our customers are multiple element arrangements that provide for multiple software products, including the rights to future products we may offer within the software suites the customer 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 products or platform protection rights. We refer to these arrangements as traditional software contracts. Finally, we offer many of our products 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;

· 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 Statement of Position 98-9, “Modification of Statement

- 13 -

of Position 97-2 With Respect to Certain Transactions,” or SOP 98-9. These contracts contain the rights to unspecified future products within the product 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 Statement of Position 97-2, “Software Revenue Recognition,” or 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, where VSOE is based upon consistent pricing charged to customers based on volumes and performance requirements on a stand-alone basis and substantive renewal terms, 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 customer 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 Emerging Issues Task Force 00-3, or EITF 00-3, “Application of AICPA Statement of Position 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 customer 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 services 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.

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 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

- 14 -

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 Products and Services

    We also market products and services on a stand-alone basis. These products and services include the following:

· software license;

· maintenance;

· professional services;

· hardware;

· network services;

· remote hosting services;

· outsourcing.
 
    Revenue related to these products and services is recognized as follows:
 
    Software license fees and maintenance are marketed on a stand-alone basis and may be licensed either under traditional contracts or under subscription arrangements. Software license fees under traditional contracts are recognized pursuant to SOP 97-2 if, when the software has been delivered, persuasive evidence of an arrangement exists, the fee is fixed or determinable and collectibility is probable. Under subscription agreements for stand-alone products, 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 customers 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 services arrangements include the assessment, assembly and delivery of a wireless network, which may include wireless carts or other wireless equipment to the customer. Our network services arrangements are sold to a customer 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 customer.
 
    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 customer 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 customers. Under these arrangements we assume all responsibilities for a healthcare organization’s information technology 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.
 
    If other judgments or assumptions had been used in the evaluation of our revenue arrangements, the timing and amounts of revenue recognized might have been significantly different.

Allowance for Doubtful Accounts
 
    In evaluating the collectibility of our accounts receivable, we assess a number of factors, including a specific customer’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 customers. If circumstances related to specific customers change, or economic conditions deteriorate such that our past collection experience is no

- 15 -

longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in our 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 products. Capitalization ceases when the products are generally released for sale to customers, at which time amortization of the capitalized costs begins. This amortization is reflected in the costs of systems and services revenues. 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, customer demand requirements, product lifecycle, changes in software and hardware technologies, and product 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 generally include a limited warranty providing that our software, in its unaltered form, will perform substantially in accordance with the related documentation. Through September 30, 2003 we did not incur any material warranty costs related to our products. In October 2003, we identified and announced response time issues within some components of the version of our next-generation core clinical software that we were developing at that time. Although some of the software components had been implemented in and were working at some customer sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. The response time issue resulted in a product delivery delay for some of our advanced clinical software functionality and also adversely affected the implementation schedules for a number of our customers. In connection with this issue, we have recorded warranty provisions to date of $4.6 million.
 
    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 customer-by-customer basis. The timing and amount of our warranty reserve could have been different if we had used other judgments or assumptions in our evaluation.

- 16 -
 
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2004
  
(In thousands except per share data)
      
                           
   
Three Months Ended September 30,
 
   
 
  
% of Total
  
 
  
% of Total
  
 
  
 
  
   
2005
  
Revenues
 
2004
  
Revenues
 
Change $
 
Change %
 
                           
Revenues
                                      
Systems and services
  
$
94,806
    
96.9
%
$
71,352
    
89.4
%
$
23,454
    
32.9
%
Hardware
    
3,046
   
3.1
%
  
8,463
   
10.6
%
  
(5,417
)
  
-64.0
%
 Total revenues
    
97,852
   
100.0
%
  
79,815
   
100.0
%
  
18,037
   
22.6
%
                                       
Costs and expenses
                                    
Costs of systems and services revenues
    
56,776
   
58.0
%
  
42,694
   
53.5
%
  
41,082
   
33.0
%
Costs of Hardware revenues
    
2,575
   
2.6
%
  
7,311
   
9.2
%
  
(4,736
)
  
-64.8
%
Sales and marketing
    
14,076
   
14.4
%
  
15,207
   
19.0
%
  
(1,131
)
  
-7.4
%
Research and development
    
12,726
   
13.0
%
  
15,032
   
18.8
%
  
(2,306
)
  
-15.3
%
General and administrative
    
3,840
   
3.9
%
  
3,281
   
4.1
%
  
559
   
17.0
%
Depreciation and amortization
    
3,625
   
3.7
%
  
3,355
   
4.2
%
  
270
   
8.0
%
 Total costs and expenses
    
93,618
   
95.7
%
  
86,880
   
108.9
%
  
6,738
   
7.8
%
Income (loss) from operations
    
4,234
    
4.3
%
  
(7,065
)
  
-8.9
%
  
11,299
     
Interest income, net
    
865
   
0.9
%
  
415
   
0.5
%
  
450
   
108.4
%
Income (loss) before income taxes
    
5,099
    
5.2
%
  
(6,650
)
  
-8.3
%
  
11,749
       
Provision for income taxes
    
-
       
-
         
-
       
                                       
Net Income (loss)
  
$
5,099
    
5.2
%
$
(6,650
)
  
-8.3
%
$
11,749
        
Basic net income (loss) per common share
  
$
0.11
        
$
(0.14
)
      
$
0.25
        
Diluted net income (loss) per common share
  
$
0.10
        
$
(0.14
)
      
$
0.24
        
                                       
 
 
RESULTS OF OPERATIONS
 
    Total revenues increased by $18.0 million, or 22.6%, to $97.9 million for the quarter-ended September 30, 2005, compared with $79.8 million for the third quarter of 2004.
 
    Systems and services revenues increased by $23.5 million, or 32.9 %, to $94.8 million for the quarter-ended September 30, 2005, compared with $71.4 million for the third quarter of 2004.  Systems and services revenues increased primarily as a result of an increase in revenues generated under long-term contracts including remote hosting, outsourcing, software and software maintenance.  Revenues under these arrangements are generally recognized ratably over the term of the contract.  These revenues increased by $11.0 million or 21.6%.  This increase was primarily a result of contracts executed in the second half of 2004 and early 2005.   Additionally, in conjunction with the delivery of these contracts, professional services revenues, which include implementation and consulting services, increased by $8.2 million to $22.2 million, an increase of 58.7%, compared to $14.0 million in the third quarter of 2004.  The increase in professional services was associated with the activation of our advanced clinical and financial products at numerous customer sites. The increase in volume of professional services is expected to continue throughout the remainder of 2005 as a significant number of our customers continue to activate these applications.  Additionally, systems and services revenues increased as a result of a higher volume of software license fees, which increased to $5.3 million in 2005, compared to $1.0 million in 2004, primarily as a result of license fees under our clinical practice content remarketing arrangement.  There were no fees from this remarketing arrangement in the 2004 period.  We do not foresee significant revenue from the remarketing arrangement in the fourth quarter, and there is no assurance that we will generate comparable levels of revenue from the remarketing arrangement in any future periods.  Revenue increases in any period are attributable, to a significant degree, to prior-year sales.  Because 2005 sales have fallen short of our expectations, the percentage revenue increases experienced in 2005 may not be repeated in 2006.  
 
    Hardware revenues decreased by $5.4 million, or 64.0%, to $3.0 million for the quarter-ended September 30, 2005, compared with $8.5 million for the third quarter of 2004. Hardware revenues in 2005 are expected to remain at levels that are lower than 2004 as a significant number of customers purchased hardware in the prior year based on the scheduled activation of their respective implementations. Additionally, sales volumes of hardware decreased as some customers have elected to obtain remote hosting services from us in lieu of hardware purchases in connection with the purchase of our applications. Furthermore, hardware revenues have been negatively impacted as a result of our sales performance to date in 2005.
 
    Costs of systems and services revenues increased by $14.1million, or 33.0%, to $56.8 million, for the quarter-ended September 30, 2005, compared to $42.7 million for the third quarter of 2004. The increase in costs of systems and services revenues was primarily a result of incremental costs associated with higher levels of outsourcing and remote hosting revenues. Additionally, costs in the quarter increased as a result of a higher level of third party consulting costs used to supplement the delivery of implementation and consulting services on our customer engagements. The heightened level of spending associated with third party consulting costs is

- 17 -

expected to continue through the remainder of 2005, which will negatively impact our overall results. Amortization of capitalized software development costs, which is included as a component of costs of systems and services revenues, increased by approximately $400,000, to $3.8 million for the three months ended September 30, 2005, compared to $3.4 million for third quarter of 2004. The increase in amortization was the result of releases of Sunrise Clinical Manager 3.5 XA and 4.0 XA.
 
    Costs of hardware revenues decreased by $4.7 million, or 64.8%, to $2.6 million for the quarter-ended September 30, 2005, compared to $7.3 million for the third quarter of 2004. Gross margins on hardware revenues were 15.5% in the third quarter of 2005 and 13.6% in the third quarter of 2004. The decrease in the costs of hardware revenues was a result of lower hardware volume.
 
    Sales and marketing expenses decreased by $1.1 million or 7.4%, to $14.1 million for the quarter-ended September 30, 2005, compared to $15.2 million for the third quarter of 2004. The decrease in sales and marketing expenses was primarily related to a decrease in payroll and travel related costs.
 
    Research and development expenses decreased by $2.3 million, or 15.3%, to $12.7 million, for the quarter-ended September 30, 2005, compared to $15.0 million for the third quarter of 2004. Research and development costs decreased as a result of higher software capitalization in the third quarter of 2005 compared to the third quarter of 2004. Software capitalization increased to $5.0 million, compared to $2.1 million in the prior year. The higher level of capitalized software development costs primarily relates to activities associated with our Sunrise Clinical Manger 4.5 XA release which is scheduled for general availability in December 2005 - January 2006.
 
    General and administrative expenses increased by $559,000, or 17.0%, to $3.8 million for the quarter-ended September 30, 2005, compared to $3.3 million for the third quarter of 2004. These expenses increased due to incremental payroll related expenses.
 
    Depreciation and amortization increased by $270,000, or 8.0%, to $3.6 million, for the quarter-ended September 30, 2005, compared to $3.4 million, for the third quarter of 2004. The increase was primarily the result of higher depreciation related to fixed assets purchased to expand our corporate infrastructure.
 
    Interest income increased by $450,000, or 108.4%, to $865,000 for the quarter-ended September 30, 2005, compared to $415,000 for the third quarter of 2004. The increase was due to a significant improvement in yields resulting from higher interest rates in the quarter.
 
    As a result of these factors, we had a net income of $5.1 million for the quarter-ended September 30, 2005, compared to a net loss of $6.7 million for the third quarter in 2004.

- 18 -

NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2004
  
(In thousands except per share data)
                           
   
Nine Months Ended September 30,
 
   
 
  
% of Total
  
 
  
% of Total
  
 
  
 
  
   
2005
  
Revenues
 
2004
  
Revenues
 
Change $
 
Change %
 
                           
Revenues
                                      
Systems and services
  
$
269,491
    
96.9
%
$
201,756
    
90.9
%
$
67,735
    
33.6
%
Hardware
    
8,660
   
3.1
%
  
20,086
   
9.1
%
  
(11,426
)
  
-56.9
%
 Total revenues
    
278,151
   
100.0
%
  
221,842
   
100.0
%
  
56,309
   
25.4
%
                                       
Costs and expenses
                                    
Costs of systems and services revenues
    
165,601
   
59.5
%
  
124,079
   
55.9
%
  
41,522
   
33.5
%
Costs of Hardware revenues
    
7,233
   
2.6
%
  
17,282
   
7.8
%
  
(10,049
)
  
-58.1
%
Sales and marketing
    
47,136
   
16.9
%
  
46,356
   
20.9
%
  
780
   
1.7
%
Research and development
    
39,276
   
14.1
%
  
44,306
   
20.0
%
  
(5,030
)
  
-11.4
%
General and administrative
    
14,707
   
5.3
%
  
10,856
   
4.9
%
  
3,851
   
35.5
%
Depreciation and amortization
    
10,891
   
3.9
%
  
9,731
   
4.4
%
  
1,160
   
11.9
%
 Total costs and expenses
    
284,844
   
102.4
%
  
252,610
   
113.9
%
  
32,234
   
12.8
%
Loss from operations
    
(6,693
)
  
-2.4
%
  
(30,768
)
  
-13.9
%
  
24,075
   
78.2
%
Interest income, net
    
2,146
   
0.8
%
  
1,094
   
0.5
%
  
1,052
   
96.2
%
Loss before income taxes
    
(4,547
)
  
-1.6
%
  
(29,674
)
  
-13.4
%
  
25,127
   
84.7
%
Provision for income taxes
    
-
       
-
        -      
                                       
Net Loss
  
$
(4,547
)
  
-1.6
%
$
(29,674
)
  
-13.4
%
$
25,127
    
84.7
%
Basic net loss per common share
  
$
(0.10
)
      
$
(0.64
)
      
$
0.54
        
Diluted net loss per common share
  
$
(0.10
)
      
$
(0.64
)
      
$
0.54
        
                                       

RESULTS OF OPERATIONS
 
    Total revenues increased $56.3 million, or 25.4%, to $278.2 million for the nine months ended September 30, 2005, compared with $221.8 million for the same period in 2004.
 
    Systems and services revenues increased $67.7 million, or 33.6 %, to $269.5 million for the nine months ended September 30, 2005, compared with $201.8 million for the same period in 2004.  Systems and services revenues increased primarily as a result of an increase in revenues generated under long term contracts including increases in software, software maintenance, outsourcing and remote hosting. These revenues, which are generally recognized on a monthly basis, increased to $184.3 million, an increase $38.1 million, or 26.1%. The increase in revenues was primarily a result of higher revenues in connection with contracts entered into the second of half of 2004 and the first half of 2005. These revenues were also favorably impacted by progress made on customer projects resulting in higher monthly revenues, including software maintenance and software. Additionally, revenues related to our remote hosting offering increased as more customers have elected this service in lieu of purchasing hardware. Furthermore, 2005 was favorably impacted by an increase in our outsourcing revenues related to several significant contracts that were entered into during late 2004. In addition, systems and services revenues increased as a result of higher revenues related to professional services, which includes implementation and consulting services. These revenues increased to $59.6 million in the nine months ended September 30, 2005 compared to $40.4 million during the same period in 2004, an increase of $19.2 million, or 47.6%. This increase was related to higher volumes associated with customer activations of our advance clinical and financial software products. The higher level of professional services is expected to continue throughout the remainder of 2005 as we continue to activate numerous customers on the newest releases of our software product. Additionally, systems and services revenues increased as a result of a higher volume of software license fees, which increased to $9.1 million in 2005, compared to $2.4 million in 2004. This increase was primarily related to revenues associated with license fees under our clinical practice content marketing arrangement. There were no fees from this remarketing arrangement in the 2004 period.  We do not foresee significant revenue from the remarketing arrangement in the fourth quarter, and there is no assurance that we will generate comparable levels of revenue from the remarketing arrangement in any future periods.  Revenue increases in any period are attributable, to a significant degree, to prior-year sales.  Because 2005 sales have fallen short of expectations, the percentage revenue increases experienced in 2005 may not be repeated in 2006.  

- 19 -
 
    Hardware revenues decreased by $11.4 million, or 56.9% to $8.7 million, for the nine months ended September 30, 2005, compared with $20.1 million for the same period in 2004. As previously mentioned, 2005 hardware revenues are expected to remain at levels that are lower than 2004 due to the change in sales mix related to the purchase of remote hosting services in lieu of hardware purchases by our customers and a lower level of hardware volume associated with the status of customer implementations and lower sales volumes to date compared to the prior year.
 
    Costs of systems and services revenues increased $41.5 million, or 33.5%, to $165.6 million, for the nine months ended September 30, 2005, compared to $124.1 million for the same period in 2004. The increase in costs of systems and services revenues was largely a result of incremental costs associated with higher levels of outsourcing and remote hosting revenues. Additionally, costs in the period increased as a result of a higher level of third party consulting costs used to supplement our delivery of services in connection with customer implementation and consulting projects. The higher level of spending associated with the third party consulting costs is expected to continue through the remainder of 2005. Furthermore, the amortization of capitalized software development costs increased by $3.7 million as a result of releases of our clinical product suite in 2004 and 2005.
 
    Costs of hardware revenues decreased by $10.0 million, or 58.1%, to $7.2 million for the nine months ended September 30, 2005, compared to $17.3 million for the same period in 2004. Gross margins on hardware revenues were 16.5% in the nine months ended September 30, 2005 and 14.0% in the same period in 2004. The decrease in the costs of hardware revenues was attributable to the decrease in hardware revenues discussed above.
 
    Sales and marketing expenses increased $780,000, or 1.7%, to $47.1million for the nine months ended September 30, 2005, compared to $46.4 million for the same period in 2004. The increase in sales and marketing expenses was primarily related to increases in payroll related costs including incentive compensation related costs, travel, training and costs associated with marketing events.
 
    Research and development expenses decreased $5.0 million, or 11.4%, to $39.3 million, for the nine months ended September 30, 2005, compared to $44.3 million for the same period in 2004. The decrease in research and development expenses was primarily related to an increase in capitalized software development costs and lower overall expenditures. Capitalized software development costs increased to $14.6 million in 2005 compared to $10.6 million in 2004. The increase in capitalized software development costs was related to development efforts and activities associated with the completion of Sunrise Clinical Manager 4.5 XA which is scheduled for general availability in December 2005 - January 2006.
 
    General and administrative expenses increased $3.9 million, or 35.5%, to $14.7 million for the nine months ended September 30, 2005, compared to $10.9 million for the same period in 2004. General and administrative expenses in 2005 included $2.2 million of costs associated with the transition of our former Chief Executive Officer. Additionally, these expenses further increased as a result of incremental payroll related costs and professional services.
 
    Depreciation and amortization increased $1.2 million or 11.9%, to $10.9 million, for the nine months ended September 30, 2005, compared to $9.7 million, for the same period in 2004. The increase was primarily the result of higher depreciation related to fixed assets purchased to expand our corporate infrastructure.
 
    Interest income increased $1.1 million, or 96.2%, to $2.2 million for the nine months ended September 30, 2005, compared to $1.1 million for the same period in 2004. The increase was due to an improvement in yields resulting from higher interest rates in the period.
 
    As a result of these factors, we had a net loss of $4.5 million for the nine months ended September 30, 2005, compared to a net loss of $29.7 million for the same period in 2004.

LIQUIDITY AND CAPITAL RESOURCES
 
    During the quarter-ended September 30, 2005, operating activities generated $8.8 million of cash, primarily related to the collection of accounts receivable from customers and an overall improvement in our results of operations. Investing activities used $58.9 million of cash, primarily related to $5.0 million of capitalized software development costs, $6.5 million of capital expenditures and $46.5 million of net purchases of marketable securities. Financing activities provided $2.3 million of cash from the exercise of stock options. For the nine months ended September 30, 2005, operating activities provided $3.4 million of cash, primarily related to collection of accounts receivable and an overall improvement in operating results. These items were partially offset by some up-front costs in connection with a significant outsourcing contract, costs associated with the Chief Executive Officer transition and payments made in conjunction with prior year employee incentive compensation plans. Investing activities used $112.0 million of cash, primarily related to $14.6 million of capitalized software development costs, $12.8 million of capital expenditures and $83.6 million of net purchases of marketable equity securities. Financing activities provided $9.9 million of cash from the exercise of stock options.
 
    As of September 30, 2005, our principal source of liquidity was our combined cash and marketable securities balance of $107.1 million. Our future liquidity requirements will depend on a number of factors including, among other things, the timing and volume of our new sales, the cost of our development efforts, the success and market acceptance of our future product releases, and

- 20 -

other related items. As of September 30, 2005, we did not have any material commitments for capital expenditures. 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 for the next twelve months.
 
    There are a number of important factors that could affect our business and future operating results, including without limitation, the factors set forth below. The information contained in this report should be read in light of such factors. Any of the following factors could harm our business and future operating results.

We face risks relating to our product strategy
 
    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 the root cause of the issue was in the technical design of the software, which did not adequately support the throughput required in the highly interactive patient care environment. We believe we have corrected the problem, but we still have some warranty issues associated with this problem, the announcement adversely affected our 2004 sales and may continue to make sales more challenging for the affected applications. These issues could harm our relationships with customers generally and our reputation in the marketplace.
 
    Our subsequent releases of Sunrise Clinical Manager 3.5 XA in June 2004 and Sunrise Clinical Manager 4.0 XA in March 2005 were significant milestones in the implementation of our product strategy and to date have not manifested the throughput issues described above. However, we continue to face a variety of risks and uncertainties associated with our software development and implementation that could harm our relationships with customers generally and our reputation in the marketplace, including among others, the following:

· We may encounter technical obstacles and delays in implementing our software development plans, and it is possible that we could discover additional problems with our software. If our software does not function as promised or if we are not able to continue to add features and functionality to address market demand and remain competitive, our business will suffer.

· It is possible that future releases of our software, with anticipated additional features for our products, may be delayed. This could result in delayed or lost sales and potential breach of commitments to certain clients regarding availability of new functionality.

· Customers who are currently implementing SunriseXA have faced delays in their implementations. As a result, existing SunriseXA customers could attempt to cancel their contracts with us or seek financial or other concessions from us.

· As a result of the changes we will make to our SunriseXA product offerings, potential customers may find such products less appealing, which could decrease demand for our products.

· 2003 operating results reflect a $1.2 million write-down of capitalized software development costs for some of our software components. Additionally, to date we have recorded warranty related costs of $4.6 million related to the anticipated costs associated with the 2003 response time issue.

Recent changes in our executive team could distract management and cause uncertainty that could result in delayed or lost sales
 
    On April 29, 2005, we announced that our Chairman, Eugene V. Fife, had been named President and Chief Executive Officer on an interim basis, pending a search for a new, long-term Chief Executive Officer. On October 20, 2005, we announced that the Board of Directors had appointed R. Andrew Eckert to replace Mr. Fife as CEO and President, effective as of November 14, 2005, with Mr. Fife continuing as Chairman of the Board. The CEO transition could 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 customers and potential customers that could lead to delays in closing new business or ultimately in lost sales.

Our product strategy is dependent on the continued development and support by Microsoft of its .Net Framework and other technologies
 
    Our product 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 products. This could lead to lost or delayed sales, unanticipated development expenses and harm to our reputation, and would cause our financial results and business to suffer.

- 21 -


Our software development efforts may not meet the demands of the market or commitments to our clients, which could adversely affect our results of operations
 
    We continuously strive to develop new software products, and improve our existing software products 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 clients’ needs, and fail to meet commitments to clients regarding delivery of new or enhanced features and functionality. We have experienced such failures in the past and previous or potential failures of this kind could impair existing customer relationships and new sales.

Given the length of our sales and implementation cycles, if a significant number of our customers delay implementation, our future operating results may suffer
 
    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 customer market. Furthermore, our software generally requires significant capital expenditures by our customers. The sales cycle for our software ranges from 6 to 18 months or more from initial contact to contract execution. Historically, our implementation cycle has 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 financial 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 customers to delay purchasing or implementing our products may adversely affect our revenues.

Implementation costs may exceed expectations, which can negatively affect our margins
 
    Some of our software is complex and our implementations may require substantial investments of time and resources by us and our customers. Each customer’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, resulting in losses of margin, inefficient use of our implementation staff, and significant use of expensive third-party consultants to help us fulfill our implementation commitments.

The healthcare industry faces financial constraints that could adversely affect the demand for our products 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 customers. Our ability to grow our business is largely dependent on our customers’ information technology budgets. To the extent healthcare information technology spending declines or increases more slowly than we anticipate, demand for our products would be adversely affected.

We have a history of operating losses and we cannot predict future profitability
 
    For the nine months of 2005, we had a net loss of $4.5 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, $34.0 million in 2000, $9.4 million in 1999, and $35.3 million in 1998. In 2001, we had net income of $4.4 million, although we had a loss from operations of $1.6 million. We may continue to incur net losses and cannot predict when, or if, we will be profitable 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 products and our ability to promptly and efficiently address product performance shortcomings or warranty issue;

· the cost, timeliness and outcomes of our software development and implementation efforts;

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· the timing, size and complexity of our product sales and implementations;

· overall demand for healthcare information technology;

· the financial condition of our customers and potential customers;

· market acceptance of new services, products and product enhancements by us an our competitors;

· customer decisions regarding renewal of their respective contracts;

· product and price competition;

· the relative proportions of revenues we derive from software, services and hardware;

· changes in our operating expenses;

· the timing and size of future acquisitions;

· personnel changes;

· significant judgments and estimates made by management in the application of generally accepted accounting principles; 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 product 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 customer, the effectiveness of the customer’s management, general economic conditions and the regulatory environment. In addition, the timing of our revenue recognition could vary considerably depending upon the extent to which our customers elect to license our products under our subscription model or our traditional licensing arrangements. We also continue to offer contracts using 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.

Because in many cases we recognize revenues for our software monthly over the term of a customer 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 customers monthly over the terms of their agreements, which are typically 7 years and can be up to 10 years. As a result, much of the revenues that we report each quarter are attributable to agreements executed during prior quarters. Consequently, a decline in sales, client renewals, or market acceptance of our products 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 customers must generally be recognized over the applicable agreement term.

We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do
 
    We operate in a market that is intensely competitive. Our principal competitors include Cerner Corporation, Epic Systems Corporation, GE Medical Systems, IDX Systems Corporation, McKesson Corporation, QuadraMed and Siemens AG. We also face competition from providers of practice management systems, general decision support, database systems and other segment-specific applications, as well as from healthcare IT consultants. A number of existing and potential competitors are more established than we are, and have greater name recognition and financial, technical and marketing resources than we do. In addition, some of our competitors could consolidate with each other or with other large, well-financed companies, which could further intensify competition in our industry. For example, GE Medical Systems recently announced their plans to acquire IDX Systems Corporation. 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.

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If the healthcare industry continues to undergo consolidation, this could impose pressure on our products’ prices, reduce our potential customer base and reduce demand for our products
 
    Many hospitals have consolidated to create larger healthcare enterprises with greater market power. If this consolidation continues, it could erode our customer base and reduce the size of our target market. In addition, the resulting enterprises could have greater bargaining power, which may lead to erosion of the prices for our products.

Potential regulation by the U.S. Food and Drug Administration of our products and content as medical devices could impose increased costs, delay the introduction of new products 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 products 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 products, or third party products that we resell, as medical devices, it could impose extensive requirements upon us, including the following:

· requiring us to seek FDA clearance of a pre-market notification submission demonstrating that a product is substantially equivalent to a device already legally marketed, or to obtain FDA approval of a pre-market approval application establishing the safety and effectiveness of the product;

· 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 product corrections, suspending production, refusing to grant pre-market clearance or approval of products, 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 products or may prevent us from marketing our products.

Changes in federal and state regulations relating to patient data could depress the demand for our products and impose significant product redesign costs on us
 
    The demand for health care information systems is affected by state and federal laws and regulations that govern the collection, use, transmission and other disclosures of electronic health information. These laws and regulations may change rapidly and may be unclear or difficult to apply.
 
    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 customers are and require that our software and services adhere to HIPAA standards. Any failure or perception of failure of our products or services to meet HIPAA standards could adversely affect demand for our products and services and force us to expend significant capital, research and development and other resources to modify our products or services to address the privacy and security requirements of our customers.
 
    States and foreign jurisdictions in which we or our customers 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 customers 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 products and services may decrease if we are not able to develop and offer products and services that can address the regulatory challenges and compliance obligations facing our customers.

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Our products and content are used to assist clinical decision-making and provide information about patient medical histories and treatment plans If our products fail to provide accurate and timely information or the treatment methodologies suggested by our content are faulty, our customers could assert claims against us that could result in substantial cost to us, harm our reputation in the industry and cause demand for our products to decline
 
    We provide products and embedded content that assist in clinical decision-making, suggest treatment methodologies, provide access to patient medical histories and assist in creating patient treatment plans. If our software fails to provide accurate and timely information, or if treatment methodologies utilizing our content or practice guidelines are determined to be faulty, we could have liability to customers 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 products. We attempt to limit by contract our liability for damages arising from negligence, errors or mistakes. In addition, we require that our customers approve all system rules and protocols. Despite these precautions, the limitations of liability set forth in our contracts may not be enforceable or may not otherwise protect us from liability for damages. We maintain general liability insurance coverage, including coverage for errors or omissions. However, 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.
 
    Highly complex software products such as ours often contain undetected errors or failures when first introduced or as updates and new versions are released. It is particularly challenging for us to test our products because it is difficult to simulate the wide variety of computing environments or treatment methodologies that our customers may deploy or rely upon. Despite testing, from time to time we have discovered defects or errors in our products. Defects, errors or difficulties could cause delays in product introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or customer satisfaction with our products. In addition, despite testing by us and by current and potential customers, errors may be found after commencement of commercial shipments, resulting in loss of or delay in market acceptance.

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.
 
    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 a 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.

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. 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.

Changing customer requirements could decrease the demand for our products, which could harm our business and decrease our revenues
 
    The market for our products and services is characterized by rapidly changing technologies, evolving industry standards and new product introductions and enhancements that may render existing products obsolete or less competitive. As a result, our position in the healthcare information technology market could erode rapidly due to unforeseen changes in the features and functions of competing products, as well as the pricing models for such products. A significant part of our revenue comes from relatively high-margin legacy products that were installed by our customers many years ago. We attempt to convert these customers to our newer generation products, but such conversions require significant investments of time and resources by customers. This reduces our advantage as the

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incumbent vendor and has allowed our competitors to target these customers, with some success. Our future success will depend in part upon our ability to enhance our existing products and services, particularly our ability to continue to release our products onto the .NET Framework under the SunriseXA initiative, and to develop and introduce new products and services to meet changing customer requirements. The process of developing products and services such as those we offer is extremely complex and is expected to become increasingly complex and expensive in the future as new technologies are introduced. If we are unable to enhance our existing products or develop new products to meet changing customer requirements, demand for our products could suffer.

We depend on licenses from third parties for rights to the technology used in several of our products, 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 products from a number of third-party vendors, including Computer Corporation of America, Computer Associates, Oracle Corporation and Microsoft. 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 product 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 products.

Our products rely on our intellectual property, and any failure by us to protect our intellectual property, or any misappropriation of it, could enable our competitors to market products with similar features, which could reduce demand for our products
 
    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 products, reverse engineer our products or otherwise obtain and use information that we regard as proprietary. In some limited instances, customers 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 customers 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 products. Furthermore, others could independently develop technologies similar or superior to our technology or design around our proprietary rights. In addition, infringement or invalidity claims or claims for indemnification resulting from infringement claims could be asserted or prosecuted against us. Regardless of the validity of any claims, defending against these claims could result in significant costs and diversion of our resources. The assertion of infringement claims could also result in injunctions preventing us from
distributing products. If any claims or actions are asserted against us, we might be required to obtain a license to the disputed intellectual property rights, which might not be available on reasonable terms or at all.

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.
 
    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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
    We do not currently use derivative financial instruments. We generally buy investments that are highly liquid. Based upon the nature of our investments, we do not expect any material loss from our investments.
 
    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. 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.
 
Annualized interest income based upon hypothetical values for cash and marketable securities combined balances and interest rates:*
 

   
Combined cash and cash equivalents and
  
 Hypothetical Interest Rate
  
marketable securities balances (in thousands)
 
  
$ 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.)
    
 
ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure and Controls and Procedures in Internal Control Over Financial Reporting
 
    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 Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) as of September 30, 2005. 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 September 30, 2005, 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 fiscal quarter-ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
                                                       - 27 -


PART II.

ITEM 1. LEGAL PROCEEDINGS
 
    We and our 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 thins assertions of contract breach or intellectual property infringement, claims for indemnity arising in the course of our business and claims by persons whose employment 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
    In March 2004, we acquired CPM Resource Center, Ltd., or CPMRC. The transaction provided for earn-out payments to the prior owner of CPMRC through 2008 based on fute operating results. The earn-out consideration is payable half in cash and half in shares of our common stock, based upon the average of the last reported sale prices of our common stock on the NASDAQ National Market for the five consecutive trading days ending on the trading day that is one day prior to the date on which the earn-out consideration is paid. During the quarter ended September 30 we made the first earn-out payment, including issuance of 25,311 shares of common stock on August 18, 2005. The transaction was exempt from registration under the Securities Act of 1933 under Section 4(2) of that act, because it did not involve any public offering.
   
     In December of 2004, we acquired eSys Medical Inc. (eSys).  The transaction provided for two additional payments to the prior owners of eSys related to certain milestones in connection with future development efforts of the acquired technology following the closing, as well as earn-out payments payable through 2008.  The first development milestone payment, totaling $750,000 and payable 25% in cash and 75% in our common stock, was earned during the quarter-ended September 30, 2005, and the cash portion was paid. The 40,612 shares that were earned are still in the process of being issued as of the date of this report.  The transaction was exempt from registration under the Securities Act of 1933 under Section 4(2) of that act, because it did not involve any public offering.


                                                    - 28 -





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 Eugene V. Fife
31.2
Rule 13a-14(a) Certification of Robert J. Colletti
32.1
Rule 13a-14(b) Certification of Eugene V. Fife
32.2
Rule 13a-14(b) Certification of Robert J. Colletti
   
   
   
   
   

(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.