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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2006

or

For the transition period from              to             

Commission file number: 000-30883

I-MANY, INC.

(Exact name of registrant as specified in its charter)

399 Thornall Street

12th Floor

Edison, New Jersey 08837

(Address of principal executive offices)

(800) 832-0228

(Registrant’s telephone number, including area code)

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

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

Large Accelerated Filer  ¨    Accelerated Filer  x    Non-Accelerated Filer  ¨

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

On November 3, 2006, 48,075,455 shares of the registrant’s common stock, $.0001 par value, were issued and outstanding.

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Discussions containing forward-looking statements may be found in the information set forth in Part II, Item 1A, “Risk Factors,” of this Quarterly Report on Form 10-Q, as well as generally in this Form 10-Q. The Company uses words such as “believes,” “intends,” “expects,” “anticipates,” “plans,” “estimates,” “should,” “may,” “will,” “scheduled” and similar expressions to identify forward-looking statements. The Company uses these words to describe its present belief about future events relating to, among other things, its expected marketing plans, future hiring, expenditures and sources of revenue. This Form 10-Q may also contain third party estimates regarding the size and growth of our market, which also are forward-looking statements. Our forward-looking statements apply only as of the date of this Form 10-Q. The Company’s actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described above and elsewhere in this Form 10-Q.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. The Company is under no duty to update any of the forward-looking statements after the date of this Form 10-Q to conform these statements to actual results or to changes in our expectations, other than as required by law.

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I-MANY, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I. UNAUDITED FINANCIAL INFORMATION

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

I-MANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share-related amounts)

See notes to condensed consolidated financial statements.

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I-MANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

See notes to condensed consolidated financial statements

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I-MANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See notes to condensed consolidated financial statements.

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I-MANY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to interim financial reporting pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. It is recommended that these condensed consolidated financial statements be read in conjunction with the financial statements and the related notes of I-many, Inc. (the “Company”) for the year ended December 31, 2005 as reported in the Company’s Annual Report on Form 10-K filed with the SEC. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for the fair presentation of these interim financial statements have been included. The results of operations for the three months and nine months ended September 30, 2006 may not be indicative of the results that may be expected for the year ending December 31, 2006, or for any other period.

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition:

The Company recognizes revenue in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” and SOP 98-9, “Software Revenue Recognition, with Respect to Certain Arrangements.” Software license fees are recognized upon execution of a signed license agreement and delivery of the software to customer, provided there are no significant post-delivery obligations, the payment is fixed or determinable and collection is probable. In multiple-element arrangements, the total fee is allocated to the undelivered professional services, training and maintenance and support services based on the fair value of those elements, which is defined as the price charged when those elements are sold separately. The residual amount is then allocated to the software license fee. In cases where the Company agrees to deliver unspecified additional products in the future, the license fee is recognized ratably over the term of the arrangement beginning with the delivery of the first product. If an acceptance period is required, revenues are deferred until customer acceptance. In cases where collection is not deemed probable, the Company recognizes the license fee as payments are received. In cases where significant production or customization is required prior to attaining technological feasibility of the software, license fees are recognized on a percentage-of-completion basis and are credited to research and development expenses as a funded development arrangement. After the software attains technological feasibility, recognizable license fees are reported as product revenue.

Current and prospective customers have the option of entering into a subscription agreement as an alternative to the Company’s standard license contract model. The standard subscription arrangement is presently a fixed fee agreement over three or more years, covering license fees, unspecified new product releases and maintenance and support, generally payable in equal quarterly installments commencing upon execution of the agreement. The Company recognizes all revenue from subscription-based arrangements ratably over the term of the subscription agreement commencing upon delivery of the initial product. In most agreements that have been executed to date, the subscription arrangement converts free-of-charge to a perpetual license after the completion of the initial term plus any extensions, generally after five years, after which time the customer would have the option of paying for the continuation of maintenance and support.

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During the third quarter of 2005, the Company became aware of certain defects in the then-current version of one of its software products, which was first shipped to customers in the fourth quarter of 2004. These defects, which were not identified in pre-release product testing, affected the performance of the software for a portion of the Company’s customers depending on each customer’s particular implementation environment and its intended use of the software. Because certain concessions have been made to customers in connection with these defects, the Company has generally not recognized revenue from sales of this software product and related implementation services beginning in the third quarter of 2005, except in those cases in which it was determined that the customer was not likely to be affected by the known, unresolved software defects. In June 2006, the Company issued a new major release of the software, which was designed to resolve known performance defects and is in the process of being implemented at several customer sites. However, the Company intends to continue deferring revenue in connection with license sales and implementation services for this software product until it has been demonstrated at customer sites that the new release of the software is free of significant performance defects. As of September 30, 2006 and December 31, 2005, the Company has reversed and deferred $2.8 million and $1.6 million, respectively, of otherwise-recognizable license and professional service revenue, based in part on its estimate of the fair value of concessions to be made until any remaining defects are resolved, and partly on its determination that license fees were not fixed and determinable because of the possibility of future concessions.

Service revenues include professional services, training, maintenance and support services and reimbursable out-of-pocket expenses. Professional service revenues are recognized as the services are performed. If conditions for acceptance exist, professional service revenues are recognized upon customer acceptance. For fixed fee professional service contracts, anticipated losses are provided for in the period in which the loss is probable and can be reasonably estimated. Training revenues are recognized as the services are provided. Included in training revenues are registration fees received from participants in the Company’s off-site user training conferences.

Maintenance and support fees are recognized ratably over the term of the service period, which is generally twelve months. When maintenance and support is included in the total license fee, a portion of the total fee is allocated to maintenance and support based upon the price paid by the customer when sold separately, generally as renewals in the second year.

Payments received from customers at the inception of a maintenance period are treated as deferred service revenues and recognized ratably over the maintenance period. Payments received from customers in advance of product shipment or revenue recognition are treated as deferred revenues and recognized when the product is shipped to the customer or when otherwise earned.

The Company accounts for consideration given to a customer or reseller of its products as a reduction of revenue in certain circumstances. To the extent that cumulative consideration earned by a customer or reseller during a reporting period exceeds revenue earned by the Company from the customer or reseller, such excess is reported as sales and marketing expense.

Stock-based Compensation:

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“FAS”) No. 123 (revised 2004) (“FAS 123(R)”), “Share-based Payment.” Under FAS 123(R), the Company measures and records the compensation cost of employee and director services received in exchange for stock option grants and other equity awards based on the grant-date fair value of the awards. The values of the portions of the awards that are ultimately expected to vest are recognized as expense over the requisite service periods. The Company accounts for stock options and awards granted to non-employees other than directors using the fair-value method, as prescribed by FAS No. 123, “Accounting for Stock-based Compensation.”

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The Company is also required to establish the value of an additional paid-in capital pool in connection with the tax impacts related to employee share-based compensation awards for which compensation costs were reflected in our pro forma disclosures required under FAS No. 123. The Company has not yet completed the calculation of this pool, which is not required to be determined until the fourth quarter of 2006, but the Company believes there will be no impact on our financial position or results of operations from this calculation.

Under the fair-value method, compensation associated with equity awards is determined based on the estimated fair value of the award itself, measured using either current market data or an established option pricing model. The measurement date for employee and director awards is generally the date of grant. The measurement date for awards granted to non-employees other than directors is generally the date that performance of certain services is complete.

The following table summarizes the components of stock-based compensation expense for the three and nine month periods ended September 30, 2006 and 2005:

As of September 30, 2006, unamortized compensation cost, net of estimated forfeitures, related to nonvested stock options and nonvested restricted shares granted under the various stock incentive plans amounted to $3.9 million and $428,000, respectively. These costs are expected to be amortized over weighted average periods of 1.3 years and 0.8 years, respectively.

The Company has four current stock incentive plans: (i) the 2000 Non-Employee Director Stock Option Plan, which provides for the granting of annual (25,000-share) and new hire (62,500-share) non-qualified stock options to non-employee directors, (ii) the 2001 Employee Stock Option Plan, which provides for grants in the form of non-qualified stock options, with not more than 25,000 shares to be issued in the aggregate to officers of directors of the Company, and (iii) the 2001 and 2003 Stock Incentive Plans, both of which are shareholder-approved plans and provide for the grant of incentive stock options and other equity awards to the Company’s employees, directors and consultants. The company also has an employee stock purchase plan that allows employees to purchase stock at a 15% discount to market prices subject to certain limitations. Participation is optional and enrollment periods are every six months.

The following table summarizes total common shares available for future grants of stock options and other equity awards at September 30, 2006:

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Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant. Stock options expire 10 years after grant and vest over periods set by the Board of Directors at the time of grant. Generally, option awards vest ratably over four years for employee grants and over three years for grants to directors. Certain stock option awards provide for accelerated vesting if there is a change in control.

The Company’s estimates of the fair value of stock option grants, including valuations for pre-2006 grant pro forma calculations, were made using the Black-Scholes option pricing model with the following assumptions and resulted in the following weighted average grant-date fair values of options granted during the nine months ended September 30:

The Company uses historical volatility of the Company’s common stock to estimate expected volatility. The expected term of options granted is estimated to be equal to the average of the contractual life of the options and the grant’s average vesting period. The risk-free interest rate is derived quarterly from the published US Treasury yield curve, based on expected term, in effect as of the last several days of the quarter.

The Company adopted FAS 123(R) using the modified prospective method, pursuant to which the Company’s financial statement for prior reporting periods have not been adjusted to include compensation cost calculated under the fair-value method. Prior to 2006, the Company used the intrinsic value method to measure compensation expense associated with the grants of stock options to employees and directors. Had the Company used the fair-value-based method to measure compensation related to such stock option awards, reported loss and loss per share would have been as follows for the three and nine month periods ended September 30, 2005:

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The following table summarizes stock option activity under all of the Company’s stock option plans for the nine month period ended September 30, 2006:

The total intrinsic value of stock options exercised during the nine-month periods ended September 30, 2006 and 2005 was $984,000 and $3.5 million, respectively.

A summary of the status of the Company’s nonvested restricted shares as of September 30, 2006, and changes during the nine months then ended, is presented below:

The total fair value of restricted shares which vested during the nine months ended September 30, 2006 and 2005 was $122,000 and $57,000, respectively.

Acquired Intangible Assets and Goodwill:

Acquired intangible assets (excluding goodwill) are amortized on a straight-line basis over their estimated useful lives and reviewed for impairment on an annual basis, or on an interim basis if an event or circumstance occurs between annual tests indicating that the assets might be impaired. The impairment test consists of comparing the cash flows expected to be generated by the acquired intangible asset to its carrying amount. If the asset is considered to be impaired, an impairment loss is recognized in an amount by which the carrying amount of the asset exceeds its fair value. Acquired intangible assets with indefinite useful lives will not be amortized until their lives are determined to be definite.

Goodwill is tested for impairment using a two-step approach. The first step is to compare the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired and the second step is not required. If the fair value of the reporting unit is less than its carrying amount,

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the second step of the impairment test measures the amount of the impairment loss, if any, by comparing the implied fair value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. The implied fair value of goodwill is calculated in the same manner that goodwill is calculated in a business combination, whereby the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets), with the excess “purchase price” over the amounts assigned to assets and liabilities representing the implied fair value of goodwill. Goodwill is tested for impairment annually, or on an interim basis if an event occurs or circumstances change that would likely reduce the fair value of a reporting unit below its carrying value.

Deferred Tax Assets:

A deferred tax asset or liability is recorded for temporary differences in the bases of assets and liabilities for book and tax purposes and loss carry forwards based on enacted rates expected to be in effect when these temporary items are expected to reverse. Valuation allowances are provided to the extent it is more likely than not that all or a portion of the deferred tax assets will not be realized.

Product Indemnification:

The Company’s agreements with customers generally include certain provisions for indemnifying the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event that our products are found to infringe upon a patent, copyright, trademark, or other proprietary right of a third party. The agreements generally seek to limit the scope of remedies for such indemnification obligations in a variety of industry-standard respects, including our right to replace an infringing product. To date, we have not had to reimburse any of our customers for any losses related to these indemnification provisions and no claims were outstanding as of September 30, 2006 and December 31, 2005. We do not expect that any significant impact on financial position or the results of operations will result from these indemnification provisions.

New Accounting Pronouncements:

The Financial Accounting Standards Board (“FASB”) has issued Interpretation No. 48 (“FIN 48”) regarding “Accounting for Uncertainties in Income Taxes,” which defines the threshold for recognizing the benefits of tax-return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authorities. FIN 48 also requires explicit disclosure requirements about a Company’s uncertainties related to their income tax position, including a detailed roll-forward of tax benefits taken that do not qualify for financial statement recognition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the possible impact of FIN 48.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 on “Quantifying Misstatements in Financial Statements.” Under SAB No. 108, the Company is required to use a combination of the two previously-acceptable approaches for quantifying misstatements, and to adjust its financial statements if this combined approach results in a conclusion that an error is material. This SAB is effective for fiscal years ending after November 15, 2006. The Company is currently assessing the impact of SAB No. 108.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and

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expands disclosures about fair value measurements. SFAS No. 157 applies under a number of other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS No. 157 are effective for the Company beginning January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial position and results of operations.

NOTE 3. NET LOSS PER SHARE

Basic net loss per share was determined by dividing the net loss applicable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share was the same as basic net loss per share for all periods presented since the effect of any potentially dilutive securities was excluded, as they are anti-dilutive as a result of the Company’s net losses. The total numbers of common equivalent shares excluded from the diluted loss per share calculation were 1,646,775 and 2,667,540 for the three months ended September 30, 2006 and 2005, respectively, and 1,696,997 and 3,693,157 for the nine months ended September 30, 2006 and 2005, respectively.

NOTE 4. SIGNIFICANT CUSTOMERS

The Company had certain customers which individually generated revenues comprising a significant percentage of total revenue, as follows:

The Company had certain customers whose accounts receivable balances individually represented a significant percentage of total receivables, as follows:

NOTE 5. STRATEGIC RELATIONSHIP AGREEMENT

In May 2000, the Company entered into a ten-year Strategic Relationship Agreement (the “Initial P&G Agreement”) with The Procter & Gamble Company (“P&G”), pursuant to which P&G designated the Company as its exclusive provider of purchase contract management software for its commercial products group for a period of three years. In addition, P&G has agreed to provide the Company with certain strategic marketing and business development services over the term of the P&G Agreement. P&G also entered into an agreement to license certain software and technology from the Company.

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As consideration for entering into the Initial P&G Agreement, the Company granted to P&G a fully exercisable warrant to purchase 875,000 shares of common stock. The warrant did not require any future product purchases or service performance. The warrant, which was exercisable for a period of two years at an exercise price of $9.00 per share, was converted into 561,960 shares of common stock via a non-cash exercise during 2000. In addition, the Company had agreed to pay P&G a royalty of up to 10% of the revenue generated from the commercial products market, as defined. As of February 2003, no such royalties had been earned or paid.

In February 2003, the Initial P&G Agreement was amended to delete the royalty provision, in exchange for which the Company granted to P&G a fully exercisable warrant to purchase 1,000,000 shares of the Company’s common stock. The warrant was exercisable for a period of three years at an exercise price of $1.20 per share. In November 2004, April 2005 and June 2005, P&G partially exercised the warrant, acquiring an aggregate of 750,000 shares of the Company’s common stock. In February 2006, P&G exercised the remaining 250,000 shares of the warrant.

NOTE 6. SEGMENT DISCLOSURE

The Company measures operating results as two reportable segments, both of which provide multiple products and services that allow manufacturers, purchasers and intermediaries to manage their complex contracts for the purchase and sale of goods. The Company’s reportable segments are strategic business units that market to separate and distinct business groups: (i) health and life sciences, which includes pharmaceutical manufacturers, and (ii) industry solutions, which markets to all other industries. The following table reflects the results of the segments consistent with the Company’s information management system.

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Undesignated amounts consist of goodwill and acquired intangible asset values and related amortization amounts with respect to the Company’s acquisition of Menerva Technologies, Inc.

NOTE 7. RESTRUCTURING AND OTHER CHARGES

In 2003 and 2004, the Company took several actions to reduce its operating expenses in order to better align its cost structure with projected revenues and to streamline its operations in advance of a planned (and subsequently terminated) sale of its health and life sciences operation. These actions included the closing of its office in Chicago, Illinois and the partial closing of its facility in London, England. With respect to the Chicago and London office closings, the Company had determined the fair value of the remaining liabilities of the unused space (net of estimated sublease rentals) for each lease as of the respective cease-use dates.

In the nine months ended September 30, 2006, the Company realized a charge of $68,000 in connection with the amortization of its long-term lease restructuring accruals for its Chicago and London facilities.

A rollforward of the Company’s accrued liability for restructuring and other charges, consisting entirely of lease costs, is as follows:

NOTE 8. VALUATION AND QUALIFYING ACCOUNTS

A rollforward of the Company’s allowance for doubtful accounts at September 30 is as follows:

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NOTE 9. TERMINATION OF PROPOSED MERGER WITH SELECTICA, INC.

On March 31, 2005, the shareholders of the Company voted to reject a proposed merger among the Company, Selectica, Inc. (“Selectica”) and a subsidiary of Selectica. As a result, the merger agreement among the parties terminated. Under the terms of the merger agreement, Selectica would have paid $1.55 per share in cash for all outstanding shares of the Company’s common stock, for a total transaction value of approximately $70.0 million. In the nine months ended September 30, 2005, the Company incurred $65,000 in legal fees and other costs related to the proposed merger.

NOTE 10. SUBSEQUENT EVENT

On November 6, 2006, the Company completed a private placement of its securities, issuing 3,535,566 shares of its common stock and common stock purchase warrants to purchase up to an additional 1,060,670 shares of common stock. The per unit price of the private placement offering was $1.98, with each unit comprised of one share of common stock and a warrant to purchase three-tenths of a share of common stock. The warrants are exercisable at $2.11 per share until November 2011. Net proceeds to the Company were approximately $6.6 million, after deducting commissions and other fees.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with our financial statements and related notes. In addition to historical information, the following discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated by such forward-looking statements due to various factors, including, but not limited to, those set forth under “Risk Factors” in Part II, Item 1A, and elsewhere, in this report.

OVERVIEW

We provide software and related services that allow our clients to more effectively manage their contract-based, business-to-business relationships through the entirety of the contract management lifecycle. We operate our business in two segments: health and life sciences and industry solutions. The health and life sciences line of business markets and sells our products and services to companies in the life sciences industries, including pharmaceutical and medical product companies, wholesale distributors and managed care organizations. The industry solutions line of business targets all other industries, with an emphasis on consumer products, foodservice, disposables, oil/gas/energy, consumer durables, industrial products, chemicals, apparel, and telecommunications.

Our primary products and services were originally developed to manage complex contract purchasing relationships in the healthcare industry. Our software is currently licensed by 17 of the 20 largest world-wide pharmaceutical manufacturers, ranked according to 2005 annual pharma revenues. As the depth and breadth of our product suites have expanded, we have added companies in the industry solutions markets to our customer base.

We have generated revenues from both products and services. Product revenues from our Contract Life Cycle Management Software Suites accounted for 14.5% of net revenues in the nine months ended September 30, 2006 versus 16.9% of net revenues in the nine months ended September 30, 2005. Service revenues include maintenance and support fees directly related to our licensed software products, professional service fees derived from consulting, installation, business analysis and training services related to our software products and hosting fees. Service revenues accounted for 85.5% of net revenues in the nine months ended September 30, 2006 versus 83.1% of net revenues in the nine months ended September 30, 2005.

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After having implemented a number of employee headcount reductions and office downsizings during the period June 2001 through March 2004, our aggregate quarterly spending on cost of products and services, sales and marketing, research and development and general and administrative expenses has remained fairly steady – ranging from $9.6 million to $11.3 million since the first quarter of 2004. Out total employee headcount has increased slightly from 170 at March 31, 2004 to 179 at September 30, 2006.

In August 2005, the Company announced the departure of its Chief Executive Officer, A. Leigh Powell, and its Chief Operating Officer, Terrence M. Nicholson. In connection with the resignation of these executives, we incurred $350,000 in future severance and benefit costs in 2005. Also, Yorgen Edholm was appointed Acting President and Chief Executive Officer, and John A. Rade was appointed Chairman of the Board of Directors with certain executive powers. In February 2006, Mr. Edholm resigned as Acting President and Chief Executive Officer while remaining on the Board of Directors, and Mr. Rade assumed the position of Acting President and Chief Executive Officer on an interim basis. In August 2006, Mr. Rade was appointed President and Chief Executive Officer on a permanent basis.

On November 6, 2006, we completed a private placement of our securities, issuing 3,535,566 shares of our common stock and common stock purchase warrants to purchase up to an additional 1,060,670 shares of common stock. The per unit price of the private placement offering was $1.98, with each unit comprised of one share of common stock and a warrant to purchase three-tenths of a share of common stock. The warrants are exercisable at $2.11 per share until November 2011. Net proceeds to the Company were approximately $6.6 million, after deducting commissions and other fees.

CRITICAL ACCOUNTING POLICIES

Revenue Recognition

We generate revenues from licensing our software and providing professional services, training and maintenance and support services. Software license revenues are attributable to the addition of new customers and the expansion or renewal of existing customer relationships through licenses covering additional users, licenses of additional software products and license renewals.

We recognize software license fees upon execution of a signed license agreement and delivery of the software to customers, provided there are no significant post-delivery obligations, the payment is fixed or determinable and collection is probable. In multiple-element arrangements, we allocate the total fee to professional services, training and maintenance and support services based on the fair value of those elements, which is defined as the price charged when those elements are sold separately. The residual amount is then allocated to the software license fee. In cases where we agree to deliver unspecified additional products in the future, the license fee is recognized ratably over the term of the arrangement beginning with the delivery of the first product. If an acceptance period is required, revenues are deferred until customer acceptance. In cases where collection is not deemed probable, we recognize the license fee as payments are received. In cases where significant production or customization is required prior to attaining technological feasibility of the software, license fees are recognized on a percentage-of-completion basis and are credited to research and development expenses as a funded development arrangement. After the software attains technological feasibility, recognizable license fees are reported as product revenue.

In 2004, we began offering current and prospective customers the option to enter into a subscription agreement as an alternative to our standard license contract model. The standard subscription arrangement is presently a fixed fee agreement over three to five years, covering

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license fees, unspecified new product releases and maintenance and support, generally payable in equal quarterly installments commencing upon execution of the agreement. In most agreements that have been executed to date, the subscription arrangement converts free-of-charge to a perpetual license after the completion of the initial term plus any extensions, generally after five years, after which time the customer would have the option of paying for the continuation of maintenance and support. We recognize all revenue from subscription based arrangements ratably over the term of the subscription agreement commencing upon delivery of the initial product. Subscription arrangements, including perpetual license arrangements with rights to unspecified additional products that are treated as subscriptions for accounting purposes, constitute a growing proportion of our new licenses, and we anticipate that this growth will continue in 2006. During the nine month periods ended September 30, 2006 and 2005, we recognized $1.6 million and $600,000, respectively, in product revenue related to such agreements. See the reconciliation table that follows under “Results of Operations – Comparison of the Three Month Periods Ended September 30, 2006 and 2005 – Net Revenues” in this Item 2.

During the third quarter of 2005, we became aware of certain defects in the then-current version of one of our software products, which was first shipped to customers in the fourth quarter of 2004. These defects, which were not identified in pre-release product testing, affected the performance of the software for a portion of our customers depending on each customer’s particular implementation environment and its intended use of the software. Because certain concessions have been made to customers in connection with these defects, we have generally not recognized revenue from sales of this software product and related implementation services beginning in the third quarter of 2005, except in those cases in which it was determined that the customer was not likely to be affected by the known, unresolved software defects. In June 2006, we issued a new major release of the software, which was designed to resolve known performance defects and is in the process of being implemented at several customer sites. However, we intend to continue deferring revenue in connection with license sales and implementation services for this software product until it has been demonstrated at customer sites that the new release of the software is free of significant performance defects. As of September 30, 2006 and December 31, 2005, we have reversed and deferred $2.8 million and $1.6 million, respectively, of otherwise-recognizable license and professional service revenue, based in part on our estimate of the fair value of concessions to be made until the remaining defect is resolved, and partly on our determination that license fees were not fixed and determinable because of the possibility of future concessions.

Service revenues include professional services, training and maintenance and support services and reimbursable out-of-pocket expenses. Professional service revenues are recognized as the services are performed. If conditions for acceptance exist, professional service revenues are recognized upon customer acceptance. For fixed fee professional service contracts, we provide for anticipated losses in the period in which the loss is probable and can be reasonably estimated. Training revenues are recognized as the services are provided. Included in training revenues are registration fees received from participants in our off-site user training conferences.

Maintenance and customer support fees are recognized ratably over the term of the maintenance contract, which is generally twelve months. When maintenance and support is included in the total license fee, we allocate a portion of the total fee to maintenance and support based upon the price paid by the customer when sold separately, generally as renewals in the second year.

Payments received from customers at the inception of a maintenance period are treated as deferred service revenues and recognized ratably over the maintenance period. Payments received from customers in advance of product shipment or revenue recognition are treated as deferred product revenues and recognized when the product is shipped to the customer or when otherwise earned.

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We account for consideration given to a customer or a reseller of our products as a reduction of revenue in certain circumstances. To the extent that cumulative consideration earned by a customer or reseller during a reporting period exceeds revenue earned by the Company from the customer or reseller, such excess is reported as sales and marketing expense.

Stock-based Compensation:

We measure and record the compensation cost of employee and director services received in exchange for stock option grants and other equity awards based on the grant-date fair value of the awards. Under the fair-value method, compensation associated with equity awards is determined based on the estimated fair value of the award itself, measured using either current market data or an established option pricing model. The measurement date for employee and director awards is generally the date of grant. The values of the portions of the awards that are ultimately expected to vest are recognized as expense over the requisite service periods.

The Company accounts for stock options and awards granted to non-employees other than directors using the fair-value method. The measurement date for awards granted to non-employees other than directors is generally the date that performance of certain services is complete.

Allowance for Doubtful Accounts

We record provisions for doubtful accounts based on a detailed assessment of our accounts receivable and related credit risks. In estimating the allowance for doubtful accounts, management considers the age of the accounts receivables, our historical write-off experience, the credit worthiness of customers and the economic conditions of the customers’ industries and general economic conditions, among other factors. Should any of these factors change, the estimates made by management will also change, which could affect the level of our future provision for doubtful accounts. If the assumptions we used to calculate these estimates do not properly reflect future collections, there could be an impact on future reported results of operations. The provisions for doubtful accounts are included in general and administrative expenses in the consolidated statements of operations.

Acquired Intangible Assets

Acquired intangible assets (excluding goodwill) are amortized on a straight-line basis over their estimated useful lives and reviewed for impairment on an annual basis, or on an interim basis if an event or circumstance occurs between annual tests indicating that the assets might be impaired. The impairment test consists of comparing the cash flows expected to be generated by the acquired intangible asset to its carrying amount. If the asset is considered to be impaired, an impairment loss will be recognized in an amount by which the carrying amount of the asset exceeds its fair value. Acquired intangible assets with indefinite useful lives will not be amortized until their lives are determined to be definite.

Goodwill

Goodwill is tested for impairment using a two-step approach. The first step is to compare the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired and the second step is not required. If the fair value of the reporting unit is less than its carrying amount, the second step of the impairment test measures the amount of the impairment loss, if any, by comparing the implied fair value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. The implied fair value of goodwill is calculated in the same manner that goodwill is calculated in a

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business combination, whereby the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets), with the excess “purchase price” over the amounts assigned to assets and liabilities representing the implied fair value of goodwill. Goodwill is tested for impairment annually, or on an interim basis if an event occurs or circumstances change that would likely reduce the fair value of a reporting unit below its carrying value.

Deferred Tax Assets

A deferred tax asset or liability is recorded for temporary differences in the bases of assets and liabilities for book and tax purposes and loss carry forwards based on enacted tax rates expected to be in effect when these temporary items are expected to reverse. Valuation allowances are provided to the extent it is more likely than not that all or a portion of the deferred tax assets will not be realized.

Product Indemnification

Our agreements with customers generally include certain provisions obligating us to indemnify the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event that our products are found to infringe upon a patent, copyright, trademark, or other proprietary right of a third party. The agreements generally seek to limit the scope of remedies for such indemnification obligations in a variety of industry-standard respects, including our right to replace an infringing product. To date, we have not had to reimburse any of our customers for any losses related to these indemnification provisions and no claims were outstanding as of September 30, 2006. We do not expect that any significant impact on financial position or the results of operations will result from these indemnification provisions.

Research and Development Costs

Research and development costs are charged to operations as incurred. Based on our product development process, technological feasibility is established upon completion of a working model. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have not been material. As such, all software development costs incurred to date have been expensed as incurred.

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RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005

NET REVENUES

Net revenues increased by $421,000, or 6.0%, to $7.5 million for the quarter ended September 30, 2006 from $7.1 million for the quarter ended September 30, 2005. Product revenues increased by $556,000, or 98.0%, to $1.1 million for the quarter ended September 30, 2006 from the same period a year earlier, while service revenues decreased by $135,000 or 2.1% to $6.3 million. As indicated in the table below, the gross value of license contracts sold during the third quarter of 2006 decreased by $1.1 million, or 39.4%, versus the third quarter of 2005, due to a decrease in the number of license transactions (minimum value of $50,000) from 9 to 5, partially offset by a 11% increase in the gross average selling price. Most of the revenue from the license transactions executed in both the third quarters of 2006 and 2005 was deferred to future reporting periods. As we work to increase our sales in both of our reportable segments, we believe that a significant proportion of future license contracts will likewise be subscription arrangements or will have conditions, such as software acceptance testing, resulting in deferral of license revenue recognition to later reporting periods. As a result, in future reporting periods we expect recognized revenues to exclude much of the license revenue generated from contracts entered into in those periods but to include larger proportions of revenues from contracts entered into in prior reporting periods.

Reconciliation of Gross Value of License Transactions to Reportable Product Revenue

The above financial information is provided as additional information and is not in accordance with or an alternative to generally accepted accounting principles, or GAAP. We believe its inclusion can enhance an overall understanding of our past operational performance and also our prospects for the future. This reconciliation of product revenues is made with the intent of providing a more complete understanding of our revenue performance, as opposed to GAAP

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revenue results, which do not include the impact of newly-executed subscription agreements and other deferred revenue arrangements that are material to the ongoing performance of our business. This information quantifies the various components comprising current revenue, which in each period consists of revenues from licenses sold in current periods plus product revenue recorded in the current period from contracts sold in prior periods, less the value of license contracts sold in the current period that is not yet recognizable. Included in the gross value of license contracts sold are license and first year maintenance and support fees, and non-cancelable subscription fee obligations that are not currently recognizable as product revenue upon execution of the license agreement because all the requirements for revenue recognition (see “Critical Accounting Policies” above) are not present, such as the presence of extended payment terms, future software deliverables, or customer acceptance provisions. This definition has been updated from the prior year’s disclosures to include the value of first year maintenance and support obligations. This provides a better comparison between license and subscription values as subscription commitments include maintenance and support over the term of the commitment. The gross value of license contracts sold also includes amounts that are not yet contractually billable to the customer and any such unbilled amounts are not yet reflected in deferred revenues on our consolidated balance sheet. Management uses this information as a basis for planning and forecasting core business activity in future periods and believes it is useful in understanding our results of operations. The presentation of this additional revenue information is not meant to be considered in isolation or as a substitute for revenues reported in accordance with GAAP in the United States.

Revenues derived from our industry solutions segment increased by $212,000, or 11.6%, to $2.0 million for the quarter ended September 30, 2006 versus the same quarter in 2005. This increase was comprised principally of a $160,000, or 8.8%, increase in service revenues, comprised principally of higher professional services revenues. The $52,000 increase in product revenues versus the third quarter of 2005 was entirely attributable to increased subscription revenues from contracts entered into in prior periods, since essentially all license fees generated from software licenses executed in both third quarters was deferred to future periods. As indicated in the above table, the gross values of license contracts sold in this segment during the quarter ended September 30, 2006 decreased by $1.2 million, or 78.1%, versus the same quarter in 2005 due primarily to a significant decrease in the average selling price as the number of license transactions decreased by only one. The recent sales results notwithstanding, we believe there is evidence of increasing demand for our new products in the Enterprise Contract Management Product Suite, which are targeted primarily to customers in the industry solutions segment but are also gaining acceptance in the health and life sciences segment. However, these new products are still in early-stage releases, which continues to limit our ability to derive consistent revenues from them and to increase revenues in general. In the three months ended September 30, 2006, we also deferred product and service revenues from certain customers with especially complex implementations of these new products. Until these new products have demonstrated a consistent record of performance in such installations, we intend to continue deferring revenue as appropriate.

Total net revenues derived from the health and life sciences segment increased by $209,000, or 4.0%, to $5.4 million for the quarter ended September 30, 2006 from $5.2 million in the year earlier period, comprised principally of a $504,000, or 92.5%, increase in product revenues partially offset by a $398,000, or 15.8%, decrease in this segment’s professional services revenues. As indicated in the table above, the gross value of license contracts sold in this segment during the second quarter of 2006 increased by $71,000, or 5.3%, relative to the third quarter of 2005, due to a significant increase in the average selling price, partially offset by a decrease in the number of license transactions from 6 to 3. Also as noted in the table above, subscription revenues recognized during the third quarter of 2006 were significantly higher than in the prior year period, which is evidence of the recent growth in the proportion of our subscription sales.

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Overall service revenues decreased by $135,000, or 2.1%, to $6.3 million in the three months ended September 30, 2006 versus $6.5 million in the year earlier period. This decrease was attributable to a $277,000, or 8.6%, decrease in professional services revenues, caused by reduced demand for consulting services in the health and life sciences segment, which is the continuation of a trend that began in mid-2005 as the number of large product implementations in this segment has been decreasing over time.

OPERATING EXPENSES

COST OF THIRD PARTY TECHNOLOGY. Cost of third party technology consists of amounts due to third parties for royalties related to integrated technology. Cost of third party technology decreased by $78,000, or 38.0%, to $128,000 for the three months ended September 30, 2006 from the year earlier period. This decrease is attributable to the change in the mix of license transactions, with fewer transactions with high content of third-party technology being executed in the quarter ended September 30, 2006 relative to the year earlier period.

COST OF SERVICES. Cost of services consists primarily of payroll and related costs and subcontractor fees for providing professional services and maintenance and support services. Cost of services increased by $822,000, or 22.3%, to $4.5 million for the quarter ended September 30, 2006 from $3.7 million in the year earlier period. This increase is primarily attributable to a $505,000 increase in the cost of consultants, resulting from the need to augment our professional services staff on certain implementation engagements, and a $120,000 increase in noncash stock compensation costs, resulting from our adoption of FAS 123(R). As noted in “Critical Accounting Policies – Revenue Recognition” in this Item 2, one of our software products has been experiencing performance defects, and consequently we have increased staffing on certain implementation engagements without a corresponding increase in billable revenue. As a percentage of service revenues, cost of services increased significantly to 71.0% for the quarter ended September 30, 2006 from 56.8% for the quarter ended September 30, 2005.

AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS. Amortization of acquired intangible assets related to our acquisitions amounted to $46,000 in the quarter ended September 30, 2006, which represents a decrease of $297,000, or 86.6%, from $343,000 recorded in the quarter ended September 30, 2005. This decrease is attributable to the intangible assets in connection with the acquisitions of NetReturn, LLC and Menerva Technologies, Inc. becoming fully-amortized during the first quarter of 2006.

SALES AND MARKETING. Sales and marketing expenses consist primarily of payroll and related benefits for sales and marketing personnel, commissions for sales personnel, travel costs, recruiting fees, expenses for trade shows and advertising and public relations expenses. Sales and marketing expenses increased by $40,000, or 2.0%, to $2.0 million in the three months ended September 30, 2006 from the same period in 2005. The increase is primarily attributable to higher marketing-related consulting fees, partially offset by a decrease in salary costs resulting from reduced headcount levels in our sales and marketing organization. As a percentage of total net revenues, sales and marketing expense decreased to 26.8% for the quarter ended September 30, 2006 from 27.8% for the quarter ended September 30, 2005.

RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of payroll and related costs for development personnel and external consulting costs associated with the development of our products and services. Research and development costs, including the costs of developing computer software, are charged to operations as they are incurred. Research and development expenses increased by $463,000, or 16.6%, to $3.3 million for the quarter ended September 30, 2006 from $2.8 million for the quarter ended September 30, 2005. This increase was principally attributable to a $245,000 increase in consulting costs, much of which is related to our efforts to resolve performance defects in one of our software products,

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as noted in “Critical Accounting Policies – Revenue Recognition” in this Item 2, and a $68,000 increase in noncash stock compensation costs, resulting from our adoption of FAS 123(R). As a percentage of total net revenues, research and development expense increased to 43.6% for the quarter ended September 30, 2006 from 39.6% for the quarter ended September 30, 2005.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of salaries and related costs for personnel in our administrative, finance and human resources departments, and legal, accounting and other professional service fees. General and administrative expenses increased by $56,000, or 4.2%, to $1.4 million for the quarter ended September 30, 2006 from the year earlier period. Increases of $227,000 in noncash stock compensation costs, resulting largely from the adoption of FAS 123(R), and $96,000 in accounting and investor relations fees were largely offset by decreases of $151,000 in salary and related costs and $150,000 in the provision for doubtful accounts. Salary and related costs incurred during the third quarter of 2005 were unusually high due to the accrual of severance payments owed to our former chief executive officer. As a percentage of total net revenues, general and administrative expenses decreased to 18.4% for the quarter ended September 30, 2006 from 18.7% for the quarter ended September 30, 2005.

DEPRECIATION. Depreciation expense increased by $14,000, or 7%, to $218,000 in the third quarter of 2006 from the year earlier period. This increase reflects the recent increase in capital investments required to service our hosting customers.

RESTRUCTURING AND OTHER CHARGES. In the quarter ended September 30, 2006, we recorded $24,000 in charges related to efforts in prior quarters to streamline operations. This charge represents the amortization of the discount incorporated in the initial restructuring provisions for future lease costs in connection with the Chicago and London office downsizings.

OTHER INCOME, NET

Other income, net, increased by $33,000, or 30%, to $143,000 in the quarter ended September 30, 2006 as compared to the year earlier period. This increase was principally comprised of a $35,000 increase in interest income, attributable to significantly higher average yields relative to the prior year.

PROVISION FOR INCOME TAXES

We incurred operating losses for all quarters in 2005 and the first three quarters of 2006 and have consequently recorded a valuation allowance for the full amount of our net deferred tax asset, which consists principally of our net operating loss carryforwards, as the future realization of the tax benefit is uncertain. No provision or benefit for income taxes has been recorded in the three-month periods ended September 30, 2006 and 2005.

COMPARISON OF THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005

NET REVENUES

Net revenues decreased by $2.4 million, or 9.7%, to $22.0 million for the nine months ended September 30, 2006 from $24.4 million for the nine months ended September 30, 2005. Product revenues decreased by $926,000, or 22.5%, to $3.2 million for the nine months ended September 30, 2006 from the same period a year earlier, while service revenues decreased by $1.4 million or 7.1%. The gross value of license contracts (minimum price of $50,000) sold during the first nine months of 2006 increased by $424,000, or 4.3%, versus the same period in 2005, due to an increase in gross average selling price to $544,000 from $392,000, partially offset

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by a decrease in the number of license contracts sold from 25 to 19. The decrease in product revenue was primarily attributable to the recognition during the nine-month period ended September 30, 2005 of $1.5 million in previously deferred license fees in connection with two license transactions executed during the fourth quarter of 2004, partially offset by a $1.0 million increase in product revenue related to subscription arrangements.

Total net revenues derived from the industry solutions segment decreased by $363,000, or 6.0%, to $5.7 million for the nine months ended September 30, 2006 from $6.0 million for the nine months ended September 30, 2005. Segment product revenues for the 2006 year-to-date period decreased by $617,000, or 81.0%, relative to the prior year while segment service revenues increased by $255,000, or 4.8%, to $5.5 million. The gross values of license contracts sold in this segment during the nine months ended September 30, 2006 decreased by $691,000, or 28.5%, versus the same period in 2005 due primarily to an 18% decrease in the average selling price. Also, virtually all product revenues in connection with the current year’s license transactions in this segment were deferred to future periods because the agreements were structured as subscription arrangements or included contractual acceptance clauses.

Total net revenues derived from the health and life sciences segment decreased by $2.0 million, or 10.9%, to $16.3 million for the nine months ended September 30, 2006 from $18.3 million in the year earlier period, comprised principally of decreases in this segment’s professional services revenues and product revenues of $2.1 million, or 24.5%, and $309,000, or 9.2%, respectively. The gross value of license contracts sold in this segment during the first nine months of 2006 increased by $1.1 million, or 14.8%, relative to the year earlier period, due to a 61% increase in the average selling price partially offset by a 28% decrease in the number of license transactions.

Overall service revenues decreased by $1.4 million, or 7.1% to $18.8 million in the nine months ended September 30, 2006 versus $20.2 million in the year earlier period. This decrease was attributable to a $2.1 million, or 19.6%, decrease in professional services revenues, caused by reduced demand for consulting services in the health and life sciences segment, partially offset by increase in maintenance and support revenues and hosting fee revenues of $284,000 and $395,000, respectively. The decrease in consulting service revenues in the health and life sciences segment is primarily attributable to a decrease in the number of large engagements for installation of new products relative to the year ago period.

OPERATING EXPENSES

COST OF THIRD PARTY TECHNOLOGY. Cost of third party technology decreased by $50,000 to $245,000 for the nine months ended September 30, 2006 from the year earlier period. This decrease is attributable to the change in the mix of license transactions, with fewer transactions with high content of third-party technology being executed in the current year relative to the year earlier period.

COST OF SERVICES. Cost of services increased by $1.1 million, or 9.2%, to $12.4 million for the nine months ended September 30, 2006 from $11.4 million in the year earlier period. This increase is primarily attributable to a $722,000 increase in the cost of consultants, resulting from the need to augment our professional services staff on certain implementation engagements, and a $236,000 increase in noncash stock compensation costs, resulting from our adoption of FAS 123(R). As noted in “Critical Accounting Policies – Revenue Recognition” in this Item 2, one of our software products has been experiencing performance defects, and consequently we have increased staffing on certain implementation engagements without a corresponding increase in billable revenue. As a percentage of service revenues, cost of services increased to 66.1% for the nine months ended September 30, 2006 from 56.2% for the nine months ended September 30, 2005.

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AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS. Amortization of acquired intangible assets related to our acquisitions amounted to $436,000 in the nine months ended September 30, 2006, which represents a decrease of $605,000, or 58.1%, from $1.0 million recorded in the nine months ended September 30, 2005. This decrease is attributable to the intangible assets in connection with the acquisitions of NetReturn, LLC and Menerva Technologies, Inc. becoming fully-amortized during the first quarter of 2006.

SALES AND MARKETING. Sales and marketing expenses increased by $477,000, or 7.7%, to $6.7 million in the nine months ended September 30, 2006 from $6.2 million in the same period in 2005. This increase is primarily attributable to a $371,000 increase in marketing-related consulting fees relative to the year earlier period. As a percentage of total net revenues, sales and marketing expense increased to 30.3% for the nine months ended September 30, 2006 from 25.4% for the nine months ended September 30, 2005.

RESEARCH AND DEVELOPMENT. Research and development expenses increased by $672,000, or 7.7%, to $9.4 million for the nine months ended September 30, 2006 from $8.7 million for the nine months ended September 30, 2005. This increase was principally attributable to a $1.2 million increase in consulting costs and a $115,000 increase in noncash stock compensation costs, partially offset by $513,000 in funded development credits and a $190,000 decrease in salary costs. Essentially all of the decrease in salary costs resulted from average headcount during the first quarter of 2006 being lower by 8 employees as compared to the year earlier period. As a percentage of total net revenues, research and development expense increased to 42.8% for the nine months ended September 30, 2006 from 35.8% for the nine months ended September 30, 2005.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased by $440,000, or 12.2%, to $4.1 million for the nine months ended September 30, 2006 from $3.6 million in the same period in 2005. This increase in general and administrative expenses was principally attributable to a $414,000 increase in noncash stock compensation costs, resulting primarily from the adoption of FAS 123(R). As a percentage of total net revenues, general and administrative expenses increased to 18.4% for the nine months ended September 30, 2006 from 14.8% for the nine months ended September 30, 2005.

DEPRECIATION. Depreciation expense decreased by $12,000, or 2%, to $579,000 in the nine months ended September 30, 2006 from the year earlier period. This decrease is principally attributable to a reduction in the level of furniture, equipment and software additions from the year 2002 ($933,000) to the year 2005 ($684,000), the majority of these asset additions being depreciated over a three-year life, partially offset by recent increases in capital investments required to service our hosting customers.

RESTRUCTURING AND OTHER CHARGES. In the nine months ended September 30, 2006, we recorded $68,000 in charges related to efforts in prior quarters to streamline operations. This charge represents the amortization of the discount incorporated in the initial restructuring provisions for future lease costs in connection with the Chicago and London office downsizings.

OTHER INCOME, NET

Other income, net, increased by $235,000, or 129%, in the nine months ended September 30, 2006 as compared to the year earlier period. This increase was principally comprised of a $154,000 increase in interest income, attributable to significantly higher average yields, and a $77,000 decrease in foreign currency transaction losses.

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PROVISION FOR INCOME TAXES

We incurred operating losses for all quarters in 2005 and the first three quarters of 2006 and have consequently recorded a valuation allowance for the full amount of our net deferred tax asset, which consists principally of our net operating loss carryforwards, as the future realization of the tax benefit is uncertain. No provision or benefit for income taxes has been recorded in the nine-month periods ended September 30, 2006 and 2005.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2006, we had cash and cash equivalents of $12.8 million, as compared to cash and cash equivalents of $16.8 million at December 31, 2005 and $17.5 million at September 30, 2005. Also at September 30, 2006, we had no long-term or short-term debt, other than obligations under capital lease financings. The non-current restricted cash balance of $496,000 at September 30, 2006 represents cash amounts held on deposit as security on two long-term real property lease obligations.

On November 6, 2006, we completed a private placement of our common stock and warrants, which resulted in our receipt of approximately $6.6 million in net proceeds. See “—Overview” above.

Net cash used in operating activities for the nine months ended September 30, 2006 was $4.3 million, as compared to $3.7 million in the nine months ended September 30, 2005. For the nine months ended September 30, 2006, net cash used in operating activities consisted principally of our net loss of $11.4 million – as reduced by non-cash items depreciation and amortization of $1.0 million and stock-based compensation of $912,000, partially offset by a $2.9 million decrease in accounts receivable and a $2.0 million increase in deferred revenue. The $2.9 million decrease in accounts receivable was principally attributable to (i) a $1.8 million decrease in the value of non-subscription license agreements executed during the quarter ended September 30, 2006 versus the quarter ended December 31, 2005 and (ii) decreases in billings for maintenance and support renewals and subscription renewals of $378,000 and $278,000, respectively, during the quarter ended September 30, 2006 versus the quarter ended December 31, 2005. Because a significant portion of our customers request a calendar year billing cycle for maintenance and support renewals regardless of the anniversary date of their license agreement, maintenance and support renewal invoicing volume is generally higher in the fourth quarter each year. Also, the number and value of new subscription arrangements executed in the fourth quarter of 2005 was significantly larger than the corresponding amounts in the third quarter of 2006. The $2.0 million year-to-date increase in deferred revenue is mostly attributable to a $2.4 million increase in license fee and professional services deferrals, resulting from increased incidence of contractual acceptance clause in license agreements and to the software performance-related deferrals noted in “Critical Accounting Policies – Revenue Recognition” in this Item 2, partially offset by a $222,000 decrease in deferred maintenance and support revenue, which is a consequence of our customers’ preference for calendar year maintenance renewal periods.

For the nine months ended September 30, 2005, net cash used in operating activities consisted principally of (i) the net loss of $7.3 million, as offset by non-cash items depreciation and amortization of $1.6 million and noncash stock-based compensation of $123,000, (ii) decreases in accounts payable and accrued expenses of $722,000 and $600,000, respectively, and (iii) an increase in prepaid expenses of $656,000, partially offset by (a) a $2.4 million decrease in accounts receivable (including the $150,000 provision for doubtful accounts) and (b) a $1.3 million increase in deferred revenue. The decrease in accounts payable was largely the result of timing, i.e., the balance at December 31, 2004 was unusually high relative to prior and subsequent quarters. The $600,000 decrease in accrued expenses was primarily attributable to a $352,000

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reduction in accrued compensation since year end 2004 and the 2005 payment of $248,000 in previously-accrued merger compensation in connection with the acquisition of Pricing Analytics. The $656,000 increase in prepaid expenses was primarily attributable to $755,000 in advance royalty payments to third-party software developers. The $2.4 million decrease in accounts receivable was principally attributable to a $2.5 million decrease in the value of non-subscription license agreements executed in the third quarter of 2005 versus the fourth quarter of 2004. The $1.3 million increase in deferred revenue was primarily attributable to the net increase in the cumulative value of deferred license transactions.

Net cash used in investing activities was $520,000 for the nine months ended September 30, 2006, as compared to cash provided by investing activities of $13.7 million for the nine months ended September 30, 2005. Net cash used in investing activities for the nine months ended September 30, 2006 consisted of $520,000 in property and equipment additions. Net cash provided by investing activities for the nine months ended September 30, 2005 consisted of $14.6 million in net redemptions of short-term investments and securities held for sale, partially offset by $630,000 in property and equipment additions and $248,000 in merger consideration paid in connection with the Pricing Analytics acquisition.

Net cash provided by financing activities was $756,000 in the nine months ended September 30, 2006, consisting primarily of $414,000 in proceeds from stock option exercises and $300,000 in proceeds from a warrant exercise. Net cash provided by financing activities was $1.4 million in the nine months ended September 30, 2005, consisting primarily of $828,000 in proceeds from stock option exercises and $600,000 in proceeds from warrant exercises.

We currently anticipate that our cash and cash equivalents of $12.8 million as of September 30, 2006, combined with the $6.6 million in net proceeds from the November 2006 private placement, will be sufficient to meet our anticipated needs for working capital, capital expenditures, and acquisitions for at least the next 12 months. Our future long-term capital needs will depend significantly on the rate of growth of our business, our profitability, the mix of subscription licensing arrangements versus perpetual licenses sold, possible acquisitions, the timing of expanded product offerings and the success of these offerings if and when they are launched. Accordingly, any projections of future long-term cash needs and cash flows are subject to substantial uncertainty. If our current balance of cash and cash equivalents is insufficient to satisfy our long-term liquidity needs, we may seek to sell additional equity or debt securities to raise funds, and those securities may have rights, preferences or privileges senior to those of the rights of our common stock. In connection with a sale of stock, our stockholders would experience dilution. In addition, we cannot be certain that additional financing will be available to us on favorable terms when required, or at all. Our current stock price may make it difficult for us to raise additional equity financing.

CONTRACTUAL OBLIGATIONS

Note: Capital Lease Obligations amounts in the above table include interest.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without assuming significant risk. This is accomplished by investing in diversified investments, consisting primarily of short-term investment-grade securities. Due to the nature of our investments, we believe there is no material risk exposure. A 10% change in interest rates, either positive or negative, would not have had a significant effect on interest income in the quarters ended September 30, 2006 and 2005.

At September 30, 2006, our cash and cash equivalents consisted entirely of money market and short-term investments with remaining maturities of 90 days or less when purchased and non-interest bearing checking accounts. Investments in marketable debt securities with maturities greater than 90 days and less than one year are classified as held-to-maturity short-term investments and are recorded at amortized cost. Under current investment guidelines, maturities on short-term investments are restricted to one year or less. Investments in auction rate securities, with maturities which can be greater than one year but for which interest rates reset in less than 90 days, are classified as available for sale securities and have been stated at fair market value. At September 30, 2006, we held no auction rate certificates, having disposed of all our holdings in such investments during 2005.

FOREIGN CURRENCY EXCHANGE RISK

We operate in certain foreign locations, where the currency used is not the U.S. dollar. However, these locations have not been, and are not currently expected to be, significant to our consolidated financial statements. Changes in exchange rates have not had a material effect on our business.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. As required by Exchange Act Rule 13a-15(b), our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that, as of September 30, 2006, our disclosure controls and procedures were effective in timely alerting them to material information required to be included in our periodic SEC filings and that information required to be disclosed by us in these periodic filings is recorded,

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processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that our internal controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with generally accepted accounting principles.

(b) Changes in Internal Control. No change in our internal control over financial reporting occurred during the quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

In addition to other information in this Form 10-Q, the following factors could cause actual results to differ materially from those indicated by forward-looking statements made in this Form 10-Q and presented elsewhere by management from time to time.

WE HAVE INCURRED SUBSTANTIAL LOSSES IN RECENT YEARS AND OUR RETURN TO PROFITABILITY IS UNCERTAIN

We incurred net losses of $7.3 million in the year ended December 31, 2004, $9.3 million in the year ended December 31, 2005 and $11.4 million in the nine months ended September 30, 2006, and we had an accumulated deficit at September 30, 2006 of $145.9 million. Our recent results have been impacted by a number of factors that caused current and prospective customers to defer, or otherwise not make, purchases from us, and we cannot assure you that we will not be affected by these or other factors in future periods. We cannot assure you that we will achieve sufficient revenues to become profitable in the future.

IT IS DIFFICULT FOR US TO PREDICT WHEN OR IF SALES WILL OCCUR AND WE OFTEN INCUR SIGNIFICANT SELLING EXPENSES IN ADVANCE OF OUR RECOGNITION OF ANY RELATED REVENUE

Our clients view the purchase of our software applications and related professional services as a significant and strategic decision. As a result, clients carefully evaluate our software products and services. The length of this evaluation process is affected by factors such as the client’s need to rapidly implement a solution and whether the client is new or is extending an existing implementation. The license of our software products may also be subject to delays if the client has lengthy internal budgeting, approval and evaluation processes, which are quite common in the context of introducing large enterprise-wide technology solutions. We may incur significant selling and marketing expenses during a client’s evaluation period, including the costs of developing a full proposal and completing a rapid proof of concept or demonstration, before the client places an order with us. Clients may also initially purchase a limited number of licenses before expanding their implementations. Larger clients may purchase our software products as part of multiple simultaneous purchasing decisions, which may result in additional unplanned administrative processing and other delays in the recognition of our license revenues. If revenues forecasted from a significant client for a particular quarter are not realized or are delayed, as has occurred in recent quarters, we may experience an unplanned shortfall in revenues or cash during that quarter. This may cause our operating results to be below the expectations of public market analysts or investors, which could cause the value of our common stock to decline.

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WE MAY NOT BE ABLE TO ACCURATELY PREDICT THE MIX OF SUBSCRIPTION LICENSES VERSUS PERPETUAL LICENSES, AND THIS COULD AFFECT OUR SHORT-TERM REVENUE AND CASH POSITIONS.

Our customers have shown a growing interest in licensing our software on a subscription basis, which results in deferral of payments and revenues that would otherwise be reportable if a traditional perpetual license were executed. Our revenue forecasts and internal budgets are based, in part, on our best assumptions about the mix of future subscription licenses versus perpetual licenses. If we enter into a larger proportion of subscription agreements than planned, we may experience an unplanned shortfall in revenues or cash during that quarter. This may cause our operating results to be below the expectations of public market analysts or investors, which could cause the value of our common stock to decline.

OUR INABILITY TO PREDICT REVENUE AND OUR FIXED COSTS HAVE LED, AND WILL CONTINUE TO LEAD, TO FLUCTUATIONS IN OPERATING RESULTS WHICH HAVE RESULTED, AND COULD IN THE FUTURE RESULT, IN A DECLINE OF OUR STOCK PRICE

A significant percentage of our expenses, particularly personnel costs and rent, are fixed costs and are based in part on expectations of future revenues. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in revenues. Accordingly, shortfalls in revenues, as we experienced in recent quarters, may cause significant variations in operating results in any quarter. Our stock price has been impacted by the failure of our quarterly results to meet the expectations of market analysts and investors, and it could decline further.

WE EXPERIENCED CHANGES OF SENIOR MANAGEMENT IN 2005 AND 2006, WHICH MAY AFFECT OUR BUSINESS, PARTICULARLY IN THE SHORT TERM

In August 2005, we announced the departure of our Chief Executive Officer and Chief Operating Officer and the appointment of a new Chairman of the Board with certain executive powers and a new Acting President and Chief Executive Officer. In February 2006, our Acting President and Chief Executive Officer resigned, and our Chairman of the Board assumed his duties on an interim basis. In August 2006, our acting President and Chief Executor Officer was appointed to these duties on a permanent basis. Changes of this nature can create a level of uncertainty and potential disruption to relationships with customers, prospective customers, employees and business partners, particularly in the short term. Our new leadership will need time to become more familiar with the Company and its culture. For at least the next several quarters, this leadership change could have an adverse effect on our business, financial condition and results of operations.

WE MAY NEED TO GROW IN MARKETS OTHER THAN THE HEALTH AND LIFE SCIENCES MARKET FOR OUR FUTURE GROWTH

To be successful, we intend to reduce our reliance on the health and life sciences market, which has traditionally been the primary source of our revenues. Revenues from our non-health and life sciences customers have comprised 27.3%, 24.4% and 25.7%, respectively, of our consolidated revenues for the years ended December 31, 2004 and 2005 and the nine months ended September 30, 2006. We have not been successful in generating the revenue growth we expected from these markets and we cannot assure you that we will be successful in the future.

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OUR CASH POSITION HAS DECLINED AND WILL LIKELY CONTINUE TO DECLINE UNTIL WE RETURN TO SUSTAINED PROFITABILITY

Our future long-term capital needs will depend significantly on the rate of growth of our business, our profitability, the mix of subscription licensing arrangements versus perpetual licenses sold, possible acquisitions, the timing of expanded product offerings and the success of these offerings if and when they are launched. Accordingly, our future long-term cash needs and cash flows are subject to substantial uncertainty. If our current balance of cash and cash equivalents is insufficient to satisfy our long-term liquidity needs, we may seek to sell additional equity or debt securities to raise funds, and those securities may have rights, preferences or privileges senior to those of the rights of our common stock. In connection with a sale of stock, our stockholders would experience dilution. In addition, we cannot be certain that additional financing will be available to us on favorable terms when required, or at all. Our current stock price may make it difficult for us to raise additional equity financing.

WE MAY NOT BE SUCCESSFUL IN DEVELOPING OR ACQUIRING NEW TECHNOLOGIES OR BUSINESSES AND THIS COULD HINDER OUR EXPANSION EFFORTS

Despite our intentions to reduce our product research and development efforts to levels more customary for our industry, in the near term we may find it necessary to continue our product research and development efforts at levels similar to current expenditures. We have had quality issues with one of our software products, which have affected our sales and has caused us to defer revenue recognition, and these issues may continue. We may also consider additional acquisitions of or new investments in complementary businesses, products, services or technologies. We cannot assure you that we will be successful in our product development efforts or that we will be able to identify appropriate acquisition or investment candidates. Even if we do identify suitable candidates, we cannot assure you that we will be able to make such acquisitions or investments on commercially acceptable terms. Furthermore, we may incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing stockholders and the issuance of debt could limit our available cash and accordingly restrict our activities.

WE MAY MAKE ADDITIONAL ACQUISITIONS AND WE MAY HAVE DIFFICULTY INTEGRATING THEM

Any company that we might acquire would have a culture different from ours as well as technologies, products and services that our employees will need to understand and integrate with our own. We have assimilated the employees, technologies and products of the companies that we have previously acquired and will need to do the same with any new companies we may acquire, and that effort has been, and will likely continue to be difficult and time-consuming and may be unsuccessful. If we are not successful, our investment in the acquired entity may be impaired or lost, and even if we are successful, the process of integrating an acquired entity may divert our attention from our core business.

WE HAVE MANY COMPETITORS AND POTENTIAL COMPETITORS AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY

The market for our products and services is competitive and subject to rapid change. We encounter significant competition for the sale of our contract management software from the internal information systems departments of existing and potential clients, software companies that target the contract management markets and professional services organizations. Our competitors vary in size and in the scope and breadth of products and services offered. We anticipate increased competition for market share and pressure to reduce prices and make sales concessions, which could materially and adversely affect our revenues and margins.

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Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Such competitors may also engage in more extensive research and development, undertake more far-reaching marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to existing and potential employees and strategic partners. Our competitors could develop products or services that are equal or superior to our solutions or that achieve greater market acceptance than our solutions. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties. We may not be able to compete successfully, and competitive pressures may require us to make concessions that will adversely affect our revenues and our margins, or reduce the demand for our products and services.

WE HAVE MULTIPLE FACILITIES AND WE MAY EXPERIENCE DIFFICULTIES IN OPERATING FROM THESE DIFFERENT LOCATIONS

We operate out of our corporate headquarters in Edison, New Jersey, an engineering office in Redwood City, California and other facilities in Portland, Maine and London, England. The geographic distance between our offices makes it more difficult for our management and other employees to collaborate and communicate with each other than if they were all located in a single facility, and, as a result, increases the strain on our managerial, operational and financial resources. Also, a significant number of our sales and professional services employees work remotely out of home offices, which adds to this strain.

WE MAY NOT BE SUCCESSFUL IN RETAINING AND ATTRACTING TALENTED AND KEY EMPLOYEES

We depend on the services of our senior management and key technical personnel. The loss of the services of key employees, and the inability to attract new employees to fill crucial roles, could have a material adverse effect on our business, financial condition and results of operations.

OUR EFFORTS TO PROTECT OUR INTELLECTUAL PROPERTY MAY NOT BE FULLY EFFECTIVE, AND WE MAY INADVERTENTLY INFRINGE ON THE INTELLECTUAL PROPERTY OF OTHERS

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain the use of information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. We cannot assure investors that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology.

We are not aware that any of our products infringe the proprietary rights of third parties. We cannot assure investors, however, that third parties will not claim infringement by us with respect to current or future products. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(b) Use of Proceeds

The Company has continued to use the proceeds of its initial public offering in the manner and for the purposes described elsewhere in this Report on Form 10-Q.

(c) Changes in Securities

On November 6, 2006, the Company completed a private placement of 3,535,566 shares of its unregistered common stock and of warrants to purchase up to 1,060,670 shares of its unregistered common stock. The private placement is exempt from registration under the Securities Act of 1933, as amended, pursuant to Regulation D and Section 4(2) of such Act. The Company received proceeds of approximately $6.6 million, after deducting commissions and other fees, from the sale of the common stock.

ITEM 6. EXHIBITS

(a) The exhibits listed on the Exhibit Index are filed herewith.

SIGNATURES

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

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INDEX TO EXHIBITS

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