UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2005

or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                                          to                                         

I-MANY, INC.

(Exact name of registrant as specified in its charter)

Delaware		01-0524931
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

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 þ            No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ            No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o            No þ

On November 1, 2005, 46,289,689 shares of the registrant’s common stock, $.0001 par value, were issued and outstanding.

 

 

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 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “—Certain Factors That May Affect Future Operating Results” as well as in the Form 10-Q generally. 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.

I-MANY, INC.

FORM 10-Q

TABLE OF CONTENTS

		PAGE
PART I. UNAUDITED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004			4
Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2005 and 2004			5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004			6
Notes to Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3. Quantitative and Qualitative Disclosures About Market Risk			28
Item 4. Controls and Procedures			29
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			30
Item 4. Submission of Matters to a Vote of Security Holders			30
Item 6. Exhibits			30
Signatures			30
Index to Exhibits			31
EX-31.1 SECTION 302 CERTIFICATION OF C.E.O.
EX-31.2 SECTION 302 CERTIFICATION OF C.F.O.
EX-32.1 SECTION 906 CERTIFICATION OF C.E.O. AND C.F.O.

PART I. UNAUDITED FINANCIAL INFORMATION

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

I-MANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share-related amounts)

		September 30,				December 31,
		2005				2004
ASSETS
Current assets:
Cash and cash equivalents		$	17,501			$	6,098
Restricted cash			21				161
Short-term investments and securities held for sale			—				14,610
Accounts receivable, net of allowance			7,564				9,964
Prepaid expenses and other current assets			1,174				518
Total current assets			26,260				31,351
Property and equipment, net			1,339				1,300
Restricted cash			641				663
Other assets			121				120
Acquired intangible assets, net			1,056				2,097
Goodwill			8,667				8,667
Total assets		$	38,084			$	44,198
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,650			$	2,372
Accrued expenses			3,550				4,199
Current portion of deferred revenue			11,338				9,975
Capital lease obligations			21				160
Total current liabilities			16,559				16,706
Deferred revenue, net of current portion			187				275
Other long-term liabilities			1,105				1,347
Total liabilities			17,851				18,328
Series A redeemable convertible preferred stock, $.01 par value
Authorized — 1,700 shares
Issued and outstanding — none			—				—
Stockholders’ equity:
Undesignated preferred stock, $.01 par value
Authorized — 5,000,000 shares; designated 1,700 shares
Issued and outstanding — none			—				—
Common stock, $.0001 par value —
Authorized — 100,000,000 shares
Issued and outstanding — 46,274,264 and 42,720,060 shares at September 30, 2005 and December 31, 2004, respectively			5				4
Additional paid-in capital			152,620				151,014
Deferred stock-based compensation			(29	)			(91	)
Accumulated other comprehensive income			3				58
Accumulated deficit			(132,366	)			(125,115	)
Total stockholders’ equity			20,233				25,870
Total liabilities, redeemable preferred stock and stockholders’ equity		$	38,084			$	44,198

See notes to condensed consolidated financial statements.

     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 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 Options:

     The Company uses the intrinsic value method to measure compensation expense associated with the grants of stock options or awards to employees and directors. The Company accounts for stock options and awards granted to non-employees other than directors using the fair value method.

     Under the intrinsic value method, compensation associated with stock awards to employees and directors is determined as the excess, if any, of the current fair value of the underlying common stock on the measurement date over the price an employee must pay to exercise the award. The measurement date for employee awards is generally the date of grant. Under the fair value method, compensation associated with stock awards to non-employees other than directors 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 such non-employee awards is generally the date that performance of certain services is complete.

     Had the Company used the fair value method to measure compensation related to stock awards to employees and directors, reported loss and loss per share would have been as follows:

		Three months ended								Nine months ended
		September 30,								September 30,
(Amounts in thousands)		2005				2004				2005				2004
Net loss, as reported		$	(3,359	)		$	(756	)		$	(7,251	)		$	(5,163	)
Add: stock-based compensation recorded			14				348				123				2,791
Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects			(3	)			(666	)			(525	)			(4,729	)
Pro forma net loss		$	(3,348	)		$	(1,074	)		$	(7,653	)		$	(7,101	)
Basic & Diluted net loss per share:
As reported		$	(0.07	)		$	(0.02	)		$	(0.16	)		$	(0.13	)
Pro forma		$	(0.07	)		$	(0.03	)		$	(0.17	)		$	(0.17	)

Options terminate 10 years after grant and vest over periods set by the Board of Directors at the time of grant. These vesting periods have generally been for four years, on a ratable basis, except for the grants of non-qualified stock options, which had a more accelerated vesting period as described below.

     In July 2003, the Company granted to certain of its employees non-qualified stock options, which had exercise prices that were below market value at the time of the grants. These options, which were granted as a retention tool to certain employees, vested on March 31, 2004. The aggregate intrinsic value of these options, totaling $1.5 million less forfeitures of $228,000, was amortized ratably over the period from the date of grant to the vesting date and recorded as compensation expense. Of this amount, $440,000 was recognized as compensation expense in the nine-month period ended September 30, 2004.

     In December 2003, the Company granted to certain of its employees non-qualified stock options, which had exercise prices that were below market value at the time of the grants. These options, which were granted in lieu of year-end bonuses, vested 50% on February 9, 2004 and the remaining 50% vested on February 7, 2005.

The aggregate intrinsic value of these options, totaling $2.7 million less forfeitures of $423,000, was amortized ratably over the period from the date of grant to the respective vesting dates and recorded as compensation expense. Of this amount, $86,000 and $1,230,000, respectively, were amortized in the nine-month periods ended September 30, 2005 and 2004.

     Also in December 2003, the Company granted to certain of its employees non-qualified stock options, which had exercise prices that were below market value at the time of the grants. These options, which were granted as a retention tool to those employees assigned to the health and life science business, vested 50% on June 30, 2004 and the remaining 50% vested on December 31, 2004. The aggregate intrinsic value of these options, totaling $1.2 million less forfeitures of $285,000, was amortized ratably over the period from the date of grant to the respective vesting dates and recorded as compensation expense. Of this amount, $707,000 was amortized in the nine-month period ended September 30, 2004.

     The Company’s calculations of the fair value of stock options were made using the Black-Scholes option pricing model with the following assumptions and resulted in the following weighted average fair value of options granted during the nine months ended September 30:

		2005				2004
Risk-free interest rates			4.05-4.33 %				3.9 %
Dividend yield			—				—
Volatility			70-80 %				105 %
Expected term		6.25 years				7 years
Weighted average fair value of options granted during the period			$ 1.08				$ 1.05

     In September 2003, the Company granted a total of 16,215 shares of restricted common stock to its non-employee directors. The aggregate value of these restricted shares, which vested on February 5, 2004, was $22,000. Of this amount, $10,000 was recorded as compensation expense in the nine months ended September 30, 2004. In January 2004, the Company granted a total of 36,000 shares of restricted common stock to its non-employee directors. The aggregate value of these restricted shares, which vested on February 7, 2005, was $56,000. Of this amount, $7,000 and $13,000, respectively, were recorded as compensation expense in the nine month periods ended September 30, 2005 and 2004. In January 2005, the Company granted a total of 24,000 shares of restricted common stock to its non-employee directors. The aggregate value of these restricted shares, which will vest on or about February 6, 2006, was $36,000. Of this amount, $25,000 was recorded as compensation expense in the nine months ended September 30, 2005 and $11,000 was recorded as deferred compensation in stockholders’ equity at September 30, 2005. In June 2005, the Company granted 15,000 shares of restricted common stock to one of its employees. The aggregate value of these restricted shares, which will vest no later than June 30, 2006, was $24,000. Of this amount $6,000 was recorded as compensation expense in the nine months ended September 30, 2005 and $18,000 was recorded as deferred compensation in stockholders’ equity at September 30, 2005. And in the nine months ended September 30, 2004, stock compensation charges included $43,000 in connection with extending the forfeiture date of stock options held by two former employees.

Short-term investments and securities held for sale:

     Investments in marketable debt securities with maturities greater than 90 days and less than one year at time of purchase are classified as held-to-maturity investments and have been recorded at amortized cost. Investments in auction rate debt securities, with maturities which can be greater than one year but for which interest rates reset in less than 90 days, are classified as securities held for sale and have been stated at fair market value.

     Purchases and sales of marketable debt securities are recorded on a trade-date basis. Dividend and interest income are recognized when earned. Realized gains and losses from the sale of marketable debt securities

are determined on a specific identification basis. There were no realized gains or losses or impairments of held-to-maturity securities during the three or nine month periods ended September 30, 2005 and 2004.

     Short-term investments and securities held for sale consisted of the following at September 30, 2005 and December 31, 2004:

		September 30,				December 31,
(Amounts in thousands)		2005				2004
Auction rate securities held-for-sale		$	—			$	11,600
Held-to-maturity short-term investments:
Corporate bonds			—				1,010
US Government agency securities			—				2,000
		$	—			$	14,610

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, 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 are outstanding as of September 30, 2005. We do not expect that any significant impact on financial position or the results of operations will result from these indemnification provisions.

NOTE 3. RECLASSIFICATIONS

     The Company has reclassified $11.6 million of certain auction rate securities, for which interest rates reset in less than 90 days, but for which the underlying maturity dates are longer than 90 days, from cash and cash equivalents to short-term investments and securities held for sale in its Condensed Consolidated Balance Sheets as of December 31, 2004. Also, amounts for net cash used in investing activities and cash and cash equivalents, beginning of period in the accompanying Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 have been revised to conform to the 2005 presentation.

NOTE 4. 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 2,667,540 and 4,291,315 for the three months ended September 30, 2005 and 2004, respectively, and 3,693,157 and 5,186,782 for the nine months ended September 30, 2005 and 2004, respectively.

NOTE 5. SIGNIFICANT CUSTOMERS

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

		Three months ended								Nine months ended
		September 30,								September 30,
		2005				2004				2005				2004
Customer A			*				*				12	%			*
Customer B			*				*				11	%			*
Customer C			*				15	%			*				25	%

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

		September 30,
		2005				2004
Customer A			17	%			*
Customer C			*				27	%
Customer D			13	%			*

NOTE 6. 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.

     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 is 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.

NOTE 7. ACQUISITION

     On April 2, 2004, the Company completed its acquisition of all of the outstanding capital stock of Pricing Analytics, Inc. (“Pricing Analytics”), a California corporation located in Redwood City, California, which marketed software used to evaluate pricing strategies, for a purchase price of $1.2 million. The Pricing Analytics acquisition provided the Company with technology that the Company believes will enhance its product offerings to its customers in both the health and life sciences and other industries segments. The merger consideration of $1.2 million consisted of $995,000 in cash, assumed liabilities of $36,000, transaction costs of $60,000 and advance royalties of $75,000 previously paid by the Company to Pricing Analytics in 2003. The cash consideration was paid in four equal quarterly installments beginning in April 2004 with the final installment of $248,000 paid in January 2005. The Company has consolidated the operating results of Pricing Analytics beginning on the date of acquisition.

     In addition, upon achievement of certain revenue milestones through March 31, 2005, the former Pricing Analytics shareholders were entitled to additional consideration of up to $1.8 million, payable in cash or common stock at the Company’s election. Since the revenue milestones were not achieved, no additional consideration was paid or recorded in the accompanying financial statements.

     The following table summarizes Company management’s estimate of fair values of the assets acquired and liabilities assumed at the date of acquisition (amounts in thousands):

Acquired intangible assets		$	740
In-process research and development			290
Goodwill			136
Total assets acquired			1,166
Less current liabilities			36
Net assets acquired		$	1,130

The $740,000 of acquired intangible assets represents the fair value of the technology acquired, which is being amortized over a four-year life. The entire value of acquired intangible assets, in-process research and

development, and goodwill was assigned to the health and life sciences segment. The Company does not expect to deduct any portion of the goodwill for tax purposes.

     The portion of the purchase price allocated to in-process research and development, totaling $290,000, was expensed upon consummation of the Pricing Analytics acquisition. This allocation was attributable to one in-process research and development project, which consisted of the development of significant new features and functionality to an existing software product. Pricing Analytics had achieved significant technological milestones on the project as of the acquisition date, but the project had not reached technological feasibility.

     The value of the purchased in-process research and development was computed using a discount rate of 45% on the projected incremental revenue stream of the product enhancements, net of anticipated costs and expenses. The 45% discount rate was derived based on the Company’s estimated weighted average cost of capital as adjusted to reflect the additional risk inherent in product development. The discounted cash flows were based on management’s forecast of future revenue, costs of revenue and operating expenses related to the products and technologies purchased from Pricing Analytics. The determined value was then adjusted to reflect only the value creation efforts of Pricing Analytics prior to the close of the acquisition. At the time of the acquisition, the project was approximately 35% to 40% complete. The Company invested approximately $135,000 in the project following acquisition. The project’s development progressed, in all material respects, consistently with the assumptions that the Company had used for estimating its fair value. The project was completed in October 2004.

NOTE 8. 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.

		Health and Life				Industry
(Amounts in thousands)		Sciences				Solutions				Undesignated				Totals
At and for the three months ended September 30, 2005:
Revenues		$	5,223			$	1,827			$	—			$	7,050
Segment loss			(274	)			(2,929	)			(156	)			(3,359	)
Segment assets			28,365				3,455				6,264				38,084
Goodwill			2,716				—				5,951				8,667
For the nine months ended September 30, 2005:
Revenues		$	18,329			$	6,021			$	—			$	24,350
Segment income (loss)			970				(7,752	)			(469	)			(7,251	)
At and for the three months ended September 30, 2004:
Revenues		$	6,590			$	2,717			$	—			$	9,307
Segment income (loss)			1,431				(2,031	)			(156	)			(756	)
Segment assets			33,830				2,994				6,888				43,712
Goodwill			2,716				—				5,951				8,667

		Health and Life				Industry
(Amounts in thousands)		Sciences				Solutions				Undesignated				Totals
For the nine months ended September 30, 2004:
Revenues		$	21,483			$	7,409			$	—			$	28,892
Segment income (loss)			3,070				(7,764	)			(469	)			(5,163	)

Undesignated amounts consist of goodwill and acquired intangible asset values and related amortization amounts with respect to the Company’s 2002 acquisition of Menerva Technologies, Inc.

NOTE 9. RESTRUCTURING AND OTHER CHARGES

     In 2003, the Company took several actions to reduce its operating expenses 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 offices in Chicago, Illinois and Mumbai, India, and significant downsizings of its operations in London, England and Portland, Maine. In the nine months ended September 30, 2004, the Company (i) accrued cease-use lease charges of $484,000 and $180,000 in connection with the partial closing of its facilities in London, England and Portland, Maine, respectively, (ii) accrued an additional $140,000 in lease charges related to its closed Chicago office, (iii) incurred $312,000 in severance costs for employees whose employment was terminated prior to March 31, 2004 and (iv) recorded impairment charges of $255,000 with respect to property and equipment that were no longer in productive use. Of these amounts, $62,000 in lease and equipment charges were incurred during the quarter ended September 30, 2004. With respect to the partial closing of its London office, the Company determined the fair value of the remaining liability (net of estimated sublease rentals) on its lease at the cease-use date. No sublease assumption was incorporated in the calculation of the cease-use lease accrual for the Portland office because the lease expired in April 2004.

     In the nine months ended September 30, 2005, the Company realized a net credit of $25,000 in connection with the amortization of its long-term lease restructuring accruals for its Chicago and London facilities. This credit resulted primarily from foreign currency adjustments.

     A rollforward of the Company’s liability for restructuring and other charges is as follows:

		Lease costs
		and asset
(Amounts in thousands)		impairments
Balance at December 31, 2004		$	1,341
Activity in nine months ended September 30, 2005:
Restructuring credits			(25	)
Payments			(160	)
Balance at September 30, 2005		$	1,156
Current portion — included in accrued expenses		$	199
Noncurrent portion — included in other long-term liabilities		$	957

NOTE 10. VALUATION AND QUALIFYING ACCOUNTS

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

(Amounts in thousands)		2005				2004
Balance at January 1,		$	402			$	588
Provisions			150				170
Write offs			(9	)			(373	)
Currency translation adjustments			(7	)			0
Balance at September 30,		$	536			$	385

NOTE 11. 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 12. CHANGE IN SENIOR MANAGEMENT

     On August 8, 2005, the Company announced the departure of its Chief Executive Officer, A. Leigh Powell, and its Chief Operating Officer, Terrence M. Nicholson. Also, Yorgen Edholm was appointed Acting President and Chief Executive Officer, and John A. Rade was appointed Chairman of the Board with certain executive powers. In connection with the resignation of these executives, the Company incurred $350,000 in future severance and benefit costs in the three month period ended September 30, 2005.

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 “Certain Factors That May Affect Our Future Operating Results” 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 18 of the 20 largest world-wide pharmaceutical manufacturers, ranked according to 2004 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 — which through mid 2001 had been principally comprised of software license fees generated from our I-many/CARS software suite and now includes licensing of our I-many ContractSphere® Enterprise Contract Management Product Suite, Government Pricing and Medicaid compliance software, and collection products — accounted for 16.9% of net revenues in the nine months ended September 30, 2005 versus 28.9% of net revenues in the nine months ended September 30, 2004. 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 83.1% of net revenues in the nine months ended September 30, 2005 versus 71.1% of net revenues in the nine months ended September 30, 2004.

     From June 2001 through March 2004, we implemented a number of employee headcount reductions, which have been partially offset by employee additions through acquisitions and selective hiring, and we have taken other measures to better align our cost structure with projected revenues. Our aggregate spending on sales and marketing, research and development and general and administrative expenses has been reduced from $12.6 million in the quarter ended June 30, 2001 to $6.1 million in the quarter ended September 30, 2005. During 2003 and the first quarter of 2004, actions taken to reduce our operating expenses included the closing of our Chicago, Illinois office, the significant downsizing of our London, England and Portland, Maine operations and selective other headcount reductions. Our total employee headcount has decreased from 358 employees at December 31, 2002 to 167 employees at September 30, 2005.

     On March 31, 2005, the shareholders of the Company voted to reject a proposed merger among the Company, 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.

     On August 8, 2005, the Company announced the departure of its Chief Executive Officer, A. Leigh Powell, and its Chief Operating Officer, Terrence M. Nicholson. Also, Yorgen Edholm was appointed Acting President and Chief Executive Officer, and John A. Rade was appointed Chairman of the Board with certain executive powers. In connection with the resignation of these executives, we incurred $350,000 in future severance and benefit costs in the three month period ended September 30, 2005.

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. 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.

     Service revenues include professional services, training and maintenance and support services and out-of-pocket reimbursable 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. Substantially all of the amounts included in cost of revenues represent direct costs related to the delivery of professional services, training and customer support.

     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 or more years, covering license fees and maintenance and support, generally payable in equal quarterly installments commencing upon execution of the agreement. Due to the extended payment terms, the installment payments are recognized as revenue ratably over the term of the subscription agreement. During the nine month periods ended September 30, 2005 and 2004, we recognized $600,000 and $34,000 respectively, in product revenue related to such agreements. See the reconciliation table that follows in this Item 2.

     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.

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 the Company’s 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.

Short-term investments and securities held for sale

     Investments in marketable debt securities with maturities greater than 90 days and less than one year at time of purchase are classified as held-to-maturity investments and are recorded at amortized cost. Investments in auction rate debt securities, with maturities which can be greater than one year but for which interest rates reset in less than 90 days, are classified as securities held for sale and are stated at fair market value.

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 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

     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 are outstanding as of September 30, 2005. We do not expect that any significant impact on financial position or the results of operations will result from these indemnification provisions.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004

NET REVENUES

     Net revenues decreased by $2.3 million, or 24.3%, to $7.1 million for the quarter ended September 30, 2005 from $9.3 million for the quarter ended September 30, 2004. Product revenues decreased by $1.8 million, or 76.3%, to $567,000 for the quarter ended September 30, 2005 from the same period a year earlier, while service revenues decreased by $431,000, or 6.2%. As indicated in the table below, the gross value of license contracts sold during the current quarter increased by 17.3% versus the third quarter of 2004, due primarily to an increase in

the number of license transactions (minimum value of $50,000) from seven to nine, partially offset by a 15% decrease in average net selling price. However, most of the revenue from the license transactions in the current quarter, amounting to 87.5% of the license fees, 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 be subscription arrangements or will have conditions (e.g., 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 also to include larger proportions of revenues from contracts entered into in prior reporting periods.

Reconciliation of Value of License Transactions to Reportable Product Revenue

		Three months ended								Nine months ended
		September 30,								September 30,
		2005				2004				2005				2004
						(AMOUNTS IN THOUSANDS)
Gross value of license contracts sold:
Health and Life Sciences		$	1,209			$	2,004			$	7,220			$	4,591
Industry Solutions			1,405				224				2,326				1,454
			2,614				2,228				9,546				6,045
Add product revenue recorded in current period from contracts sold in prior periods:
Health and Life Sciences — subscriptions			239				34				600				34
Health and Life Sciences — other deferrals			—				—				1,476				3,139
Industry Solutions — other deferrals			—				550				—				794
			239				584				2,076				3,967
Less value of license contracts sold in current period and deferred to future periods:
Health and Life Sciences			904				419				5,933				1,121
Industry Solutions			1,382				—				1,565				550
			2,286				419				7,498				1,671
Product revenue recorded:
Health and Life Sciences			544				1,619				3,363				6,643
Industry Solutions			23				774				761				1,698
		$	567			$	2,393			$	4,124			$	8,341

     The above financial information is provided as additional information and is not in accordance with or an alternative to generally accepted accounting principles (“GAAP”). We believe its inclusion can enhance an overall understanding of the company’s past operational performance and also its prospects for the future. This reconciliation of product revenues is made with the intent of providing a more complete understanding of the revenue performance of the company, as opposed to GAAP 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 the company’s business. This information quantifies the various components comprising current revenue, which in each period consists of revenues from licenses sold in current periods plus revenues deferred from prior periods, less revenue deferred from licenses sold in current periods. 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.

     Total net revenues derived from the industry solutions segment decreased by $890,000, or 32.8%, to $1.8 million for the quarter ended September 30, 2005 from the quarter ended September 30, 2004. However, the gross value of license contracts sold in this segment during the current quarter increased by $1.2 million, or 527.2%, relative to the same quarter in 2004, although this increase was not reflected in revenues because of the deferral of nearly all of the current transactions’ license revenue to future periods. This upward trend in this segment’s recent sales results is further evidence of increasing demand in our new products in the I-many

ContractSphere® Enterprise Contract Management Product Suite, which are targeted primarily to customers in the industry solutions segment. However, these new products are still in early-stage releases, which continues to limit our ability to derive revenues from them.

     Total net revenues derived from the health and life sciences segment decreased by $1.4 million, or 20.7%, to $5.2 million for the quarter ended September 30, 2005 from $6.6 million in the year earlier period. Decreases in this segment’s product revenues and professional services revenues of $1.1 million and $507,000, respectively, were partially offset by a $207,000 increase in maintenance and support revenues. The decrease in product revenues was discussed above.

     Overall service revenues decreased by $431,000, or 6.2% to $6.5 million in the quarter ended September 30, 2005 versus $6.9 million in the same quarter in 2004. This decrease was attributable to a $733,000 decrease in professional services revenues, caused by reduced utilization levels, primarily in the health and life sciences segment, partially offset by a $302,000 increase in maintenance and support and hosting revenues, which was attributable to continued growth in our maintenance-paying, installed customer base.

COST OF REVENUES

     Cost of revenues consists primarily of payroll and related costs and subcontractor costs for providing professional services and support services, and to a lesser extent, amounts due to third parties for royalties related to integrated technology. Historically, cost of product revenues has not been a significant component of total cost of revenues. Cost of revenues increased by $100,000, or 2.6%, to $3.9 million for the quarter ended September 30, 2005 from the same period in 2004. This increase is primarily attributable to a $134,000 increase in salary and benefit costs in the customer support department, which resulted from an increase in headcount.

     As a percentage of total net revenues, cost of revenues increased to 55.1% for the quarter ended September 30, 2005, from 40.7% for the quarter ended September 30, 2004. The high level of cost of revenues as a percentage of total net revenues experienced during the quarter ended September 30, 2005 is primarily attributable to the current quarter’s relative low level of product revenues as a percent of total revenues (see Net Revenues discussion above). Product revenues have typically generated higher margins than service revenues and are expected to do so in the foreseeable future.

OPERATING EXPENSES

     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 were flat, decreasing by only $3,000, or 0.2%, to $2.0 million in the three months ended September 30, 2005 from the same period in 2004. Small decreases in compensation costs, attributable to lower headcount and reduced commissions, were mostly offset by higher spending on consulting and promotion. As a percentage of total net revenues, sales and marketing expense increased to 27.8% for the quarter ended September 30, 2005 from 21.1% for the quarter ended September 30, 2004.

     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 slightly by $36,000, or 1.3%, to $2.8 million for the quarter ended September 30, 2005 from the same period in 2004. This increase is primarily attributable to a $191,000 increase in off-shore consulting costs, partially offset by a $132,000 decrease in noncash compensation costs incurred pursuant to non-qualified stock options. The decrease in noncash compensation costs resulted from non-qualified option grants, which had an exercise price that was below market value at the time of grant, becoming fully-vested during the first quarter of 2005. Also, $133,000 in severance and benefit costs incurred in connection with the August 2005 resignation of our former chief operating officer were offset by a $143,000 decrease in other salary costs from the year earlier period. As a percentage of total net

revenues, research and development expense increased to 39.6% for the quarter ended September 30, 2005, from 29.6% for the quarter ended September 30, 2004.

     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 $252,000, or 23.6%, to $1.3 million for the quarter ended September 30, 2005 from $1.1 million in the quarter ended September 30, 2004. This increase is primarily attributable to $217,000 in severance and benefit costs incurred in connection with the August 2005 resignation of our former chief executive officer and a $150,000 increase to our allowance for doubtful for doubtful accounts, partially offset by a $91,000 reduction in noncash compensation costs incurred pursuant to the issuance of non-qualified stock options to employees which had exercise prices that were below market value at the time of grant. The decrease in noncash compensation costs resulted from non-qualified option grants becoming fully-vested during the first quarter of 2005. As a percentage of total net revenues, general and administrative expenses increased to 18.7% for the quarter ended September 30, 2005 from 11.5% for the quarter ended September 30, 2004.

     DEPRECIATION. Depreciation expense decreased by $29,000, or 12%, from $233,000 in the third quarter of 2004 to $204,000 in the third quarter of 2005. This decrease is principally attributable to a significant drop-off in the level of furniture, equipment and software additions from the years 2001 ($1.8 million) and 2002 ($933,000) to the year 2004 ($698,000) and the nine-month period ended September 30, 2005 ($630,000), the majority of these asset additions being depreciated over a three-year life.

     AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS. Amortization of acquired intangible assets related to our acquisitions amounted to $343,000 in the quarter ended September 30, 2005, which represents a 9% decrease in amortization from $378,000 recorded in the quarter ended September 30, 2004. This decrease is attributable to the intangible assets in connection with the acquisition of Vintage Software, Inc. (“Vintage”) becoming fully-amortized during the first quarter of 2005.

     RESTRUCTURING AND OTHER CHARGES. In the quarter ended September 30, 2005, we recorded $8,000 in charges related to efforts in prior quarters to streamline operations. This charge resulted from reductions in the provisions for future lease costs for the Chicago and London offices.

OTHER INCOME, NET

     Other income, net, increased by $3,000, or 3%, from $107,000 in the third quarter of 2004 to $110,000 in the third quarter of 2005. Increases of $34,000 in interest income and $28,000 in non-recurring miscellaneous income were mostly offset by an increase of $56,000 in state franchise taxes.

PROVISION FOR INCOME TAXES

     In the quarter ended September 30, 2004, we recorded an $82,000 benefit resulting from a refund related to the carry back of an operating loss to a pre-acquisition fiscal period for our subsidiary based in the United Kingdom. Other than this carry back benefit, we have incurred operating losses for all quarters in 2004 and the first three quarters of 2005 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 period ended September 30, 2005.

COMPARISON OF THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004

NET REVENUES

     Net revenues decreased by $4.5 million, or 15.7%, to $24.4 million for the nine months ended September 30, 2005 from $28.9 million for the nine months ended September 30, 2004. Product revenues decreased by $4.2

million, or 50.6%, to $4.1 million for the nine months ended September 30, 2005 from the same period a year earlier, while service revenues decreased by $325,000, or 1.6%, due to reduced billable utilization of professional services. The gross value of license contracts sold during the first nine months of 2005 increased by $3.5 million, or 57.9%, to $9.5 million versus $6.0 million in the same period in 2004, due primarily to an increase in average net selling price (minimum deal size of $50,000) to $277,000 from $233,000 while the number of such license transactions also increased during the period. However, $7.5 million of the $9.5 million in gross license transactions sold during the nine months ended September 30, 2005 was deferred to future periods. By comparison, only $1.7 million in gross license transaction value during the nine months ended September 30, 2004 was deferred. Also, product revenues recognized in the nine-month period ended September 30, 2004 benefited from the recognition of $3.4 million in license fees from a 2003 contract that had been previously deferred, while product revenue in the nine-month period ended September 30, 2005 included only $2.1 million of license revenue from previously deferred license transactions. See the reconciliation table that precedes this in this Item 2.

     Total net revenues derived from the industry solutions segment decreased by $1.4 million, or 18.7%, to $6.0 million for the nine months ended September 30, 2005 from $7.4 million for the nine months ended September 30, 2004. However, the gross value of license contracts sold in this segment during the nine months ended September 30, 2005 increased by $872,000, or 60.0%, to $2.3 million from $1.5 million in the same period in 2004, although this increase was not reflected in revenues because of the deferral of much of the current year’s license revenue to future periods. Service revenues in the industry solutions segment amounted to $1.8 million, a decreased of $139,000, or 7.2%, from $1.9 million recorded in the prior year period as professional service revenues were affected by the partial deferral to future periods of consulting work conducted on a substantial project during the period ended September 30, 2005.

     Total net revenues derived from the health and life sciences segment decreased by $3.2 million, or 14.7%, to $18.3 million for the nine months ended September 30, 2005 from $21.5 million in the year earlier period. A $3.3 million, or 49.4%, decrease in this segment’s product revenues accounted for essentially all of the revenue decrease as a $340,000 decrease in professional services revenues, attributable to lower utilization, was offset by a $354,000 increase in maintenance and support revenues, resulting from an increase in our maintenance-paying, installed customer base. The gross value of license contracts sold in this segment during the nine months ended September 30, 2005 increased by $2.6 million, or 57.3%, to $7.2 million from $4.6 million in the year earlier period. However, as indicated above, a substantially larger portion of the revenue from the contracts sold in the 2005 period versus 2004 was deferred to future periods.

COST OF REVENUES

     Cost of revenues decreased by $98,000, or 0.8%, to $11.7 million for the nine months ended September 30, 2005, from the year earlier period. This decrease is primarily attributable to a $717,000 decrease in noncash compensation costs incurred pursuant to non-qualified stock options, partially offset by a $512,000 increase in salary and benefit costs. The increase in salary and benefit costs is mostly due to headcount increases in the customer service department and salary increases that took effect January 1, 2005.

     As a percentage of total net revenues, cost of revenues increased to 47.9% for the six months ended September 30, 2005, from 40.7% for the year earlier period. This increase in cost of revenues as a percentage of total net revenues is principally attributable to the decrease in product revenues as a percent of total revenues. Product revenues have typically generated higher margins than service revenues and are expected to do so in the foreseeable future.

OPERATING EXPENSES

     SALES AND MARKETING. Sales and marketing expense decreased by $158,000, or 2.5%, to $6.2 million in the nine months ended September 30, 2005 from the same period in 2004. This decrease in sales and marketing expense is primarily attributable to a $341,000 reduction in noncash compensation costs incurred

pursuant to non-qualified stock options, partially offset by higher commission costs attributable to the increase in the gross value of license transactions during 2005 versus 2004. The decrease in noncash compensation costs resulted from non-qualified option grants becoming fully-vested during the first quarter of 2005. As a percentage of total net revenues, sales and marketing expense increased to 25.4% for the nine months ended September 30, 2005, from 21.9% for the year earlier period.

     RESEARCH AND DEVELOPMENT. Research and development expenses decreased by $152,000, or 1.7%, to $8.7 million for the nine months ended September 30, 2005 from the same period in 2004. This decrease in research and development expenses is attributable to a $1.0 million reduction in noncash compensation costs incurred pursuant to the issuance of non-qualified stock options to employees which had exercise prices that were below market value at the time of grant, partially offset by increases in off-shore consulting costs and salary expenses of $627,000 and $248,000, respectively. Included in the salary increase is $133,000 in severance and benefit costs incurred in connection with the August 2005 resignation of our former chief operating officer. As a percentage of total net revenues, research and development expense increased to 35.8% for the nine months ended September 30, 2005, from 30.7% for the year earlier period.

     GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by $308,000, or 7.9%, to $3.6 million for the nine months ended September 30, 2005 from $3.9 million for the nine months ended September 30, 2004. This decrease in general and administrative expenses is primarily attributable to a $553,000 reduction in noncash compensation costs incurred pursuant to the issuance of non-qualified stock options to employees which had exercise prices that were below market value at the time of grant, partially offset by $217,000 in severance and benefit costs incurred in connection with the August 2005 resignation of our former chief executive officer. As a percentage of total net revenues, general and administrative expenses increased to 14.8% for the nine months ended September 30, 2005 from 13.6% for the year earlier period.

     DEPRECIATION. Depreciation expense decreased by $73,000, or 11%, to $591,000 in the nine months ended September 30, 2005 from the same period in 2004. This decrease is principally attributable to a significant drop-off in the level of furniture, equipment and software additions from the years 2001 ($1.8 million) and 2002 ($933,000) to the year 2004 ($698,000) and the nine months ended September 30, 2005 ($630,000), the majority of these asset additions being depreciated over a three-year life.

     AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS. Amortization of acquired intangible assets related to our acquisitions amounted to $1.0 million in the nine months ended September 30, 2005, which represents a $46,000, or 4%, decrease in amortization from the year earlier period. The decrease in amortization attributable to Vintage’s acquired intangible assets becoming fully-amortized during the first quarter of 2005 was partially offset by an increase attributable to the acquisition of Pricing Analytics in April 2004.

     RESTRUCTURING AND OTHER CHARGES. In the nine months ended September 30, 2005, we recorded $25,000 in credits related to efforts in prior quarters to streamline operations. These credits resulted from reductions in the provisions for future lease costs for the Chicago and London offices.

OTHER INCOME, NET

     Other income, net, increased by $15,000, or 9%, to $182,000 in the third quarter of 2005 from the year earlier period. A $129,000 increase in interest income, attributable to higher average yields, and $20,000 decrease in interest expense was partially offset by increases in state franchise taxes and foreign currency losses of $71,000 and $60,000, respectively.

PROVISION FOR INCOME TAXES

     In the quarter ended September 30, 2004, we recorded an $82,000 benefit resulting from a refund related to the carry back of an operating loss to a pre-acquisition fiscal period for our subsidiary based in the United Kingdom. Other than this carry back benefit, we incurred operating losses for all quarters in 2004 and the first three quarters of 2005 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.

LIQUIDITY AND CAPITAL RESOURCES

     In 2002 and 2003, we entered into several capital lease financing arrangements with a financial institution. Under the terms of the financings, the aggregate proceeds were deposited in a restricted bank account. At September 30, 2005, $21,000 of the remaining aggregate proceeds are restricted, all of which is classified as current restricted cash. The non-current restricted cash balance of $641,000 at September 30, 2005 represents cash held on deposit with respect to long-term lease obligations.

     At September 30, 2005, we had net working capital of $9.7 million, including cash and cash equivalents of $17.5 million. This compares to a net working capital balance of $14.6 million at December 31, 2004. Also on September 30, 2005, we had no long-term or short-term debt, other than obligations under capital lease financings. The year-to-date $4.9 million decrease in net working capital was primarily attributable to a $3.2 million decrease in combined cash and short-term investments and a $2.4 million decrease in accounts receivable, as more fully described below.

     Net cash used in operating activities for the nine months ended September 30, 2005 was $3.7 million, as compared to net cash used in operating activities of $2.7 million in the nine months ended September 30, 2004. 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 is primarily attributable to a $352,000 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 is primarily attributable to the net increase in the cumulative value of deferred license transactions.

     For the nine months ended September 30, 2004, net cash used in operating activities consisted principally of the net loss of $5.2 million, as offset by non-cash items depreciation and amortization of $1.8 million, restructuring and other charges of $1.4 million, in-process research and development of $290,000 and noncash stock-based compensation of $2.8 million, and decreases in accrued expenses and deferred revenue of $2.6 million and $2.8 million, respectively, partially offset by a $858,000 decrease in accounts receivable. The year-to-date decrease in accrued expenses resulted largely from: (i) $1.1 million in year-to-date payments against the restructuring lease and severance accruals, (ii) a $660,000 decrease in the Company’s self-insured medical claims obligation, (iii) a net $427,000 reduction in the sales commission accrual, a consequence of the decrease in new license deals in the third quarter of 2004 relative to the fourth quarter of 2003, and (iv) a $381,000 reduction in accrued consulting fees. The $2.8 million decrease in deferred revenue was the result of the recognition into revenue of previously-deferred license fees. The $858,000 decrease in accounts receivable was principally attributable to a 44.2% drop in product revenues in the third quarter of 2004 versus the fourth quarter of 2003.

     Net cash provided by investing activities was $13.8 for the nine months ended September 30, 2005, as compared to net cash used of $1.2 million for the nine months ended September 30, 2004. 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 used in investing activities for the nine months ended September 30, 2004 consisted primarily of $633,000 in

merger consideration paid in connection with the Pricing Analytics acquisition and $451,000 in property and equipment additions. Also during this period, purchases of short-term investments and securities held for sale of $11.9 million were nearly offset by $11.8 million in redemptions of such investments.

     Net cash provided by financing activities was $1.4 million in the nine months ended September 30, 2005, consisting primarily of $600,000 in proceeds from warrant exercises and $828,000 in proceeds from stock option exercises. Net cash used by financing activities was $102,000 in the nine months ended September 30, 2004, comprised of $497,000 in payments on existing capital leases, partially offset by $395,000 in proceeds from stock option exercises and the employee stock purchase plan.

     We currently anticipate that our cash and cash equivalents of $17.5 million 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, 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 such a sale of stock, our stockholders may 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

		Payments due by Period — Amounts in $000s
						Less than												More than
		Total				1 year				1-3 years				3-5 years				5 years
Capital Lease Obligations		$	21			$	21			$	—			$	—			$	—
Operating Leases			8,669				1,718				3,657				2,369				925
Severance Obligations			296				296				—				—				—
Total Contractual Obligations		$	8,986			$	2,035			$	3,657			$	2,369			$	925

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

CERTAIN FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS

     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 RECENTLY EXPERIENCED A CHANGE OF SENIOR MANAGEMENT, WHICH MAY AFFECT OUR BUSINESS, PARTICULARLY IN THE SHORT TERM

     On August 8, 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. 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 few quarters, this leadership change could have an adverse effect on our business, financial condition and results of operations.

WE WILL NEED TO GROW IN MARKETS OTHER THAN THE HEALTHCARE MARKET FOR OUR FUTURE GROWTH

     We will need to be successful in our efforts to reduce our reliance on the health and life sciences market, which has traditionally been, and continues to be, the primary source of our revenues. Revenues from our non-healthcare customers in the industry solutions segment have comprised 34.0%, 27.3%, and 24.7%, respectively, of our consolidated revenues for the years ended December 31, 2003 and 2004 and for the nine months ended September 30, 2005. The Company must continue to evolve its products and marketing strategies in order to be successful in these markets. We have not been successful in generating the revenue we expected from these markets and we cannot assure you that we will be successful in the future. Although we have had some success in selling to markets outside of healthcare, we have not yet demonstrated that our product offerings have significant appeal in many of the markets we are targeting.

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

     We incurred net losses of $39.5 million in the year ended December 31, 2003, $7.0 million in the year ended December 31, 2004, and $7.3 million for the nine months ended September 30, 2005, and we had an accumulated deficit at September 30, 2005 of $132.4 million. Our recent results have been affected 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. And an increasing percentage of our customers and prospective customers seek to negotiate license agreements that permit regular subscription payments to us over periods greater than 12 months, instead of full payment of the license fee within the first few months after contract execution. 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 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 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 HAVE MULTIPLE FACILITIES AND WE MAY EXPERIENCE DIFFICULTIES IN OPERATING FROM THESE FACILITIES

     We will continue to operate out of our corporate headquarters in Edison, New Jersey, our primary engineering office in Redwood City, California and 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 will potentially add to this strain.

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

     We intend to continue our product research and development efforts at levels similar to current expenditures and to 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 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.

THE BID PRICE OF OUR COMMON STOCK ON THE NASDAQ NATIONAL MARKET HAS BEEN BELOW $1.00 PER SHARE, AND IF THE BID PRICE AGAIN FALLS BELOW $1.00 PER SHARE FOR AN EXTENDED PERIOD, OUR COMMON STOCK MAY BE DELISTED FROM THE NASDAQ NATIONAL MARKET WHICH COULD REDUCE THE LIQUIDITY OF OUR COMMON STOCK AND ADVERSELY AFFECT OUR ABILITY TO RAISE ADDITIONAL NECESSARY CAPITAL

     In April 2003 we received written notification from Nasdaq that we were not in compliance with Nasdaq Marketplace Rule 4450(b)(4) because the closing bid price of our common stock was below $1.00 for 30 consecutive trading days. We subsequently regained compliance when the bid price of our common stock closed at $1.00 per share or more for 10 consecutive trading days. This process occurred again in September 2004, when we received a similar notice of deficiency, and for which we regained compliance in November 2004. If the closing bid price of our common stock again falls below $1.00 per share for 30 consecutive trading days and we do not regain compliance, we would be delisted from the Nasdaq National Market. The delisting of our common stock may result in the trading of the stock on the Nasdaq SmallCap or the OTC Bulletin Board. Consequently, a delisting of our common stock from the Nasdaq National Market may reduce the liquidity of our common stock, adversely affect our ability to raise additional necessary capital and could adversely affect our sales efforts.

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.

     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 MAY MAKE ADDITIONAL ACQUISITIONS AND WE MAY HAVE DIFFICULTY INTEGRATING THEM

     Any company that we acquire will 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, 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.

IF WE DO ACQUIRE NEW TECHNOLOGIES OR BUSINESSES, OUR RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED

     In connection with our acquisitions, we have recorded substantial goodwill and other purchased intangible assets. In addition, we recorded charges for write-offs of a portion of the purchase prices of acquired companies as in-process research and development. The carrying values of intangible assets and goodwill are reviewed for impairment on a periodic basis. In the years ended December 31, 2002 and 2003, we recorded impairment charges of $13.3 million and $16.8 million, respectively , in connection with the write-off of goodwill and other purchased intangible assets. We cannot assure you that future write-downs of any such assets will not affect future operating results.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

     The Company’s exposure to market risk for changes in interest rates relate primarily to the Company’s investment portfolio. The Company does not use derivative financial instruments in its investment portfolio. The primary objective of the Company’s 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 periods ended September 30, 2004 and 2005.

     As of September 30, 2005, the Company’s cash and cash equivalents consisted entirely of money market and other marketable 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 have been recorded at amortized cost. At September 30, 2005, the Company had no held-to-maturity investments, all such investments held at March 31, 2005 having matured during the quarter ended June 30, 2005. 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 securities held for sale and have been stated at fair market value. At September 30, 2005, the Company held no auction rate certificates, having disposed of all its holdings in such investments during the quarter ended June 30, 2005.

FOREIGN CURRENCY EXCHANGE RISK

     The Company operates 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, 2005. 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. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. Based on this evaluation, our CEO and CFO concluded that, as of September 30, 2005, 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, 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. The Company made no material changes to its internal controls procedures in the quarter ended September 30, 2005. No change in our internal control over financial reporting occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Annual Meeting of Stockholders of the Company was held on October 10, 2005. The stockholders of the Company elected members of the Board of Directors and ratified the selection of BDO Seidman, LLP as the Company’s independent auditors for 2005. The following tables show the results of voting for each matter:

		NUMBER OF SHARES OF COMMON STOCK
Election of members								BROKER
of Board of Directors:		FOR		AGAINST		WITHHELD		NON-VOTES
Yorgen H. Edholm		41,916,820		—		660,307		—
Steven L. Fingerhood		41,914,229		—		662,898		—
Murray B. Low		41,839,264		—		737,863		—
Mark A. Mitchell		41,797,739		—		779,388		—
Karl E. Newkirk		41,837,829		—		739,298		—
John A. Rade		41,916,529		—		660,598		—
Ratified selection of BDO Seidman, LLP		42,533,674		11,689		32,764		—

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.

				I-MANY, INC
Date: November 7, 2005		By:		/s/ Kevin M. Harris
				Kevin M. Harris
				Chief Financial Officer and Treasurer
				/s/ Kevin M. Harris
				Kevin M. Harris
				Chief Financial Officer

INDEX TO EXHIBITS

EXHIBIT
NO.		DESCRIPTION
31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certifications pursuant to 18 U.S.C. sec. 1350.