S-1/A 1 b413913_s1.htm FORM S-1 Prepared and filed by St Ives Financial

As filed with the Securities and Exchange Commission on November 22, 2006

Registration No. 333-136532

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


Amendment No. 5
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933


MEDECISION, INC.
(Exact name of registrant as specified in its charter)

Pennsylvania
    7371     23-2530889  
(State or other jurisdiction of
incorporation or organization)
    (Primary standard industrial
classification code number)
    (I.R.S. employer
identification number)
 


601 Lee Road
Chesterbrook Corporate Center
Wayne, Pennsylvania 19087
(610) 540-0202
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)


David St. Clair
Chief Executive Officer and Chairman of the Board of Directors
MEDecision, Inc.
601 Lee Road
Chesterbrook Corporate Center
Wayne, Pennsylvania 19087
(610) 540-0202
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)


Copies to:

Brian M. Katz, Esq.
    Selim Day, Esq.  
Pepper Hamilton LLP
    Wilson Sonsini Goodrich & Rosati  
3000 Two Logan Square
    Professional Corporation  
18th & Arch Streets
    1301 Avenue of the Americas, 40th Floor  
Philadelphia, PA 19103
    New York, NY 10019  
(215) 981-4000
    (212) 999-5800  


Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ______________

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ______________

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ______________

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 


The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

PROSPECTUS (Subject to Completion)
Dated November 22, 2006

5,500,000 Shares

Common Stock

This is an initial public offering of 5,500,000 shares of our common stock. We are offering 3,300,000 shares and the selling shareholders are offering 2,200,000 shares of our common stock. We will not receive any proceeds from the sale of shares by the selling shareholders. Prior to this offering, there has been no public market for our common stock. We have applied to have our common stock approved for quotation on the NASDAQ Global Market under the symbol “MEDE.” We expect that the initial public offering price will be between $11.50 and $13.50 per share.

Our business and an investment in our common stock involve significant risks. These risks are described under the caption “Risk Factors” beginning on page 9 of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.


      Per Share     Total  
   

 

 
               
Public offering price
   
$     
   
$     
 
Underwriting discounts
   
$     
   
$     
 
Proceeds, before expenses, to us
   
$     
   
$     
 
Proceeds, before expenses, to selling shareholders
   
$     
   
$     
 

The underwriters also may purchase up to an additional 825,000 shares of our common stock from the selling shareholders at the initial public offering price, less the underwriting discounts, within 30 days from the date of this prospectus to cover overallotments.

The underwriters expect to deliver the shares against payment in New York, New York on  _____________, 2006.


                                                                                                                                          

Cowen and Company
CIBC World Markets
 

 
Pacific Growth Equities, LLC

___, 2006

 


Improving the relationship between patients, payers
and providers since 1988

     


TABLE OF CONTENTS

    Page  
     
 
    1  
    9  
    27  
    28  
    28  
    29  
    31  
    33  
    35  
    37  
    73  
    86  
    103  
    108  
    112  
    118  
    121  
    124  
    128  
    128  
    128  
    F-1  


You should rely only on the information contained in this prospectus. We have not, and the selling shareholders and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the selling shareholders and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

Information contained on our website is not part of this prospectus.

i


Back to Contents

PROSPECTUS SUMMARY

This summary provides an overview of selected information contained elsewhere in this prospectus and does not contain all of the information you should consider before investing in our common stock. You should carefully read the prospectus and the registration statement, of which this prospectus is a part, in their entirety before investing in our common stock, including the information discussed under “Risk Factors” beginning on page 9 and our financial statements and notes thereto that appear elsewhere in this prospectus. As used in this prospectus, the terms “we,” “our,” “us,” “the Company” or “our Company” refer to MEDecision, Inc. and its subsidiaries, taken as a whole, unless the context otherwise indicates. Unless otherwise stated, all the information in this prospectus assumes that the underwriters will not exercise their overallotment option.

Company Overview

We are a provider of software, services and clinical content to healthcare payers that allow them to improve the quality and affordability of healthcare provided to their members and increase their administrative efficiency. Our Collaborative Care Management solution analyzes data, automates payer workflow processes and electronically connects payers, providers and patients, providing them with a common view of the patient’s health that helps to foster better clinical decision making. Our solution is built around a suite of modular and easily configurable software applications and utilizes the Internet to link our payer customers to their members and their members’ chosen healthcare providers.

Our Collaborative Care Management solution is comprised of two related suites of products – Integrated Medical Management and Collaborative Data Exchange. Our Integrated Medical Management suite allows our healthcare payer customers to identify active care management opportunities among their members and automate an intervention process based on clinical best practices. Our Collaborative Data Exchange suite allows our customers to securely transmit Patient Clinical Summaries, which are health records containing critical patient information in an easily understood format, to patients and providers at the time they are making treatment decisions.

As of September 30, 2006, our customers included approximately 56 regional and national managed care organizations, including the largest organizations in more than 27 regional markets. Depending on the application, we provide our solutions on an annual subscription basis, under limited term licenses or on a per-transaction basis, all of which provide us with recurring revenue. We primarily license our solutions through direct sales to customers in the United States. We have experienced operating losses for each of the years ended December 31, 2003, 2002 and 2001. Our revenue has increased at a compound annual growth rate of 32.8% since 2001, from $12.4 million for the year ended December 31, 2001 to $38.6 million for the year ended December 31, 2005. Collectively, our top five customers accounted for approximately 50% of our revenue for fiscal year 2005 and 64% of our revenue for the nine months ended September 30, 2006. One of those customers, HealthCare Services Corporation accounted for approximately 25% of our revenue for fiscal year 2005, and two of our customers, HealthCare Services Corporation and Horizon Blue Cross Blue Shield, accounted for approximately 27% and 22%, respectively, of our revenue for the nine months ended September 30, 2006. At September 30, 2006, our shareholders’ deficiency was $25.6 million.

Industry Overview

According to the Centers for Medicare & Medicaid Services, or CMS, healthcare spending will grow to $4.0 trillion by 2015, or 20% of the United States Gross Domestic Product, representing 7.2% annual growth since 2004. Rising healthcare costs negatively impact a wide range of constituencies; however, we believe that the broad array of healthcare payers is the most directly impacted. We also believe that payers have two options if they are to maintain their viability. First, payers can proactively manage the delivery of healthcare services and products to their members to improve the quality and cost of care. Second, they can offset rising healthcare costs by reducing their internal administrative costs through efficiency gains. Accordingly, payers are consistently seeking new strategies to more effectively manage the care delivery process for their members and reduce their internal operating costs. We believe, based on our research, the market for care management solutions that accomplish these objectives is currently in excess of $1 billion per year and is growing at a compound annual growth rate in excess of 15.8%.

 

1


Back to Contents

We believe that one of the material contributors to rising healthcare costs is overuse, underuse and misuse of medical services and treatments, which we refer to as poor-quality care. We believe that there are two significant causes of this poor-quality care that payers can positively influence. First, providers often do not have the tools to universally apply clinical best practices, which negatively impacts the quality and cost effectiveness of the treatment. Second, providers frequently lack critical patient information needed to provide optimal care. Consequently, they often misdiagnose medical conditions, prescribe medications that negatively interact with each other and order duplicative or medically unnecessary tests and procedures.

As the financial intermediary between the provider and patient, payers are uniquely positioned to monitor the care provided to their members and identify poor-quality care. They also have a vested interest in improving outcomes for their members to reduce the cost of care. However, we believe that payers generally lack the information technology systems to play these roles effectively and efficiently. Based on our experience, we believe that payers generally rely on a combination of manual processes, third-party point solutions and proprietary systems for many components of the care management process. As a result, we believe that these processes generally suffer from a variety of weaknesses. First, payers fail to effectively and efficiently identify high-risk patients that warrant active care management. Second, payers lack information systems to optimally manage their care management programs. As a result, care managers fail to consistently identify poor-quality care and apply the most recent clinical best practices and often make manual errors. Furthermore, payers fail to capture and analyze valuable historical data and only apply care management to the most obvious, highest cost members. Perhaps most importantly, payers lack systems necessary to share the large volume of patient information in electronic format contained in their legacy claims processing and care management systems internally and with providers.

Benefits of Our Solutions

We believe our solutions allow our payer customers to improve the quality of care and reduce costs by enabling payers to:

 
Identify high-risk members.  Our solutions automatically organize the data contained in our customers’ legacy claims processing and care management systems and apply proprietary algorithms to that data to classify their members based on their risk of incurring material medical costs. We believe that our solutions increase the effectiveness of our customers’ care management programs by more accurately and efficiently identifying members that would benefit from active disease or case management, thereby helping to improve the quality and to reduce the cost of care.
     
 
Promote consistency and reduce manual errors and administrative costs through automation.   Our solutions automate the workflow process for utilization management, case management and disease management. By doing so, we believe our solutions promote consistent utilization and consistent care management processes that are less prone to manual error.
     
 
Promote the consistent application of clinical best practices.  Our solutions enable care management professionals to apply clinical best practices and best processes when adjudicating the medical appropriateness of requested services, evaluating treatment plans and creating intervention plans. Accordingly, adjudications are more accurate and care management intervention plans are consistently based on clinical best practices helping to improve the quality and to reduce the cost of care.
     
 
Utilize analytics to improve processes.  Our reporting tools allow our customers to analyze historical results, allowing our customers to continually refine and improve their internal care management rules and guidelines.
     
 
Enable enhanced information access.  Our solutions establish a single source of clinical information that supports integration with our customers’ other operational systems to ensure that care managers have access to the most current information. Our Patient Clinical Summaries provide, in real time, critical patient information to patients and providers in an easily understood format that we believe improves the quality and reduces the cost of care. For example, in a study conducted by HealthCore, Inc. dated July 24, 2006 that we commissioned concerning our Patient Clinical Summaries, in cases where Patient Clinical Summaries were utilized in the emergency room, the overall costs paid by the payers and the patient dropped by an average of approximately $545 per emergency department visit, or 19.7% of the average cost of the control visits that did not utilize this information.

 

2


Back to Contents

 
Our Strategy

Our goal is to be the leading provider of care management solutions and to encourage market-wide adoption of our Patient Clinical Summaries. Key elements of our strategy include:

 
continuing to expand our relationships with customers;
     
 
developing innovative new solutions and leading the next generation of Collaborative Care Management;
     
 
applying resources to ensure provider adoption of Patient Clinical Summaries;
     
 
expanding our customer base; and
     
 
continuing to build recurring and predictable revenue streams.
 
Internal Controls and Restated Financial Statements

Our independent auditors identified and informed us that we had material weaknesses with respect to our accounting and reporting of certain complex transactions. As a result of these material weaknesses, we restated our financial statements as of and for the years ended December 31, 2005, 2004 and 2003. Our selected financial data as of and for the years ended December 31, 2002 and 2001 were derived from financial statements, which we restated as a result of these material weaknesses and which were audited by Grant Thornton, LLP, our independent auditors.

To address the weaknesses identified by our current and former independent auditors, we have revised our internal control procedures, have expanded our accounting staff with additional skills and experience and have begun to engage qualified outside professionals to provide support and guidance in areas where we cannot economically maintain the required skills and experience internally. As of September 30, 2006, we have incurred an immaterial amount of costs related to our efforts to remediate our material weaknesses. We cannot assure you that we will not incur material costs for remediation in the future. See “Risk Factors” for a discussion of the risks related to our material weaknesses and the related restatements of our financial statements.

Company Information

We began operations in 1988 by licensing an automated medical management solution to large regional healthcare insurance companies. This solution was the predecessor to our current Advanced Medical Management module. In 1999, we acquired the assets of an analytical software company that became the basis of our current Analytics and Disease Management module. In 2000, we expended a significant amount of capital to begin the development of our Transactions and Information Exchange module, completing the initial development of the module in the third quarter of 2001. In December 2002, we acquired assets that were the foundation for clinical decision support content, which enabled us to create our Clinical Rules and Processes module. In 2005, we began to offer our customers the ability to electronically transmit Patient Clinical Summaries to providers at the point of care.

About Us

We are a Pennsylvania corporation. Our principal executive offices are located at 601 Lee Road, Chesterbrook Corporate Center, Wayne, Pennsylvania 19087. Our telephone number is (610) 540-0202. We maintain a website at http://www.medecision.com (which is not intended to be an active hyperlink in this prospectus). The information contained on, connected to or that can be accessed via our website is not part of this prospectus.

 

 

3


Back to Contents

This prospectus contains references to a number of trademarks that are our registered trademarks or trademarks for which we have pending registration applications or common law rights. These include OptiCareCert™ and OptiCarePath™. All other registered trademarks and trade names referred to in this prospectus are the property of their respective owners.

You should carefully consider the information contained in the “Risk Factors” section of this prospectus beginning on page 9 before you decide to purchase our common stock.

 

4


Back to Contents

The Offering

Common stock offered by us
3,300,000 shares
   
Common stock offered by the selling shareholders
2,200,000 shares (plus 825,000 shares if the underwriters exercise their overallotment option in full)
Common stock to be outstanding after this offering
14,930,792 shares
   
Directed share program
The underwriters have reserved for sale, at the initial public offering price, up to 275,000 shares of our common stock being offered for sale to our business associates, employees and friends and family members of our employees. The number of shares available for sale to the general public in this offering will be reduced to the extent these persons purchased reserved shares. Any reserved shares not purchased will be offered by the underwriters to the general public on the same terms as the other shares.
Estimated initial public offering price
$11.50 to $13.50
   
Use of proceeds
We intend to use approximately $9.5 million of the net proceeds from this offering to pay accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering.
   
 
We intend to use the remaining net proceeds for general corporate purposes, including working capital needs, potential strategic acquisitions and investments. You should read the discussion in the “Use of Proceeds” section of this prospectus for more information.
   
Risk factors
See “Risk Factors” beginning on page 9 and other information included in this prospectus for a discussion of factors you should consider carefully before deciding to invest in shares of our common stock.
   
Proposed NASDAQ Global Market symbol
MEDE

The number of shares of our common stock to be outstanding after this offering is based on 11,630,792 shares of our common stock outstanding as of November 22, 2006 and excludes:

 
2,918,455 shares of our common stock issuable upon exercise of outstanding options to purchase shares of our common stock subject to the terms of our Amended and Restated Stock Option Plan as of November 22, 2006 at a weighted average exercise price of $4.29 per share;
     
 
55,000 shares of our common stock issuable upon exercise of outstanding options to purchase shares of our common stock subject to the terms of our Series C Stock Equity Incentive Plan as of November 22, 2006 at a weighted average exercise price of $2.26 per share (such awards were originally exercisable for Series C preferred stock but will become options to purchase common stock on a one-for-two basis upon the consummation of this offering);

 

 

5


Back to Contents

 
1,500,000 shares of our common stock reserved for future grants under our 2006 Equity Incentive Plan, which will become effective immediately prior to when we become subject to the reporting requirements of the Securities Exchange Act of 1934; and
 
431,858 shares of our common stock issuable upon exercise of warrants to purchase shares of our common stock outstanding as of November 22, 2006 at a weighted average exercise price of $2.83 per share.

Unless otherwise indicated, all information in this prospectus assumes:

 
a 1-for-2 reverse stock split of our common stock to be effective prior to the consummation of this offering (other than our Consolidated Financial Statements beginning on page F-1, which present the reverse stock split on a pro forma basis);
 
an initial public offering price of $12.50 per share, the mid-point of the estimated offering price range shown on the front cover page of this prospectus;
     
 
the conversion of all outstanding shares of our Series A preferred stock, including the estimated accrued and unpaid dividends thereon immediately prior to the consummation of this offering, into 2,357,186 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
     
 
the conversion of all of the then outstanding shares of our Series B preferred stock and Series C preferred stock into 3,399,302 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
     
 
the issuance of 217,500 shares of our common stock at a weighted average exercise price of $2.62 per share upon the exercise of outstanding warrants that would otherwise terminate upon the consummation of this offering;
     
 
the conversion of all outstanding options to purchase shares of Series C preferred stock into options to purchase common stock at the then applicable conversion rate of the Series C preferred stock in effect upon the consummation of this offering;
     
 
the effectiveness of our amended and restated articles of incorporation and second amended and restated bylaws upon the completion of this offering; and
     
 
no exercise by the underwriters of their overallotment option to purchase 825,000 additional shares of common stock in this offering.

 

6


Back to Contents

Summary Consolidated Historical and Pro Forma Financial Data

The following table summarizes our consolidated financial data for the periods indicated. The data for each of the nine month periods ended September 30, 2006 and 2005 have been derived from our unaudited consolidated financial statements, which, in the opinion of management, contain all adjustments necessary to fairly present the information set forth below. The data for each of the three years ended December 31, 2005, 2004 and 2003 have been derived from our audited consolidated financial statements. You should read this information in conjunction with the “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this prospectus and our consolidated financial statements and the related notes elsewhere in this prospectus. Our historical results are not necessarily indicative of results for any future period.

The summary pro forma financial data reflects the earnings per share impact of our 1-for-2 reverse stock split of our common stock to be effective prior to the consummation of this offering.

 

    Nine Months Ended
September 30,
  Year Ended December 31,  
   
 
 
    2006   2005   2005   2004   2003  
   

 

 

 

 

 
    (unaudited)                    
    (in thousands, except share and per share data)  
                                 
Consolidated Statement of Operations Data:
                               
Revenue
                               
Term license revenue
  $ 7,403   $ 6,867   $ 9,729   $ 6,260   $ 2,439  
Subscription, maintenance and transaction fees
    16,311     10,961     17,187     14,666     12,600  
Professional services
    9,825     6,445     11,680     7,102     5,488  
   

 

 

 

 

 
Total revenue
    33,539     24,273     38,596     28,028     20,527  
Cost of revenue:
                               
Term licenses
    1,204     775     1,653     1,455     872  
Subscription, maintenance and transaction fees
    5,560     6,046     8,163     6,774     4,837  
Professional services
    4,435     3,911     5,499     4,843     3,622  
   

 

 

 

 

 
Total cost of revenue
    11,199     10,732     15,315     13,072     9,331  
   

 

 

 

 

 
Gross margin
    22,340     13,541     23,281     14,956     11,196  
Operating expenses
                               
Sales and marketing
    7,692     5,334     7,778     4,668     3,211  
Research and development
    5,828     1,951     2,627     3,243     3,903  
General and administrative
    8,904     5,727     9,707     6,320     4,343  
   

 

 

 

 

 
Total operating expenses
    22,424     13,012     20,112     14,231     11,457  
   

 

 

 

 

 
(Loss) income from operations
    (84 )   529     3,169     725     (261 )
(Gain) loss on change in fair value of redeemable convertible preferred stock conversion options
    2,413     993     694     576     (38 )
Interest expense, net
    287     174     274     175     249  
   

 

 

 

 

 
(Loss) income before benefit for income taxes
    (2,784 )   (638 )   2,201     (26 )   (472 )
Benefit (provision) for income taxes
    148     (139 )   6,491          
   

 

 

 

 

 
Net (loss) income
    (2,636 )   (777 )   8,692     (26 )   (472 )
Accretion of convertible preferred shares and redeemable convertible preferred shares
    (3,799 )   (3,310 )   (3,994 )   (6,113 )   (7,958 )
   

 

 

 

 

 
(Loss) income available to common shareholders
  $ (6,435 ) $ (4,087 ) $ 4,698   $ (6,139 ) $ (8,430 )
   

 

 

 

 

 
(Loss) income per share available to common shareholders, basic
  $ (0.87 ) $ (0.63 ) $ 0.73   $ (0.96 ) $ (1.36 )
(Loss) income per share available to common shareholders, diluted
  $ (0.87 ) $ (0.63 ) $ 0.33   $ (0.96 ) $ (1.36 )
Weighted average shares used to compute (loss) income available to common shareholders per common share, basic
    7,374,336     6,444,413     6,458,129     6,378,732     6,215,840  
Weighted average shares used to compute (loss) income available to common shareholders per common share, diluted
    7,374,336     6,444,413     28,287,173     6,378,732     6,215,840  
                                 
Pro forma stock split data (unaudited)
                               
Pro forma (loss) income per share available to common shareholders – basic
  $ (1.75 ) $ (1.27 ) $ 1.45   $ (1.92 ) $ (2.71 )
Pro forma (loss) income per share available to common shareholders – diluted
  $ (1.75 ) $ (1.27 ) $ 0.66   $ (1.92 ) $ (2.71 )
Weighted average shares used to compute pro forma (loss) income available to common shareholders – basic
    3,687,168     3,222,207     3,229,065     3,189,366     3,107,920  
Weighted average shares used to compute pro forma (loss) income available to common shareholders – diluted
    3,687,168     3,222,207     14,143,586     3,189,366     3,107,920  

 

 

7


Back to Contents

The following table presents a summary of our unaudited balance sheet data as of September 30, 2006:

 
On an actual basis;
     
 
On a pro forma basis to give effect to:
       
   
the restoration of our Treasury shares to our authorized but unissued common stock;
       
   
a 1-for-2 reverse stock split of our common stock to be effective prior to the consummation of this offering;
       
   
the issuance of 217,500 shares of our common stock at a weighted average exercise price of $2.62 per share upon the exercise of outstanding warrants that would otherwise terminate upon the consummation of this offering;
       
   
the conversion of all outstanding shares of our Series A preferred stock, including the estimated accrued and unpaid dividends thereon immediately prior to the consummation of this offering, into 2,357,186 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
       
   
the conversion of all of the then outstanding shares of our Series B preferred stock and Series C preferred stock into 3,399,302 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
       
   
the incurrence of an approximately $0.2 million charge due to the accretion on the Series A preferred stock, Series B preferred stock and Series C preferred stock after September 30, 2006; and
<R>
   
the incurrence of an approximately $9.5 million liability relating to the payment of the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering.
     
 
On a pro forma as adjusted basis to give effect to the sale by us of 3,300,000 shares of our common stock in this offering at an assumed initial public offering price of $12.50 per share, the midpoint of the range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and our estimated offering expenses.
</R>
<R>
    September 30, 2006  
   
 
    Actual   Pro Forma   Pro Forma
As Adjusted
 
   

 

 

 
    (unaudited)

 
    (in thousands)  
Consolidated Balance Sheet Data:
                   
Cash and cash equivalents
  $ 387   $ 957   $ 29,869  
Total assets
    38,214     38,784     65,137  
Short-term debt
    5,684     5,684     5,684  
Deferred revenue, current
    7,275     7,275     7,275  
Deferred revenue, net of current
    686     686     686  
Total current liabilities
    22,667     29,683     21,473  
Long-term debt
    2,936     2,936     2,936  
Preferred stock
    33,427          
Total shareholders’ (deficiency) equity
  $ (25,606 ) $ 1,375   $ 35,938  
</R>

 

8


Back to Contents

RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below and all of the other information set forth in this prospectus before deciding to invest in shares of our common stock. If any of the events or developments described below actually occur, our business, financial condition or results of operations could be negatively affected. In that case, the trading price of our common stock could decline, and you could lose all or part of your investment in our common stock.

Risks Related to our Business
 
     Our business may not continue to grow if the size of the market for care management solutions and market acceptance of our solutions does not continue to grow.

Our growth is dependent upon the overall growth of the market for care management solutions, which is in the early stages of development and is rapidly evolving. In addition, our growth is dependent on the continued adoption of new software and technologies, including electronic health records, by managed care organizations. In new and rapidly evolving industries such as ours, there is significant uncertainty and risk as to the demand for, and market acceptance of, recently introduced solutions and services. Achieving and maintaining market acceptance for new or updated solutions and services is likely to require substantial marketing efforts and the expenditure of significant funds to create awareness and demand by potential customers. There can be no assurance that the revenue opportunities from new or updated solutions and services will allow us to recover amounts we spend for their development, marketing and roll-out. If the market refuses to adopt our solutions or if a competitor develops a solution or service that is preferred by the market, the demand for our solutions will decrease, and we may not be able to sustain or increase our levels of revenue or profitability in the future.

     If the reliance and adoption of electronic Patient Clinical Summaries by healthcare providers is not
widespread or competing solutions prove more attractive to healthcare providers, then our future revenue growth will be materially adversely affected.

Although our success in marketing our Patient Clinical Summaries will be measured by sales to healthcare payers, the growth of our revenue is reliant on the adoption of electronic Patient Clinical Summaries by doctors and other healthcare providers. In the future, there may be more effective alternatives to our Patient Clinical Summaries for patient records, including solutions marketed by our competitors, physician sponsored electronic health records and other more traditional means of medical record storage. The future success of our business model is, in large part, linked to the adoption by healthcare professionals of our Patient Clinical Summaries. If these professionals ultimately prefer a different method by which to gain medical information about their patients, then our results of operations and financial condition could be adversely affected.

     If Regional Health Information Organizations do not gain widespread acceptance, our future growth and revenue may suffer.

Our growth prospects are dependent, in part, on the implementation of Regional Health Information Organizations as a facility for the retrieval of patient data and delivery of Patient Clinical Summaries. If federal, state and other regional legislative and regulatory authorities delay or oppose implementing these clinical data exchanges, it will be more difficult for us to incorporate data from healthcare providers into our Patient Clinical Summaries. This limitation could negatively affect the usefulness of our products and could significantly limit the growth of our market. In addition, this limitation could lead to greater competition for what would become a smaller market in which to license our current solutions, resulting in additional expenses in marketing our solutions and adverse effects on our results from operations and our ability to provide Patient Clinical Summary based products. Furthermore, our solutions may not be well suited for the type of organization, if any, that ultimately gains widespread acceptance for the dissemination of patient health information. This situation could cause us to incur additional expenses to customize our solutions to be acceptable to these new market participants without any short-term revenue, or future prospect of revenue, to cover these costs. As a result, we may not achieve our expected growth or sustain or increase our revenue or profitability in the future.

9


Back to Contents

 
     The ability of some of our customers to compete with us, and other customers to provide solutions that are similar to those we offer may adversely affect our market and lower our revenue and profits.

Some of our customers sell or license care management solutions that compete with ours or have current intentions to develop them. For example, some payer customers currently offer electronic data transmission services to healthcare providers that allow them to download patient health information in a format similar to the format offered by our solutions through affiliated clearinghouses, Internet portals and other means of communications. In addition, some of our customers have extensive internal development resources and provide their organizations with solutions similar to ours. For example, some of our customers internally develop functions such as patient analytics and data warehousing. The ability of payers to implement competing technology or to provide services similar to ours may adversely affect our ability to sell our solutions to these entities or the terms and conditions we are able to negotiate in our agreements with them, which may lower the revenue and profits that we currently realize from these transactions.

     If we fail to comply with broad patient privacy and medical information security laws and regulations, we could be subject to fines and civil and criminal penalties that could negatively impact our business and operating results.

As part of the operation of our business, our customers provide us, or our solutions interface, with patient-identifiable medical information. Government legislation and industry rulemaking, particularly the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and standards and requirements published by industry groups such as the Joint Commission on Accreditation of Healthcare Organizations, require the use and implementation of security, privacy and other standards and requirements for the receipt, creation, maintenance and transmission of certain electronic protected health information. Generally, HIPAA regulations directly affect what are referred to as Covered Entities. Most of our customers are Covered Entities, and we function in many of our relationships as a business associate, under business associate agreements with those customers. The federal agencies charged with enforcement authority under HIPAA have taken the position that a Covered Entity can be subject to HIPAA penalties and sanctions for certain material breaches of a business associate agreement. The penalties for a violation of HIPAA by a Covered Entity can be significant and include both civil and criminal penalties and fines and could have an adverse impact on our business, financial condition and results of operations, if such penalties ever were imposed on customers of ours due to a defect in one of our solutions or the unauthorized release of patient-identifiable medical information. We have policies and procedures that we believe assure material compliance with all federal and state confidentiality requirements for the handling of protected health information that we receive from Covered Entities and with our obligations under business associate agreements. If, however, we do not follow those policies and procedures, or if they are not sufficient to prevent the unauthorized disclosure of protected health information, we could be subject to liability and lawsuits, termination of our customer contracts or our operations could be shut down.

Moreover, because all HIPAA regulations are subject to change or interpretation and because certain other HIPAA standards are not yet published, we cannot predict the full future impact of HIPAA on our business and operations. In the event that the HIPAA regulations and compliance requirements materially change or are interpreted in a way that requires any material change to the way in which we do business, our business, financial condition and results of operations could be adversely affected.

Furthermore, states may pass legislation regulating how a patient’s medical information may be shared among payers and providers that are more stringent than the equivalent federal laws. The passage of state laws that affect information sharing may affect the ability of our customers to use our solutions, therefore reducing demand for our solutions, which would negatively impact our revenue and financial condition. We may need to incur significant costs to monitor active state legislation and to lobby legislators to prevent the passage of state legislation that would adversely affect our ability to sell our solutions.

 

10


Back to Contents

     If HIPAA regulations are changed to require patients to provide written consent to the sharing of their information for treatment and health care operations, our future growth and revenue may suffer.

Currently under HIPAA, written consent from patients is not required when sharing patient health information among Covered Entities and business associates for “treatment” purposes and “healthcare operations.” Patients may choose to “opt out” of an information sharing process, if desired, to protect their privacy. However, if federal or state legislation modifies existing privacy regulations to require a patient to provide written consent prior to any provider’s or payer’s retrieval of a patient’s health care information from certain sources for treatment or healthcare operations, it may significantly decrease the amount of information that we could gather in our Patient Clinical Summaries. This situation would decrease the usefulness of our Patient Clinical Summaries and the demand for such products. Any decreased demand would reduce our future revenue and negatively impact our business and future growth.

     Initiatives encouraging increased use of information technology in the healthcare sector may result in increased competition.

There are currently numerous federal, state and private initiatives and studies seeking ways to increase the use of information technology in healthcare to improve care while reducing costs. These and other initiatives may encourage more competitors to develop, sell or license solutions and services to our current and potential customers. In addition, competition from information technology solutions and services made available to healthcare payers on a not-for-profit or other low-cost basis by or on behalf of governmental entities could have an adverse impact on sales of our solutions and services. The effect that these initiatives may have on our business is difficult to predict, and we can provide no assurances that we will adequately respond to the increased competition resulting from these initiatives or that we will be able to take advantage of any resulting opportunities.

     Increased government involvement in the healthcare sector may limit the ability of potential customers to purchase and use our solutions, which could reduce revenue and materially affect future growth.

Healthcare system reform in the United States under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 and other federal and state initiatives, such as a national healthcare system, could increase government involvement in healthcare, lower reimbursement rates and otherwise change the business environment of our customers and the other entities with which we have a business relationship and may limit their ability to purchase and use our solutions and services. We cannot predict whether or when future healthcare reform initiatives at the federal or state level or other initiatives affecting our business will be proposed, enacted or implemented or the impact those initiatives may have on our business, financial condition or results of operations. Our customers and the other entities with which we have a business relationship could react to these initiatives by curtailing or deferring purchases of our solutions and/or services. Additionally, government regulation could alter the manner in which physicians and other healthcare providers, hospitals, healthcare payers and other healthcare participants provide care to patients, maintain patient medical information and interact with one another, thereby limiting the utility of our solutions and services to existing and potential customers and curtailing broad acceptance of our solutions and services.

     Increased governmental regulation of the Internet could require us to modify our products, which could result in a reduction in our revenue and profitability.

The Internet and its associated technologies are subject to significant government regulation. Given our use of the Internet to deliver our solutions and services, our failure, or the failure of our payer customers and business partners, to accurately anticipate the application of laws and regulations affecting how we deliver our solutions and services, or any other failure to comply with such applicable laws and regulations, could create legal liability for us. This situation could result in adverse publicity or decreased revenue, each of which could materially and adversely affect our business. In addition, new laws and regulations, or new interpretations of existing laws and regulations, may be adopted or implemented with respect to the Internet or other online services that may materially affect the way we and our customers handle user privacy, patient confidentiality, consumer protection and other similar issues. Such adoption or implementation could cause our current solutions or services to fail to comply with then applicable laws or regulations, and would require the revision of our current solutions or services or the development of new solutions or services in compliance with such laws or regulations. Such revision or new development could be costly and take a significant amount of time which could reduce our revenue and profitability and otherwise materially adversely affect our financial condition.

11


Back to Contents

New laws and regulations or new interpretations of existing laws and regulations could impact the rates charged by Internet service providers to companies such as ours. Such laws and regulations could result in increased costs to provide our solutions to our customers, which could reduce our profitability and otherwise materially adversely affect our financial condition.

     We may be liable for the misdiagnoses, mistreatment, injury or other harm to patients resulting from the use of data that we provide to healthcare providers, and any resulting claims could negatively impact our operating results and result in a decline in our stock price.

We provide, and facilitate providing, information for use by healthcare providers in treating patients. Our healthcare payer customers’ data is the primary source of a majority of this information. If this data is incorrect or incomplete, the patient could be misdiagnosed or mistreated resulting in adverse consequences, including death, giving rise to claims against us. In addition, certain of our solutions relate to patient health information, and a court or government agency may take the position that our delivery of this information, including through licensed physicians or other healthcare providers, exposes us to personal injury liability or other liability for wrongful delivery or handling of healthcare services or erroneous health information. While we maintain liability insurance coverage in an amount that we believe is sufficient for the risks associated with our business, we cannot assure you that this coverage will prove to be adequate or will continue to be available on acceptable terms, if at all. A claim brought against us that is uninsured or under-insured could harm our business, financial condition and results of operations. Even unsuccessful claims could result in substantial costs and diversion of management resources and could cause the trading price of our common stock to decline.

     Consolidation in the healthcare industry could lead to a decrease in revenue and profitability.

Many healthcare industry participants are combining or considering combining with other participants to create fewer and larger customers and potential customers, each of which would likely have greater market power and leverage in negotiating contracts for our solutions and services. Moreover, as provider networks and managed care organizations consolidate and the number of market participants decreases, competition to provide solutions and services such as ours will become more intense, and the importance of establishing relationships with key industry participants will increase. These industry participants may try to use their market power to negotiate price reductions for our solutions and services. If we are forced to reduce our prices, our revenue would decrease and our profitability would decline.

Although some of our customers have been parties to consolidations in the past, our revenue and customer base have not been materially affected by such consolidations during the periods presented in this prospectus. We cannot assure, however, that we will not be materially affected by such consolidations in the future.

     We operate in a market with limited potential clients, derive a significant portion of our revenue from a limited number of customers, and if we are unable to maintain these customer relationships or attract additional customers, our revenue will be adversely affected.

Our sales to HealthCare Services Corporation and its affiliates, on an aggregate basis, accounted for approximately 25% of our revenue for 2005. Our sales to HealthCare Services Corporation and Horizon Blue Cross Blue Shield accounted for approximately 27% and 22%, respectively, of our revenue for the nine months ended September 30, 2006. Collectively, our top five customers accounted for approximately 50% of our revenue for 2005. Although we are seeking to broaden our customer base, we anticipate that a small number of customers will continue to account for a large percentage of our revenue. The loss of one or more of our key customers, or fewer or smaller orders from them, would adversely affect our revenue.

 

12


Back to Contents

In addition, the number of potential customers in the electronic healthcare information market is limited, and therefore, our total customer base is limited. We believe that there are approximately 300 additional potential customers in our market. As of September 30, 2006, we had contracts with 45 entities that represented approximately 56 regional and national managed care organizations. If we lose one contract, we may lose more than one entity as a customer. Our contracts with our customers are typically five-year agreements. We do, however, enter into contracts with our customers that do not require long-term commitments, such as annual maintenance contracts or contracts for our transactional solutions. If we are not able to attract additional customers, license new solutions to our existing customers or obtain contract renewals from our customers, our revenue could decline.

     We derive a significant portion of our revenue from recurring revenue streams, and if we are unable to maintain these customer relationships, our revenue will be adversely affected.

Each of our license agreements with third-party customers provides us with a revenue stream that generally recurs. Historically, a substantial portion of our customers have renewed their licenses at the end of each license term, which is typically five years. During the year ended December 31, 2005, our customers renewed 100% of the contracts the stated terms of which were to expire during that period. The combination of recurring revenue and high renewal rates has provided us with a substantial annual revenue base. However, our customers may not continue to renew at this rate, and if they do renew, the value of the contracts may be less. Thus, there is no assurance we will be able to sustain these renewal rates, and if we are unable to sustain them, our revenue and profits could be adversely affected.

     We have grown rapidly, and if we fail to manage our growth, our reputation, revenue and results of operations may be negatively impacted.

Although we commenced operations 18 years ago, recently we have experienced, and continue to experience, significant growth in our operations. This growth has entailed hiring key personnel, developing and introducing several new products into the market and establishing new customer and licensing relationships. We anticipate further expansion of our operations to address our potential growth as we continue to address market opportunities. This expansion has placed, and we expect will continue to place, a substantial strain on our management, operational and financial resources. In order to manage future growth, we will be required to improve existing, and to implement new, operating and management systems, procedures and controls. We also need to hire, train and manage additional qualified personnel. A significant factor in our growth has been a substantial increase in consumer demand for our products. If we do not effectively manage our growth, we may not adequately satisfy this demand. In addition, the quality of our offerings or our ability to develop and bring our offerings to market on a timely or cost effective basis could suffer. This could negatively impact our reputation, revenue and results of operations.

     We have a history of losses and cannot assure you that we will remain profitable, and as a result, we may have to cease operations and liquidate our business.

Our expenses have exceeded our revenue in three of the last five years, and no net income has been available to common shareholders in four of the last five years. Our shareholders’ deficiency on September 30, 2006 was $25.6 million. Our future profitability depends on revenue continuing to exceed expenses, but we cannot ensure that this will continue. If it does not continue, we could be forced to curtail operations and sell or liquidate our business, and you could lose some or all of your investment.

     We have a history of quarterly fluctuations in our revenue and operating results and expect these fluctuations to continue, which may result in volatility in our stock price.

As a result of fluctuations in our revenue and operating expenses, our quarterly operating results may vary significantly. We may not be able to curtail our spending quickly enough if our revenue falls short of our expectations. We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our new product development efforts and hire additional personnel. Our operating results may fluctuate in the future as a result of the factors described below and elsewhere in this prospectus:

 

13


Back to Contents

 
customers’ budgetary constraints and the procedures that they must follow in order to purchase solutions and services;
     
 
the existence and growth of markets for our solutions and services;
     
 
potential reductions in the funds available to pay for our solutions;
     
 
the size and timing of orders from customers;
     
 
the specific mix of software and services in customer orders;
     
 
the period of time necessary for a customer to select and purchase our solutions;
     
 
changes in pricing policies by us or our competitors;
     
 
the timing of new solution announcements and solution introductions by us or our competitors;
     
 
changes in revenue recognition or other accounting guidelines employed by us and/or established by the Financial Accounting Standards Board or other rule making bodies;
     
 
the financial stability of our customers;
     
 
our ability to develop, introduce and market new solutions, applications and solution enhancements;
     
 
market acceptance of new solutions, applications and solution enhancements;
     
 
our success in expanding our sales and marketing programs;
     
 
deferrals of customer orders in anticipation of new solutions;
     
 
execution of, or changes to, our strategy; and
     
 
general market and economic conditions affecting businesses generally.
 
     Lengthy sales cycles for some of our solutions and the adoption of transaction-based solutions may result in unanticipated fluctuations in the revenue that we receive from such solutions.

The duration of the sales cycle for our solutions and services is difficult to predict and depends on a number of factors, including the nature and size of the potential customer and the size of the purchase contemplated by the potential customer. Our sales and marketing efforts with respect to healthcare payers generally involve a lengthy sales cycle due to these organizations’ complex decision-making processes. Additionally, in light of increased governmental involvement in the healthcare industry and related changes in the operating environment for healthcare organizations, our current and potential customers may react to these changes by curtailing or deferring investments, including those for our products and services. If potential customers take longer than we expect to decide whether to purchase our solutions or to adopt our transaction-based solution, the expenses we incur in attempting to market our solutions could increase and our revenue could decrease, which could harm our business, financial condition and results of operations and the trading price of our common stock could decline.

     If our information systems or the Internet experience security breaches or are otherwise perceived to be insecure, our business could suffer, and our revenue could decline.

The difficulty of securely transmitting confidential information and patient-related personal health information over the Internet has been a significant barrier to existing or potential customers’ willingness to engage in communications over the Internet. Our business model relies on our customers’ ability and willingness to use the Internet to transmit confidential patient health information. Any compromise of Internet security may deter customers from using the Internet for these purposes and from using our solutions or services.

We may be required to expend significant capital and other resources to protect against security breaches and hackers or to alleviate problems caused by breaches. Despite the implementation of security measures, it also is possible that third-parties could penetrate the network security of our solutions or otherwise misappropriate confidential patient health information and other data that may be stored on or transmitted using our solutions. In that event, our operations could be interrupted, and we could be subject to allegations of liability and the effects of regulatory action. We may need to devote significant financial and other resources to defend ourselves from such allegations, to protect against security breaches and to alleviate problems caused by such breaches, whether or not such breaches were a result of a deficiency in our solutions or services.

14


Back to Contents

 
     Consumer groups with concerns about privacy issues relating to the use and storage of personally-identifiable data, such as patient medical information, may influence healthcare professionals to refrain from adopting our solutions.

Consumer sentiment regarding healthcare privacy issues is constantly evolving. Such consumer sentiment may affect our customers’ interest in our current or future products. In some cases, consumer groups and individual consumers have already begun to express concern over the storage and/or use of personally-identifiable patient information. Accordingly, privacy concerns of consumers may influence healthcare professionals to refrain from adopting our solutions, which could in turn harm our prospects. Moreover, strong consumer attitudes may precipitate significant adverse opinions, which may lead to new regulations. If we fail to successfully monitor and address the privacy concerns of consumers, our business and prospects would be harmed.

     If we do not develop and implement new or updated solutions and services in order to generate revenue from existing and new customers and compete effectively against our competitors, our revenue could decline, and our future growth could be adversely affected.

We must introduce and license new solutions and improve the functionality of our existing core solutions and services in a timely manner in order to retain existing customers and attract new customers. The pace of change in the markets we serve is rapid, and there are frequent new solution and service introductions by our competitors and by vendors whose solutions and services we use in providing our own solutions and services. If we do not successfully identify and respond to technological and regulatory changes and evolving industry standards in a timely manner, our core solutions and services may become obsolete or unattractive to potential or existing customers. Technological changes also may result in the offering of competitive solutions and services at prices lower than we are charging for ours, which could result in our losing sales unless we lower our prices. Furthermore, our development and implementation of proposed solutions and services may take longer and cost more than originally expected, requiring more testing than anticipated and the addition of personnel and other resources. Any such failure or delay could adversely affect our competitive position and our profitability or could make our current solutions obsolete or unattractive to potential or existing customers.

     Competition for our employees is intense, and we may not be able to attract and retain the highly skilled employees that we need to support our business.

The industry in which we operate is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that our current employees will continue to work for us. Our ability to provide high-quality solutions to our customers depends in large part upon our employees’ experience and expertise. We must attract and retain highly qualified personnel, including doctors and nurses, with a deep understanding of the healthcare and healthcare information technology industries. We compete with a number of companies for experienced personnel and many of these companies, including customers and competitors, have greater resources than we have and may be able to offer more attractive terms of employment. In addition, we invest significant time and expense in training our employees, which increases their value to customers and competitors who may seek to recruit them and increases the costs of replacing them. If we fail to retain our employees, the quality of our products and services and our ability to provide such products and services could diminish and this could have a material adverse effect on our business, financial condition and results of operations and as a result, the trading price of our common stock may decline.

 

15


Back to Contents

     If we lose the services of our key personnel, we may be unable to replace them, and our business, financial condition and results of operations could be adversely affected.

Our success largely depends on the continued skills, experience, efforts and policies of our management and other key personnel and our ability to continue to attract, motivate and retain highly qualified employees. In particular, the services of David St. Clair, our Chairman of the Board of Directors and Chief Executive Officer; John H. Capobianco, our President and Chief Operating Officer; and Carl E. Smith, our Executive Vice President and Chief Financial Officer are integral to the execution of our business strategy. If one or more of our key employees leaves our employment, we will have to find a replacement with the combination of skills and attributes necessary to execute our strategy. Because competition for skilled employees is intense, and the process of finding qualified individuals can be lengthy and expensive, we believe that the loss of the services of key personnel could adversely affect our business, financial condition and results of operations. We cannot assure you that we will continue to retain such personnel.

     Our failure to compete successfully could cause our revenue or market share to decline.

The market for our solutions and services is intensely competitive and is characterized by rapidly evolving industry standards, technology and user needs and the frequent introduction of new solutions and services. Some of our competitors may be more established, benefit from greater name recognition and have substantially greater financial, technical and marketing resources than we do. In addition, a number of companies new to our market have introduced or developed solutions and services that are competitive with one or more components of the solutions that we offer. We expect that additional competitors will continue to enter this market. Moreover, we expect that competition will continue to increase as a result of consolidation in both the information technology and healthcare technology industries. If one or more of our competitors or potential competitors were to merge or partner with one of our competitors, the change in the competitive landscape could adversely affect our ability to compete effectively. Furthermore, our potential customer base is composed of a limited number of healthcare insurance payers. This limited number of potential customers, and the fact that many of our competitors already may have an existing relationship with many of them, is likely to further increase the level of competition within our industry and may lead to increased price competition. We compete on the basis of several factors, including:

 
solution depth and functionality;
     
 
ease of deployment, integration and configuration;
     
 
domain expertise;
     
 
depth of clinical content;
     
 
service support;
     
 
solution price;
     
 
breadth of sales infrastructure; and
     
 
breadth of customer support.

There can be no assurance that we will be able to compete successfully against current and future competitors or that the competitive pressures that we face will not materially adversely affect our business, financial condition and results of operations.

     Acquisitions, business combinations and other transactions may be difficult to complete and, if completed, may have a negative effect on our operating results, financial condition and the prospects of our business.

We may pursue acquisitions of existing companies in order to grow our business and to diversify our solutions and services if we determine that such acquisitions are likely to serve our strategic goals. We cannot assure you that we will be able to locate any suitable acquisition opportunities. Further, even if we find such opportunities, we cannot assure you that we will be able to integrate successfully any future acquisitions, that these acquired companies will operate profitably or that we will realize the potential benefits from these acquisitions. To date, our Company and its management has had limited experience with the integration of acquired businesses. If we do not successfully integrate acquired companies, the attention of our management may be diverted and our business, financial condition and results of operations could be adversely affected.

16


Back to Contents

     Complex software such as ours often contains undetected defects or errors, which could lead to an increase in our costs or a reduction in our revenue.

It is possible that errors may be found in our solutions after the introduction of new software or enhancements to existing software have been made. We continually introduce new solutions and enhancements to our solutions, and despite testing by us, it is possible that errors might occur in our software. If we detect any errors before we introduce a solution, we might have to delay deployment for an extended period of time while we address the problem. If we do not discover software errors that affect our new or current solutions or enhancements until after they are deployed, we would need to provide enhancements to correct such errors. Errors in our software could result in:

 
harm to our reputation;
     
 
lost sales;
     
 
delays in commercial release;
     
 
solution liability claims;
     
 
delays in or loss of market acceptance of our solutions;
     
 
license terminations or renegotiations; and
     
 
expenses and diversion of resources to remedy errors.

Furthermore, our customers might use our software solutions together with solutions from other companies. As a result, when problems occur, it might be difficult to identify the software solution that is the source of the problem. Even when our software solutions do not cause these problems, the existence of these errors might cause us to incur significant costs, divert the attention of our technical personnel from our solution development efforts, impact our reputation and cause significant customer relations problems.

     If we are deemed to infringe on the proprietary rights of third-parties, we could incur unanticipated expenses and be prevented from providing our solutions and services.

Many participants in our industry have an increasing number of patents and patent applications, as well as copyrights and trade secrets, and have frequently demonstrated a readiness to take legal action based on allegations of patent and other intellectual property infringement. We could face an adverse claim and litigation alleging infringement by us of the intellectual property rights of others.

We could be subject to intellectual property infringement claims for our current or future solutions and services if our solutions’ functionality overlaps with competitive solutions. While we do not believe that we have infringed or are infringing on any proprietary rights of third-parties, we cannot assure you that infringement claims will not be asserted against us or that those claims will be unsuccessful.

If infringement claims are brought against us, we would likely incur substantial costs and suffer the diversion of management resources defending any infringement claims. We cannot be certain that we will have the financial resources to defend ourselves against any patent or other intellectual property litigation. If we were found to infringe on the intellectual property rights of others, we might be forced to pay significant license fees or royalties or damages for infringement, including, if the claimant successfully claims willful infringement, potential treble damages. Moreover, we cannot assure you that a license for any intellectual property of third-parties that might be required for the operation of our solutions or services will be available on commercially reasonable terms, or at all. In addition, we could be forced to stop providing certain solutions and services or using certain technology or trademarks if we are enjoined or face an injunction from a court, or our use of such items could be restricted on terms that we find unacceptable. Even the mere announcement of intellectual property litigation against us could cause our stock price to drop, regardless of the ultimate outcome of the dispute. We would likely incur substantial costs and suffer the diversion of management resources defending any infringement claims. Furthermore, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could effectively block our ability to provide solutions or services. In addition, we cannot assure you that licenses for any intellectual property of third-parties that might be required for the operation of our solutions or services will be available on commercially reasonable terms, or at all.

17


Back to Contents

     Our failure to license and effectively integrate third-party technologies could adversely affect our ability to sell our solutions and lead to a decline in revenue and the future growth of our business.

For some of the technology that is used in our solutions and in providing our services, we depend upon licenses from third-party vendors. For example, we license a database module that is material to our Advanced Medical Management module from InterSystems Corporation. We must continue licensing these technologies to operate and license our solutions and to service our customers. These technologies might not continue to be available to us on commercially reasonable terms, if at all. Most of these licenses are for a limited duration and can be renewed only by mutual consent, including the InterSystems license that expires on December 31, 2006. In addition, most of these licenses, including the InterSystems license, may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. Our inability to obtain any of these licenses could delay development of new solutions and services or cause us to cease operating one or more solutions or services until equivalent replacement technology can be identified, licensed and integrated. There is no assurance that we would be able to find an equivalent replacement technology, and if we did, the resources required to obtain and implement an equivalent replacement technology could be significant and could harm our business, financial condition and results of operations.

Most of the technology that we license from third-parties is licensed pursuant to agreements that are non-exclusive. Therefore, our competitors may obtain the right to use the technology covered by such licenses and use the technology to compete directly with us. Our use of third-party technologies exposes us to increased risks, including, but not limited to, risks associated with the integration of such technology into our solutions and services, the diversion of our resources from the development of our own proprietary technology and our inability to generate revenue from such licensed third-party technology sufficient to offset associated acquisition and maintenance costs. In addition, if our vendors choose to cease providing any of our licensed third-party technology or discontinue support of the licensed third- party technology in the future, we might not be able to offer our related modules and services. Furthermore, if these third-parties are unsuccessful in their continued research and development efforts or we are unsuccessful in our internal technology development efforts, we might not be able to modify or adapt our own solutions to effectively compete in our industry.

     We have limited intellectual property protection and may be unable to adequately protect or enforce our intellectual property rights. This could substantially impair our ability to compete and achieve our business goals.

Our success and business plan are predicated on our proprietary systems and technology. Accordingly, protecting our intellectual property rights related to our systems and technology is critical to our continued success and our ability to maintain our competitive position. We protect our proprietary systems through a combination of trademark, trade secret and copyright law, confidentiality agreements and technical measures. We currently have one pending patent application and we also filed an application under the Patent Cooperation Treaty, which preserves our rights to seek a corresponding patent in certain foreign countries should we determine that foreign patent protection is desirable. However, we can give no assurance that such patents will ever be issued or, if such patents are issued, that their claims will have sufficient scope to ensure protection of any of our solutions or services or to offer a competitive advantage. We cannot be sure that the steps we have taken will prevent misappropriation of our technology or infringement of our intellectual property rights. We cannot ensure that others will not independently develop similar or alternative technologies or duplicate any of our or our licensors’ technologies, or that we will develop additional proprietary technologies that are patentable or protectable intellectual property. In addition, the process of completing patents could divert our resources away from designing new solutions or otherwise developing our solutions.

 

18


Back to Contents

To protect our intellectual property rights, we may in the future need to assert claims of infringement or misappropriation of such rights against third-parties. The outcome of litigation to enforce our intellectual property rights is highly unpredictable, could result in substantial costs and diversion of resources and could have a material adverse effect on our financial condition and results of operations regardless of the final outcome of such litigation. Such infringement or misappropriation of our intellectual property would have an adverse effect on our competitive position. We may also have to engage in litigation in the future to enforce or protect our intellectual property rights or to defend against claims of invalidity, and we may likely incur substantial out of pocket costs and the diversion of management’s time and attention in so doing.

Despite our efforts to protect our unpatented and unregistered intellectual property rights, we may not be successful or the safeguards may not be adequate to detect or deter misappropriation of our technology or to prevent an unauthorized third-party from copying or otherwise obtaining and using our products, technology or other information that we regard as proprietary. Policing unauthorized use of our solutions, services and proprietary technology is very difficult, and nearly impossible on a worldwide basis. If we are not able to protect our intellectual property rights or if our intellectual property is otherwise impaired, it could result in significant harm to our future growth plans and the success of our business could be materially and adversely affected.

     Factors beyond our control could cause interruptions in our operations, which would adversely affect our reputation in the marketplace and our business, financial condition and results of operations.

To succeed, we must be able to operate our systems without interruption. Certain of our communications and information services are provided through our third-party service providers, which we do not control. Our operations are vulnerable to interruption by damage from a variety of sources, many of which are not within our control, including without limitation:

 
power loss and telecommunications failures;
     
 
software and hardware errors, failures or crashes;
     
 
loss or interruption of Internet access;
     
 
computer viruses and similar disruptive problems; and
     
 
fire, flood and other natural disasters.

Any significant interruptions in our services or operations would damage our reputation in the marketplace, may result in liability to our customers and have a negative impact on our business, financial condition and results of operations.

     Performance problems with our solutions or services or our customers’ system failures, whether caused by hardware, software or other problems, could cause us to lose business or incur liabilities.

Our customer satisfaction and our business could be harmed if our customers experience transmission delays or failures or loss of data in their systems as a result of our solutions or services. These systems, and the software used in these systems, are complex, and despite testing and quality control, we cannot be certain that problems will not occur or that they will be detected and corrected promptly and permanently when they do occur.

We have developed contingency plans for handling customer system failures and other customer emergencies; however, we have limited backup facilities if these systems are not functioning. The occurrence of a major catastrophic event or other system failure at any of our facilities or at one of our third-party facilities could interrupt our services or result in the loss of stored data, which could have a material adverse impact on our business or cause us to incur material liabilities. If we are unable to deliver our solutions to our customers as a result of the failure of a customer’s system, our inability to deliver will negatively impact our financial condition. Although we maintain insurance for our business, we cannot assure that our insurance will be adequate to compensate us for all losses that may occur or that this coverage will continue to be available on acceptable terms or in sufficient amounts.

 

19


Back to Contents

     We may not generate sufficient future taxable income to allow us to realize our deferred tax assets.

We have a significant amount of tax loss carryforwards that will be available to reduce the taxes we would otherwise owe in the future. We have recognized the value of a portion of these future tax deductions in our consolidated balance sheet at December 31, 2005. The realization of our deferred tax assets is dependent upon our generation of future taxable income during the periods in which we are permitted, by law, to use those assets. We exercise judgment in evaluating our ability to realize the recorded value of these assets, and consider a variety of factors, including the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Our evaluation of the realizability of deferred tax assets must consider both positive and negative evidence, and the weight given to the potential effects of positive and negative evidence is based on the extent to which the evidence can be verified objectively. While we believe that sufficient positive evidence exists to support our determination that the realization of a portion of our deferred tax assets is more likely than not, we cannot assure you that we will have profitable operations in the future that will allow us to fully realize those assets.

     If we fail to develop or maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our common stock.

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement.

In connection with the audit of our financial statements as of and for the year ended December 31, 2005 and re-audit of the financial statements as of and for the years ended December 31, 2004 and 2003, our independent auditors reported to our audit committee on July 28, 2006 that we had material weaknesses in our internal controls (as defined under the standards established by the Public Company Accounting Oversight Board — U.S.) with respect to our accounting and reporting of certain complex transactions. In addition, on December 16, 2005, in connection with their audit of our financial statements as of and for the year ended December 31, 2004, our previous independent auditors reported to our audit committee and informed us that we had material weaknesses in our internal controls as defined under auditing standards generally accepted in the United States of America. A material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The following material weaknesses were reported by our independent auditors in connection with their audit of our financial statements as of and for the year ended December 31, 2005 and re-audit of the financial statements as of and for the years ended December 31, 2004 and 2003:

 
We did not have adequate controls to provide reasonable assurance that all elements of contractual arrangements with customers were being recorded in accordance with generally accepted accounting principles. Specifically, we did not have adequate controls to properly determine that persuasive evidence of contractual arrangements with customers existed before recording revenue. Errors in determining that contracts had been signed by customers resulted in the premature recognition of revenue that should have been deferred to later periods, in accordance with Statement of Position 97-2 (SOP 97-2), “Software Revenue Recognition,” and related interpretations. As a result of these identified deficiencies, material revenue-related audit adjustments were recorded to our financial statements to defer revenue from the periods in which they were originally recorded until such time as the appropriate revenue recognition criteria were met.
     
 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for our Series A convertible preferred stock and Series B and C redeemable convertible preferred stock to provide reasonable assurance that all transactions were being appropriately recorded and summarized in our financial statements. Specifically, we did not properly identify and record the beneficial conversion option relating to the accrued and unpaid dividends on our Series A convertible preferred stock. We did not identify and record the embedded derivative conversion option on our Series B and C redeemable convertible preferred stock and reflect the changes in the fair value of those conversion options in earnings. We did not accrete the carrying value of the Series C redeemable convertible preferred stock to liquidation value, which was three times the stated value. As a result of these identified deficiencies, we recorded material post-closing audit adjustments to our financial statements for the years ended December 31, 2005, 2004 and 2003.

20


Back to Contents

The following material weaknesses were reported by our previous independent auditors in connection with their audit of our financial statements as of and for the years ended December 31, 2004 and 2003:

 
Errors in revenue recognition were identified that resulted primarily from a lack of secondary review over the application of accounting principles to specific contract terms as well as the analysis and estimates supporting the amounts recorded. These errors resulted from the lack of a systematic process for accumulating information supporting VSOE and underlying recorded revenue as well as the lack of appropriate levels of review. As a result, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.
     
 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for our Series A convertible preferred stock and Series B and C redeemable convertible preferred stock to provide reasonable assurance that all transactions were being appropriately recorded and summarized in the financial statements. Specifically, we did not accrete the carrying value to redemption value at the earliest redemption date and did not properly record the accrued and unpaid dividends on Series A convertible preferred stock and Series B and C redeemable convertible preferred stock. As a result of these identified deficiencies, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.
     
 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for income taxes, specifically the appropriate valuation allowance for deferred tax assets. As a result of this material weakness, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.

These material weaknesses may have contributed to the errors corrected in the restatement of our financial statements as of and for the years ended December 31, 2005, 2004 and 2003. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Controls and Procedures; Material Weaknesses in Internal Controls and Changes in Accountants.”

We have begun our remediation efforts and we believe that our actions in this regard have strengthened our internal controls over financial reporting. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Controls and Procedures; Material Weaknesses in Internal Controls and Changes in Accountants.” Our efforts to date have included the following:

 
We have expanded our accounting staff to add additional skills and experience, specifically experience in revenue recognition for software sales and services, and will continue the expansion of our accounting staff, as well as the use of qualified outside professionals as necessary to enhance and maintain our internal accounting controls.
     
 
We instituted new internal accounting controls, including a detailed review of new contracts by qualified accounting personnel to appropriately recognize and record revenue from term license sales as well as the sales from professional services and subscription and maintenance.
     
 
We instituted new internal accounting controls over the pricing of our separate software and service offerings.
     
 
We instituted new accounting procedures to accrete the value of our preferred stock to its redemption value at the earliest redemption date, and to accrete the value of our preferred stock for accrued but unpaid dividends.

 

21


Back to Contents

 
We have engaged qualified outside professionals to assist our accounting staff in analyzing and recording current and deferred income tax provisions and benefits, assets, and liabilities, and will continue to do so as necessary to improve, enhance and maintain our system of internal accounting controls.

Although initiated, our plans to improve the effectiveness of our internal controls and processes are not complete. We anticipate that it will take some time to establish the disclosure controls and procedures desired by our management and our board of directors. While we expect to complete this remediation process as quickly as possible, we cannot at this time estimate how long it will take to complete the remedial steps identified above because doing so depends on several factors beyond our control, including the hiring of additional qualified personnel. While the costs to date of our remediation efforts have not been material, we may incur material costs in the future for remediation of material weaknesses in internal controls. We will continue to evaluate the effectiveness of the control environment and will continue to refine existing controls. We cannot assure you that the measures we have taken to date or any future measures will remediate the material weaknesses reported by our independent auditors. Additional deficiencies in our internal controls may be discovered in the future. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our prior period financial statements. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our common stock.

In addition, these material weaknesses and any other deficiencies in internal controls that we identify in the future will need to be addressed as part of the evaluation of our internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and may impair our ability to comply with Section 404. See the immediately following risk factor in this prospectus regarding our reporting obligations and internal controls over financial reporting. These material weaknesses indicate that improvements in our overall control environment are needed in order to meet our responsibilities for financial reporting as a public company.

     If we fail to comply with the reporting obligations of the Securities Exchange Act of 1934 and Section 404 of the Sarbanes-Oxley Act of 2002, or if we fail to achieve and maintain adequate internal controls over financial reporting, our business results of operations and financial condition, and investors’ confidence in us, could be materially adversely affected.

As a public company, we will be required to comply with the periodic reporting obligations of the Securities Exchange Act of 1934, including preparing annual reports, quarterly reports and current reports. Our failure to prepare and disclose this information in a timely manner could subject us to penalties under federal securities laws, expose us to lawsuits and restrict our ability to access financing. In addition, we will be required under applicable law and regulations to integrate our systems of internal controls over financial reporting. We plan to evaluate our existing internal controls with respect to the standards adopted by the Public Company Accounting Oversight Board. During the course of our evaluation, we may identify areas requiring improvement and may be required to design enhanced processes and controls to address issues identified through this review. This could result in significant delays and costs to us and require us to divert substantial resources, including management time from other activities.

We expect to dedicate significant management, financial and other resources in connection with our compliance with Section 404 of the Sarbanes-Oxley Act of 2002 in the second half of 2006 and in 2007. We expect these efforts to include a review of our existing internal control structure. As a result of this review, we may either hire or outsource additional personnel to expand and strengthen our finance function. We cannot be certain at this time that we will be able to comply with all of our reporting obligations and successfully complete the procedures, certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 by the time that we are required to file our annual report on Form 10-K for the year ended December 31, 2007. If we fail to achieve and maintain the adequacy of our internal controls and do not address the deficiencies identified by our auditors, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with the Sarbanes-Oxley Act of 2002. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 on a timely basis could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our common stock.

22


Back to Contents

Risks Related to our Offering
 
     We will incur significant increased costs as a result of operating as a public company, and our management and key employees will be required to devote substantial time to new compliance initiatives.

We have never operated as a public company. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules and regulations implemented by the Securities and Exchange Commission and the NASDAQ Global Market, impose various new requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will devote substantial amounts of time to these new compliance initiatives. These rules and regulations will significantly increase our legal and financial compliance costs and will make some activities more time-consuming and costly. We will also incur additional costs associated with our public company reporting requirements and the remediation of any material weaknesses we identify through these efforts. We expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. We currently are evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. If our profitability is adversely affected because of these additional costs, it could have a negative effect on the trading price of our common stock.

     We cannot assure you that a market will develop for our common stock or what the market price of our common stock will be.

Before this offering, there was no public trading market for our common stock, and we cannot assure you that one will develop or be sustained after this offering. If a market for our common stock does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at an attractive price, if at all. We cannot predict the prices at which our common stock will trade. The initial public offering price for our common stock will be determined through our negotiations with the underwriters and may not bear any relationship to the market price at which our common stock will trade after this offering or to any other established criteria of the value of our business. It is possible that, in future quarters, our operating results may be below the expectations of securities analysts and investors. As a result of these and other factors, the price of our common stock may materially decline.

     Anti-takeover provisions of Pennsylvania law and our articles of incorporation and bylaws could delay and discourage takeover attempts that shareholders may consider to be favorable.

Certain provisions of our amended and restated articles of incorporation and second amended and restated bylaws that will be in effect upon completion of this offering and applicable provisions of the Pennsylvania Business Corporation Law may make it more difficult for a third-party to acquire, or prevent a third-party from acquiring, control of us or effecting a change in our board of directors and management. These provisions include:

 
the classification of our board of directors into three classes, with one class elected each year;
     
 
a prohibition on cumulative voting in the election of directors;
     
 
the ability of our board of directors to issue preferred stock without shareholder approval;
     
 
the ability of our shareholders to take action only at a meeting of our shareholders and not by written consent;
     
 
the prohibition on shareholders calling a special meeting of our shareholders;

 

23


Back to Contents

 
the requirement that shareholders comply with advance notice procedures in order to nominate candidates for election to our board of directors or to provide shareholder proposals for consideration at any meeting of our shareholders; and
     
 
the prohibition of our entering into certain business combinations with holders of 20% or more of our voting securities without prior approval of our board of directors, unless a majority of our disinterested shareholders approves the transaction.

The Pennsylvania Business Corporation Law further provides that because our amended and restated articles of incorporation and second amended and restated bylaws provide for a classified board of directors, shareholders may remove directors only for cause. These and other provisions of the Pennsylvania Business Corporation Law and our amended and restated articles of incorporation and second amended and restated bylaws could delay, defer or prevent us from experiencing a change of control or changes in our board of directors and management and may adversely affect our shareholders’ voting and other rights. Any delay or prevention of a change of control transaction or changes in our board of directors and management could deter potential acquirers or prevent the completion of a transaction in which our shareholders could receive a substantial premium over the then current market price for their shares of our common stock.

     The price of our common stock may be highly volatile.

In the past several years, technology stocks have experienced high levels of volatility and significant declines in value from their historic highs. The trading price of our common stock following this offering may fluctuate substantially. The price of our common stock that will prevail in the market after this offering may be higher or lower than the price you pay to purchase shares of our common stock. The prevailing price depends on many factors, some of which are beyond our control and may not be related to our operating performance. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that could cause fluctuations in the trading price of our common stock include the following:

 
price and volume fluctuations in the overall stock market from time to time;
     
 
significant volatility in the market price and trading volume of software companies in general, and healthcare information software companies in particular;
     
 
actual or anticipated changes in our earnings or fluctuations in our operating results;
     
 
actual or anticipated changes in the expectations of securities analysts;
     
 
general economic conditions and trends affecting the United States and/or the world economy generally;
     
 
the success of our competitors and fluctuations in their stock prices;
     
 
major catastrophic events;
     
 
sales of large blocks of our stock; and
     
 
departures of key personnel.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business, which could cause the trading price of our common stock to decline.

     Sales of outstanding shares of our common stock into the market in the future could cause the market price of our common stock to drop significantly, even if our business is doing well.

If our existing shareholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the 180-day contractual lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline below the initial public offering price. After this offering, approximately 14,930,792 shares of our common stock will be outstanding, assuming no exercise of the underwriters’ overallotment option. Of these shares, 5,558,455 shares of our common stock (including the 5,500,000 shares of our common stock sold in this offering) will be freely tradable, without restriction, in the public market. Cowen and Company, LLC may, in its sole discretion, permit our directors, officers, employees and current shareholders who are subject to the 180-day contractual lock-up to sell shares prior to the expiration of the lock-up agreements. The lock-up is subject to extension under certain circumstances. See “Shares Eligible for Future Sales—Lock-Up Agreements” elsewhere in this prospectus.

24


Back to Contents

After the lock-up agreements pertaining to this offering expire 180 days from the date of this prospectus, up to an additional 9,372,337 shares will be eligible for sale in the public market, 7,024,246 of which are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act of 1933 as amended, or the Securities Act, and various vesting agreements. In addition, the shares subject to outstanding warrants and the shares underlying options that are either subject to the terms of our Amended and Restated Stock Option Plan or our Series C Stock Equity Incentive Plan or reserved for future issuance under our 2006 Equity Incentive Plan will become eligible for sale in the public market to the extent permitted by the provisions of various option agreements and warrants, the lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. For additional information, see “Shares Eligible for Future Sale.”

 
     If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution.

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution of $10.94 per share, because the price that you pay will be substantially greater than the net tangible book value per share of our common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon the exercise of options to purchase common stock under our equity incentive plans, if we issue restricted stock or other equity-based incentives to our employees under these plans or if we otherwise issue additional shares of our common stock.

     If research analysts fail to research or publish reports about our business or if they issue unfavorable commentary or fail to recommend the purchase of our common stock, the price of our common stock could decline.

The trading market for our common stock will depend in part on the research performed by, and the reports published by, research analysts concerning our business. These research analysts are independent and are outside of our and our underwriters’ control. The trading price of our common stock could decline if research analysts fail to research and publish, cease publishing or publish negative reports on our business or otherwise fail to recommend the purchase of our common stock.

     We do not intend to pay dividends to our common shareholders for the foreseeable future.

We have never declared or paid any dividends on our common stock and do not intend to do so for the foreseeable future. We intend to retain all of our earnings for the foreseeable future to finance the operation and expansion of our business. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases. See “Dividend Policy” elsewhere in this prospectus.

     We have broad discretion in the use of the net proceeds of this offering.

We intend to use approximately $9.5 million of the net proceeds from this offering to pay accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering. We intend to use the remaining net proceeds from this offering, as determined by our management in its sole discretion, for general corporate purposes, including working capital needs and potential strategic acquisitions and investments. We have not determined the specific allocation of the net proceeds of this offering among these additional uses. Our management will have broad discretion over the use and investment of the net proceeds of this offering, and accordingly, investors in this offering will need to rely upon the judgment of our management with respect to the use of proceeds, with only limited information concerning management’s specific intentions.

25


Back to Contents

     Insiders will continue to have substantial control over us after this offering, which could limit your ability to influence the outcome of key transactions, including a change of control.

Our directors, executive officers and each of our shareholders who own greater than 5% of our outstanding common stock and their affiliates, in the aggregate, will beneficially own approximately 53.3% of the outstanding shares of our common stock after this offering. As a result, these shareholders, if acting together, would be able to influence or control matters requiring approval by our shareholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of us, could deprive our shareholders of an opportunity to receive a premium for their common stock as part of a sale of us and might ultimately affect the market price of our common stock.

     We may issue additional securities in the future, including shares, debt or equity-linked debt, which may depress our stock price.

Our issuance of additional securities could:

 
cause substantial dilution of the percentage ownership of our shareholders at the time of the issuance;
     
 
cause substantial dilution of our earnings per share;
     
 
subject us to the risks associated with increased leverage, including a reduction in our ability to obtain financing or an increase in the cost of any financing we obtain;
     
 
subject us to restrictive covenants that could limit our flexibility in conducting future business activities; and
     
 
adversely affect the prevailing market price for our outstanding securities.

We do not intend to seek security holder approval for any such acquisition or security issuance unless required by applicable law or regulation or the terms of existing securities. If these securities are issued, such issuances may cause the trading price of our stock to decline.

     We may not be able to raise additional funds on terms that are acceptable to us when such funds are needed for our business or to exploit opportunities.

Our future liquidity and capital requirements will depend upon numerous factors, including the success of our businesses, our existing and new solutions and service offerings, competing technologies and market developments, potential future acquisitions and additional repurchases of our common stock. We may need to raise additional funds to support expansion, develop new or enhanced solutions and services, respond to competitive pressures, acquire complementary businesses or technologies or take advantage of unanticipated opportunities. If required, we may raise such additional funds through public or private debt or equity financing, strategic relationships or other arrangements. There can be no assurance that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our shareholders.

26


Back to Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. These forward-looking statements, which are usually accompanied by words such as “may,” “might,” “will,” “should,” “could,” “would,” “intends,” “estimates,” “predicts,” “potential,” “continue,” “believes,” “anticipates,” “plans,” “expects” and similar expressions, relate to, without limitation, statements about our market opportunities, our strategy, our competition, our projected revenue and expense levels and the adequacy of our available cash resources. This prospectus also contains forward-looking statements attributed to third-parties relating to their estimates regarding our industry. You should not place undue reliance on any of the forward-looking statements contained in this prospectus.

The cautionary statements contained in “Risk Factors” and other similar statements contained elsewhere in this prospectus identify important factors with respect to such forward-looking statements, including certain risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those expressed or forecasted in, or implied by, such forward-looking statements.

Although we believe that the expectations reflected in these forward-looking statements are based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We disclaim any obligation or undertaking to disseminate any updates or revision to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

27


Back to Contents

USE OF PROCEEDS

We estimate that we will receive net proceeds from the sale of the shares of our common stock in this offering of approximately $34.6 million, assuming an initial public offering price of $12.50 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses. A $1.00 increase (decrease) in the assumed public offering price of $12.50 per share would increase (decrease) the net proceeds to us from this offering by $3.1 million (assuming the number of shares set forth on the cover page of this preliminary prospectus remains the same). We will not receive any of the proceeds from the sale of shares of common stock sold by the selling shareholders, including any shares of our common stock sold by the selling shareholders if the underwriters exercise their overallotment option.

We will use approximately $9.5 million of the net proceeds of this offering to pay the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering.

We intend to use the remaining net proceeds of this offering for general corporate purposes, including working capital needs. While we have not allocated the remaining net proceeds of this offering to specified general corporate purposes, we may utilize such proceeds by allocating them amongst the following categories: technology infrastructure to help increase transaction volume and further enhance our software products and develop new software solutions; the addition of sales and marketing personnel to encourage adoption of Patient Clinical Summaries, increase awareness of our solutions and expand our customers within the payer markets; and development of marketing, sales and other promotional programs to cross-sell products to our existing and future customers. We believe opportunities may exist to expand our current business through strategic acquisitions and investments in technology, and we may use a portion of the proceeds for these purposes. We are not currently a party to any contracts or letters of intent, nor do we have any arrangements or understandings, with respect to any strategic acquisitions or investments. The amount of net proceeds to be utilized for strategic acquisitions has not been determined.

Pending the uses described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities. We cannot predict whether the proceeds invested will yield a favorable return.

DIVIDEND POLICY

We have never declared or paid any dividends on our common stock. We currently intend to retain any future earnings to finance our operations and the further expansion and development of our business, and therefore, do not intend to declare or pay cash dividends on our capital stock in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon a number of factors, including our results of operations, financial condition, future prospects, contractual restrictions, restrictions in any future loan covenants, restrictions imposed by applicable law and other factors our board of directors deems relevant.

28


Back to Contents

CONVERSION AND EXERCISE TRANSACTIONS

Current Capitalization

As of November 22, 2006, we had outstanding:

     
 
2,333,333 shares of Series A preferred stock;
     
 
2,755,261 shares of Series B preferred stock;
     
 
3,323,350 shares of Series C preferred stock; and
     
 
5,656,804 shares of common stock (not including any conversion of preferred stock assumed elsewhere in this prospectus).

As of November 22, 2006, we had warrants outstanding for the purchase of an aggregate of 649,358 shares of our common stock. As of November 22, 2006, we also had outstanding options to purchase 2,973,455 shares of our common stock. These options include options to purchase shares of our Series C preferred stock issued pursuant to our Series C Stock Equity Incentive Plan, which awards will become options to purchase 55,000 shares of our common stock upon the consummation of this offering.

Our articles of incorporation provide that upon the consummation of the first public offering of our common stock resulting in proceeds to us of at least $30 million and the satisfaction of other conditions:

 
all of the outstanding shares of our Series A preferred stock will automatically convert into shares of our common stock at a rate of 1.010 shares of our common stock for each share of our Series A preferred stock, subject to adjustment for certain future events;
     
 
all of the outstanding shares of our Series B preferred stock will automatically convert into shares of our common stock at a rate of 0.631 shares of our common stock for each share of our Series B preferred stock, subject to adjustment for certain future events; and
     
 
all of the outstanding shares of our Series C preferred stock will automatically convert into shares of our common stock at a rate of 0.500 shares of our common stock for each share of our Series C preferred stock, subject to adjustment for certain future events.

Outstanding shares of our Series A, Series B and Series C preferred stock are entitled to receive dividends in an amount equal to 9%, 9% and 10%, respectively, on the stated values of those shares, which are set forth in the rights and preferences of the preferred stock. On November 22, 2006, the aggregate dividends payable to the holders of all of the outstanding shares of our Series A, Series B and Series C preferred stock was approximately $3.1 million, $7.6 million and $1.9 million, respectively. We plan to use part of the net proceeds of this offering to pay the Series B and Series C preferred stock dividends. No cash dividends will be paid on our Series A preferred stock in connection with this offering. Instead, the holders of our Series A preferred stock have elected that we include the value of the accrued and unpaid dividends on the Series A preferred stock when calculating the number of shares of our common stock to be issued to them when the Series A preferred stock converts to common stock upon the consummation of this offering.

Upon the consummation of this offering, there will be no outstanding shares of our preferred stock. As discussed above, based on the number of such shares currently outstanding, these shares of our Series A, Series B and Series C preferred stock (including estimated accrued and unpaid dividends on the Series A preferred stock outstanding upon the consummation of this offering) would convert into 2,357,186 shares, 1,737,638 shares and 1,661,664 shares of common stock, respectively, upon the consummation of this offering.

Reverse Stock Split

We anticipate effecting a 1-for-2 reverse stock split of our shares of common stock prior to the consummation of this offering. All information in this section “Conversion and Exercise Transactions” assumes the completion of this reverse stock split.

 

29


Back to Contents

Conversion Agreements

We entered into conversion agreements with the holders of our outstanding Series B and Series C preferred stock. Eight of these holders, Britannia Holdings Limited, Carl E. Smith, David St. Clair, Grotech Partners V, L.P. (affiliated with Grotech Capital Group V, LLC), Grotech V Maryland Fund, L.P. (affiliated with Grotech Capital Group V, LLC), Liberty Ventures I, L.P. (affiliated with Liberty Ventures), Liberty Ventures II, L.P. (affiliated with Liberty Ventures) and Stockwell Fund, L.P., are our affiliates by virtue of their positions as employees of ours, membership on our board of directors and/or the beneficial ownership of our common stock and their affiliation with a member of our board of directors. See “Management,” “Certain Relationships and Related Party Transactions” and “Principal and Selling Shareholders” elsewhere in this prospectus.

Under the terms of each conversion agreement, each holder was entitled to elect prior to July 12, 2006 to convert up to 31.5% of such holder’s outstanding shares of Series B preferred stock and of Series C preferred stock into shares of our common stock. As part of this conversion, the accrued but unpaid dividends on the converted shares were taken into account in calculating the number of shares of common stock issuable upon conversion of the shares of Series B and Series C preferred stock. The provisions of the conversion agreements became effective upon the filing of the Registration Statement on Form S-1 on August 11, 2006 of which this prospectus is a part. Therefore, the preferred stock and common stock presented above as outstanding as of November 22, 2006 take into account the conversion. Under such arrangements, an aggregate of 1,266,991 shares and 1,528,199 shares of Series B and Series C preferred stock, respectively, were converted for 1,240,448 shares and 1,122,134 shares of our common stock, which included 441,393 shares and 358,033 shares of our common stock, respectively, on account of accrued dividends.

 
Termination of Shareholders Agreement

Pursuant to the terms of the Third Amended and Restated Shareholders Agreement dated January 11, 2002 among us and the shareholders party thereto, all of the rights of the shareholders under the agreement will be terminated upon the consummation of this offering, which is considered a qualified initial public offering. For purposes of the agreement, a qualified initial public offering is a first public offering of our common stock in which the proceeds to us are at least $30 million and as to which our capital stock outstanding immediately prior to the closing of this offering on a fully diluted basis will have an aggregate public market value of not less than $150 million.

 
Conversion of Options Issued Pursuant to the Series C Stock Equity Incentive Plan

Upon the consummation of this offering, we will substitute shares of common stock for shares of Series C preferred stock subject to previously granted options to purchase shares of Series C preferred stock on a one-for-two basis. No options will be available for grant pursuant to the Series C Stock Equity Incentive Plan thereafter.

Warrants

On August 1, 2006, we amended the outstanding warrants to purchase 172,302 shares of our common stock that we had previously issued to Commerce Bank to provide for the right to exercise such warrant on a “cashless” basis. In connection with such amendment, Commerce Bank agreed to terminate its rights to register the shares of common stock issued upon the exercise of such warrants.

Outstanding warrants to purchase an aggregate of 217,500 shares of our common stock will terminate upon the consummation of this offering. Shares of common stock that may be purchased upon exercise of these warrants are included in the presentation of outstanding shares of common stock in this prospectus. In addition, we have assumed the exercise of these warrants for the purpose of presenting our pro forma and our pro forma as adjusted balance sheet in the “Summary Consolidated Financial Information” and “Capitalization” sections of this prospectus.

30


Back to Contents

CAPITALIZATION

The following table describes our capitalization as of September 30, 2006. Our capitalization is presented:

 
On an actual basis;
     
 
On a pro forma basis to give effect to:
     
 
a 1-for-2 reverse stock split of our shares of common stock to be effective prior to the consummation of this offering;
     
 
the restoration of our Treasury shares to our authorized but unissued common stock; and
     
 
the issuance of 217,500 shares of our common stock at a weighted average exercise price of $2.62 per share upon the exercise of outstanding warrants that would otherwise terminate upon the consummation of this offering;
     
 
the conversion of all outstanding shares of our Series A preferred stock, including the accrued and unpaid dividends thereon, into 2,357,186 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
     
 
the conversion of all of the then outstanding shares of our Series B preferred stock and Series C preferred stock into 3,399,302 shares of our common stock, which will automatically occur immediately prior to the consummation of this offering;
     
 
the incurrence of an approximately $0.2 million charge due to the accretion on the Series A preferred stock, Series B preferred stock and Series C preferred stock after September 30, 2006; and
 
the incurrence of an approximately $9.5 million liability relating to the payment of the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering.
     
 
On a pro forma as adjusted basis to give effect to the sale by us of 3,300,000 shares of our common stock in this offering at an assumed initial public offering price of $12.50 per share, the midpoint of the range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and our estimated offering expenses.

31


Back to Contents

The pro forma and pro forma as adjusted information below is illustrative only and our capitalization table following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with the sections of this prospectus entitled “Use of Proceeds,” “Conversion and Exercise Transactions” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included elsewhere in this prospectus.

 

    September 30, 2006

 
    Actual   Pro Forma   Pro Forma
As Adjusted
 
   

 

 

 
    (unaudited)

 
    (in thousands, except for share data)  
Consolidated Balance Sheet Data:
                   
Cash and cash equivalents(1)
  $ 387   $ 957   $ 29,869  
   
 
 
 
Long-term debt, net of current portion
    2,936     2,936     2,936  
Series B convertible preferred stock, no par value; 7,500,000 shares authorized, 2,755,261 shares issued and outstanding, actual; 7,500,000 shares authorized, no shares issued and outstanding, pro forma; 7,500,000 shares authorized, no shares issued and outstanding, pro forma as adjusted
    20,452          
Series C convertible preferred stock, no par value; 7,500,000 shares authorized, 3,323,350 shares issued and outstanding, actual; 7,500,000 shares authorized, no shares issued and outstanding, pro forma; 7,500,000 shares authorized, no shares issued and outstanding, pro forma as adjusted
    12,975          
                     
Shareholders’ equity (deficiency):
                   
Series A convertible preferred stock, no par value; 2,333,333 shares authorized, 2,333,333 shares issued and outstanding, actual; 2,333,333 shares authorized, no shares issued and outstanding, pro forma; 2,333,333 shares authorized, no shares issued and outstanding, pro forma as adjusted
    6,535          
Common stock – no par value, 50,000,000 shares authorized -
11,291,108 shares issued and outstanding, actual; no par value, 50,000,000 shares authorized, 11,619,542 shares issued and outstanding, pro forma; 100,000,000 shares authorized, 14,919,542 shares issued and outstanding, pro forma as adjusted
    30,668     65,512     100,075  
Additional paid in capital Beneficial conversion feature
    3,375          
Accumulated deficit
    (66,184 )   (64,137 )   (64,137 )
   
 
 
 
Total shareholders’ (deficiency) equity(1)
    (25,606 )   1,375     35,938  
   
 
 
 
Total capitalization
  $ 10,757   $ 4,311   $ 38,874  
   
 
 
 
               

 
(1)
A $1.00 increase (decrease) in the assumed initial public offering price of $12.50 per share would increase (decrease) each of cash and cash equivalents, total shareholders’ (deficiency) equity and total capitalization by $3.1 million assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

32


Back to Contents

DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering.

Our pro forma net tangible book value as of September 30, 2006 was approximately $(13.8) million, or approximately $(1.19) per share. Pro forma net tangible book value per share is determined by dividing the amount of our tangible net worth, or total tangible assets less total liabilities, by the pro forma number of shares of our common stock outstanding after giving effect to the transactions described in “Conversion and Exercise Transactions” in this prospectus. Dilution to new investors represents the difference between the amount per share paid by investors in this offering and the pro forma net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to our sale of the shares offered hereby at an assumed initial public offering price of $12.50 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses and the application of the estimated net proceeds therefrom, our pro forma net tangible book value as of September 30, 2006 would have been $23.3 million, or $1.56 per share. This represents an immediate increase in pro forma net tangible book value of $2.75 per share to existing shareholders and an immediate dilution in pro forma net tangible book value of $10.94 per share to new investors. The following table illustrates this per share dilution:


Assumed initial public offering price per share
        $ 12.50  
Pro forma net tangible book value per share as of September 30, 2006
  $ (1.19 )      
Increase per share attributable to new investors
    2.75        
   
       
Pro forma net tangible book value per share after this offering
          1.56  
         
 
Dilution per share to new investors
         $ 10.94  
         
 

The following table sets forth, on a pro forma basis as of September 30, 2006, after giving effect to the transactions described in “Conversion and Exercise Transactions” elsewhere in this prospectus, the total number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid to us by existing shareholders and by new investors who purchase shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and estimated offering expenses, assuming an initial public offering price of $12.50 per share:


    Shares Purchased

  Total Consideration

  Average Price  
    Number   Percent   Amount   Percent   Per Share  
   

 

 

 

 

 
Existing shareholders
    11,619,542     77.9 % $ 48,448,008     54.0 % $ 4.17  
New investors
    3,300,000     22.1     41,250,000     46.0     12.50  
   
 
 
 
     
Total
    14,919,542     100.0 % $ 89,698,008     100.0 %      
   
 
 
 
   

The foregoing tables and calculations assume no exercise of any options or warrants outstanding as of November 22, 2006. Specifically, these tables and calculations exclude:

     
 
2,918,455 shares of our common stock issuable upon exercise of outstanding options to purchase shares of our common stock subject to the terms of our Amended and Restated Stock Option Plan as of November 22, 2006 at a weighted average exercise price of $4.29 per share;
     
 
55,000 shares of our common stock issuable upon exercise of outstanding options to purchase shares of our common stock subject to the terms of our Series C Stock Equity Incentive Plan as of November 22, 2006 at a weighted average exercise price of $2.26 per share (such awards were originally exercisable for Series C preferred stock but will become options to purchase common stock options on a one-for-two basis upon the consummation of this offering);
     
 
1,500,000 shares of our common stock reserved for future grants under our 2006 Equity Incentive Plan, which will become effective immediately prior to when we become subject to the reporting requirements of the Securities Exchange Act of 1934; and

 

33


Back to Contents

 
431,858 shares of our common stock issuable upon exercise of warrants to purchase shares of our common stock outstanding as of November 22, 2006 at a weighted average exercise price of $2.83 per share.

Because the exercise price of the outstanding options and some of the warrants is significantly below the assumed offering price, investors purchasing common stock in this offering will suffer additional dilution when and if these options or warrants are exercised. See “Management—Employee Benefit Plans” for further information regarding our equity incentive and stock option plans and “Description of Capital Stock—Warrants to Purchase Common Stock” for further information on warrants.

A $1.00 increase (decrease) in the assumed initial public offering price of $12.50 per share would increase (decrease) our pro forma as adjusted net tangible book value by $3.1 million and the pro forma as adjusted net tangible book value per share after completion of this offering by $0.21 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

34


Back to Contents

SELECTED CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA

The selected consolidated financial data set forth below are derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus. The consolidated statement of operations data for each of the years ended December 31, 2005, 2004 and 2003 and the consolidated balance sheet data as of December 31, 2005, 2004 and 2003 are derived from, and qualified by reference to, our audited consolidated financial statements and related notes appearing elsewhere in this prospectus. The consolidated statement of operations data for each of the years ended December 31, 2002 and 2001 and the consolidated balance sheet data as of December 31, 2002 and 2001 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for each of the nine month periods ended September 30, 2006 and 2005 and the consolidated balance sheet data as of September 30, 2006 and 2005 are derived from our unaudited consolidated financial statements which, in the opinion of management, contain all adjustments necessary to fairly present the information set forth below. Our historical results are not necessarily indicative of results for any future period.

The pro forma portion of the following selected consolidated financial data reflects the earnings per share impact of our 1-for-2 reverse stock split of our common stock to be effective prior to the consummation of this offering.

    Nine Months Ended
September 30,

  Year Ended December 31,

 
    2006   2005   2005   2004   2003   2002   2001  
   

 

 

 

 

 

 

 
    (unaudited)                                
    (in thousands, except share and per share data)  
Consolidated Statement of Operations Data:
                                           
Revenue
                                           
Term license revenue
  $ 7,403   $ 6,867   $ 9,729   $ 6,260   $ 2,439   $ 2,119   $ 1,655  
Subscription, maintenance and transaction fees
    16,311     10,961     17,187     14,666     12,600     9,456     6,776  
Professional services
    9,825     6,445     11,680     7,102     5,488     4,844     3,973  
   

 

 

 

 

 

 

 
Total revenue
    33,539     24,273     38,596     28,028     20,527     16,419     12,404  
Cost of revenue:
                                           
Term licenses
    1,204     775     1,653     1,455     872     764     1,140  
Subscription, maintenance and transaction fees
    5,560     6,046     8,163     6,774     4,837     4,047     5,325  
Professional services
    4,435     3,911     5,499     4,843     3,622     3,348     2,690  
   

 

 

 

 

 

 

 
Total cost of revenue
    11,199     10,732     15,315     13,072     9,331     8,159     9,155  
   

 

 

 

 

 

 

 
Gross margin
    22,340     13,541     23,281     14,956     11,196     8,260     3,249  
Operating expenses
                                           
Sales and marketing
    7,692     5,334     7,778     4,668     3,211     2,159     2,216  
Research and development
    5,828     1,951     2,627     3,243     3,903     4,787     7,911  
General and administrative
    8,904     5,727     9,707     6,320     4,343     4,626     5,088  
   

 

 

 

 

 

 

 
Total operating expenses
    22,424     13,012     20,112     14,231     11,457     11,572     15,215  
   

 

 

 

 

 

 

 
(Loss) income from operations
    (84 )   529     3,169     725     (261 )   (3,312 )   (11,966 )
(Gain) loss on change in fair value of redeemable convertible preferred stock conversion options
    2,413     993     694     576     (38 )   (127 )   (50 )
Interest expense (income)
    287     174     274     175     249     209     (60 )
   

 

 

 

 

 

 

 
(Loss) income before benefit for income taxes
    (2,784 )   (638 )   2,201     (26 )   (472 )   (3,394 )   (11,856 )
Benefit (provision) for income taxes
    148     (139 )   6,491                  
   

 

 

 

 

 

 

 
Net (loss) income
  $ (2,636 ) $ (777 ) $ 8,692   $ (26 ) $ (472 ) $ (3,394 ) $ (11,856 )
Accretion of convertible preferred shares and redeemable convertible preferred shares
    (3,799 )   (3,310 )   (3,994 )   (6,113 )   (7,958 )   (5,799 )   (3,794 )
   

 

 

 

 

 

 

 
(Loss) income available to common shareholders
  $ (6,435 ) $ (4,087 ) $ 4,698   $ (6,139 ) $ (8,430 ) $ (9,193 ) $ (15,650 )
   

 

 

 

 

 

 

 
(Loss) income per share available to common shareholders, basic
  $ (0.87 ) $ (0.63 ) $ 0.73   $ (0.96 ) $ (1.36 ) $ (1.49 ) $ (3.66 )
(Loss) income per share available to common shareholders, diluted
  $ (0.87 ) $ (0.63 ) $ 0.33   $ (0.96 ) $ (1.36 ) $ (1.49 ) $ (3.66 )
Weighted average shares used to compute (loss) income available to common shareholders per common share, basic
    7,374,336     6,444,413     6,458,129     6,378,732     6,215,840     6,180,387     4,275,635  
Weighted average shares used to compute (loss) income available to common shareholders per common share, diluted
    7,374,336     6,444,413     28,287,173     6,378,732     6,215,840     6,180,387     4,275,635  
Pro forma stock split (unaudited)
                                           
Pro forma (loss) income per share available to common shareholders – basic
  $ (1.75 ) $ (1.27 ) $ 1.45   $ (1.92 ) $ (2.71 ) $ (2.97 ) $ (7.32 )
Pro forma (loss) income per share available to common shareholders – diluted
  $ (1.75 ) $ (1.27 ) $ 0.66   $ (1.92 ) $ (2.71 ) $ (2.97 ) $ (7.32 )
Weighted average shares used to compute
pro forma (loss) income available to common shareholders – basic
    3,687,168     3,222,207     3,229,065     3,189,366     3,107,920     3,090,193     2,137,817  
Weighted average shares used to compute
pro forma (loss) income available to common shareholders – diluted
    3,687,168     3,222,207     14,143,586     3,189,366     3,107,920     3,090,193     2,137,817  

35


Back to Contents

    September 30,

  December 31,

 
    2006   2005   2005   2004   2003   2002   2001  
   

 

 

 

 

 

 

 
    (unaudited)                                
    (in thousands, except share and per share data)  
Consolidated Balance Sheet Data:
                                           
Cash and cash equivalents
    $        387     $          62     $    2,447     $        431     $        764   $   $ 186  
Total current assets
    19,316     12,318     16,366     5,836     4,028     3,147     2,430  
Total assets
    38,214     20,543     32,283     12,219     7,150     7,402     7,080  
Short-term debt
    5,684     3,023     1,262     552     699     2,143     2,006  
Deferred revenue, current
    7,275     9,097     8,951     5,639     3,861     1,823     271  
Deferred revenue, net of current
    686     385     666     246              
Total current liabilities
    22,667     18,072     17,137     10,016     7,077     6,979     4,118  
Long-term debt
    2,936     1,686     2,515     1,180     174     309     466  
Preferred stock
    33,427     46,549     47,115     50,837     44,724     36,414     29,548  
Total shareholders’ deficiency
    (25,606 )   (47,425 )   (38,402 )   (51,082 )   (44,980 )   (36,561 )   (27,373 )

36


<

Back to Contents

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

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the “Selected Consolidated Financial Information” and our consolidated financial statements and the related notes included elsewhere in this prospectus. In addition to historical information, the following discussion and analysis includes forward-looking information that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this prospectus. See “Cautionary Note Regarding Forward-Looking Statements” included elsewhere in this prospectus.

Overview

We are a provider of software, services and clinical content to healthcare payers that allow them to improve the quality and affordability of healthcare provided to their members and increase their administrative efficiency. Our Collaborative Care Management solution analyzes data, automates payer workflow processes and electronically connects payers, healthcare providers and patients, providing them with a common view of the patient’s health that helps to foster better clinical decision making. Our solution is built around a suite of modular and easily configurable software applications and utilizes the Internet to link our payer customers to their members and their members’ chosen healthcare providers.

Our Collaborative Care Management solution is comprised of two related suites of products – Integrated Medical Management and Collaborative Data Exchange. Our Integrated Medical Management suite allows our healthcare payer customers to identify active care management opportunities among their members and automate an intervention process based on clinical best practices. Our Integrated Medical Management suite also helps our customers reduce internal administrative costs by automating traditionally manual processes. Our Collaborative Data Exchange suite allows our customers to securely transmit health records containing critical patient information in an easily understood format to patients and providers at the time they are making treatment decisions. We refer to these health records as Patient Clinical Summaries and believe that they are a critical first step to developing electronic health records. In the future, we expect our Patient Clinical Summaries to integrate additional information provided by patients and a broad range of providers, thereby increasing their value to all constituents.

Since 1999, we have focused on broadening our solution portfolio in order to respond to the evolving needs of our customers. In 1999, we began offering our Analytics and Disease Management module; in 2001, we began offering our Transactions and Information Exchange module; in 2003, we began offering OptiCareCert; in 2004, we began offering OptiCarePath; and in 2005, we began offering our customers the ability to electronically transmit Patient Clinical Summaries via our Transactions and Information Exchange infrastructure.

We operate in a relatively small market, where we have 56 of approximately 350 potential customers. This presents our management with the challenge of expanding our revenue within a limited potential customer base and the attendant risk of our inability to grow revenue if we are unable to do so. In addition, in the past, our non-recurring revenue, which primarily consists of term license fees for our software products and professional service fees associated with implementation of these software products, has constituted a significant portion of our revenue. This non-recurring revenue is generally paid in lump sums, thereby decreasing the predictability of our revenue. As a result of these risks and challenges, we have focused, and anticipate that we will continue to focus, on the growth of our business, expanding existing customer relationships, developing innovative new solutions, expanding our customer base within our market and continuing to build recurring and predictable revenue through new products like our Patient Clinical Summary. While we anticipate funding our growth primarily from operating cash flow, we may utilize a portion of the net proceeds for one or more of the components of our growth strategy. See “Use of Proceeds.”

37


Back to Contents

For the three years ending December 31, 2005, we experienced our fastest growth in term licenses and professional services revenue, thereby increasing those items as a percentage of our revenue. Consequently we realized a decreasing percentage of subscription, maintenance and transaction fee revenue even though that revenue grew as well. However, in the future, we anticipate the market will have an increased focus on Electronic Health Records and what we refer to as our Patient Clinical Summary. For these solutions, our customers pay an annual subscription fee and pay a transaction fee each time they utilize the solution. In addition, once adopted by a customer, there are less sales and administrative efforts required to increase the transaction volume with a customer as compared to the efforts required to sell a new term license for one of our other solutions. We anticipate that the growth of this portion of our business will outpace our traditional software licenses and, as a result, subscription and transaction revenue will become a larger portion of our overall revenue. We anticipate that this strategy will lead to more recurring and predictable overall revenue. In addition, given the lower administrative and sales costs associated with this revenue, we anticipate that this will increase our margins, especially as transaction volume with a given customer increases.

We evaluate and monitor our business based on our results from operations, including our percentage of revenue growth, our revenue by category, operating expenses as a percent of total revenue and our overall financial position. In doing so, we monitor margins for our existing business and evaluate the potential margin contributions for each type of revenue that we generate. In addition, we monitor our Earnings Before Interest, Depreciation and Amortization, or EBITDA, as a measure of operating performance in addition to net income and the other measures included in our financial statements.

We license our solutions primarily to large regional healthcare insurance companies. As of September 30, 2006, our customers included approximately 56 regional and national managed care organizations, including the largest organizations in more than 27 regional markets. Our revenue has increased at a compound annual growth rate of 32.8% since 2001, to $38.6 million for the year ended December 31, 2005. Our overall increase in revenue is attributable to increased emphasis by our customers on active management of their total insured population and the expansion of our solutions to meet their evolving needs.

Background

We began operations in 1988 by licensing an automated medical management solution to large regional healthcare insurance companies. This solution was the predecessor to our current Advanced Medical Management module. In 1999, we acquired the assets of an analytical software company that became the basis of our current Analytics and Disease Management module. In 2000, we expended a significant amount of capital to begin the development of our Transactions and Information Exchange module, completing the initial development of the module in the third quarter of 2001. In December 2002, we acquired assets that were the foundation for clinical decision support content, which enabled us to create our Clinical Rules and Processes module. In 2005, we began to offer our customers the ability to electronically transmit Patient Clinical Summaries to providers at the point of care.

From inception until 1997, our operations were funded primarily through internally generated cash flows and bank borrowings. In 1997, we issued approximately $3.5 million of Series A convertible preferred stock in order to raise capital for marketing our products. In 1999, we made a strategic decision to develop new products. To fund this initiative, in the fourth quarter of 1999 and in the first half of 2000, certain existing investors, including our Chief Executive Officer and Liberty Ventures I, L.P., which is an affiliate of ours as a result of their ownership of our outstanding capital stock, provided bridge financing until the closing of our Series B convertible preferred financing. To those investors who participated in the bridge financing, we issued seven-year warrants to purchase an aggregate of 435,000 shares of common stock, 375,000 of which had an exercise price of $2.00 per share and 60,000 of which had an exercise price of $5.00 per share. In June, July and August of 2000, we issued in the aggregate approximately $30.0 million of Series B convertible preferred stock, primarily to fund the research and development of new products. In September 2001 and March 2002, we issued in the aggregate approximately $4.9 million of Series C convertible preferred stock in order to fund our working capital requirements.

38


Back to Contents

In 1997, we entered into a borrowing arrangement with a third-party lender pursuant to which we issued warrants to purchase 200,000 shares of common stock at an exercise price of $2.00 per share. In 1999, we issued additional warrants to purchase 100,000 shares of common stock at an exercise price of $2.00 per share to the same lender. We entered into an arrangement with a different lender in 2001 pursuant to which we issued warrants to purchase 283,185 shares of common stock at an exercise price of $1.13 per share. In 2002, we entered into a borrowing arrangement with our current lender to provide working capital financing up to $4.0 million based upon eligible receivables. In connection with that arrangement, we issued warrants to purchase an aggregate 235,929 shares of common stock at an exercise price of $0.90 per share.

Sources of Revenue

We derive revenue from the following sources: (i) term license fees for our solutions; (ii) subscription, maintenance and transaction fees; and (iii) fees for discrete professional services.

     Term License Revenue

Our customers pay a term license fee to utilize our Advanced Medical Management and Clinical Rules and Processes modules for five years. We recognize revenue for term license fees upon delivery of the software.

     Subscription, Maintenance and Transaction Fees

Our customers pay an annual subscription fee to process data through MEDecision’s service bureau and access reports using our Analytics and Disease Management module and to transmit clinical data and decisions through Information Exchange modules. Customers also pay a fee for each transaction transmitted over our network. We recognize subscription fees ratably over the term of the subscription agreement and include this in the subscription, maintenance and transaction fee revenue on our consolidated statements of operations. We also offer our customers a hosted solution and receive monthly fees for those services. We recognize hosting revenue ratably over the term of the related agreement, which is typically five years in duration. Hosting revenue is included in subscription, maintenance and transaction fee revenue on our consolidated statements of operations.

Our customers pay an annual maintenance and support fee equal to approximately 22% of the annualized Advanced Medical Management license fee, which entitles our customers to unspecified software updates and upgrades and basic product support. For clinical content, our customers pay an additional 13% of the annualized license fee for maintenance and support. We recognize maintenance and support fees ratably over the term of the maintenance and support agreement.

Our customers pay transaction fees for each member eligibility verification, clinical adjudication of treatment requests and access to on-demand member health information, including Patient Clinical Summaries. We recognize transaction fees at the time of the transaction.

     Professional Services

In conjunction with our solutions, we provide services to assist our customers in the installation and implementation of the software and the integration of our solutions with other systems within the healthcare insurance company. We sell these services on either a fixed price or a time-and-materials basis and recognize revenue when the services are performed. Services revenue also includes reimbursable billable travel, lodging and other out-of-pocket expenses incurred as part of delivering services to our customers.

Each of our license models provides us with a recurring revenue stream. Historically, a substantial portion of our clients have renewed their licenses each year. During the year ended December 31, 2005, our clients renewed 100% of the contracts the stated terms of which were to expire during that period. The combination of recurring revenue and high renewal rates provide us with substantial annual revenue visibility. Although in general our revenue is consistent throughout the year, sales of certain modules that have an initial term license can cause revenue volatility from quarter to quarter. The sales cycle for our Advanced Medical Management module is typically eight months or longer. As a result, it is difficult for us to predict the quarter in which a particular sale may occur. In addition, in a small portion of our sales, the license fee is material relative to our total revenue during the quarter. Accordingly, our revenue may vary significantly from quarter to quarter depending on the quarter during which a large sale occurs.

39


Back to Contents

 
     Strategy for Growth

Our strategy for revenue growth is to (1) increase recurring and transaction-based revenue streams as a percentage of total revenue, primarily Patient Clinical Summary transactions; (2) expand our customer base into additional managed care organizations in the United States that could benefit from our entire Integrated Medical Management suite or certain components; (3) expand relationships with our customers; and (4) develop the next generation of our Collaborative Care Management Solution.

Historically, we derived most of our revenue from our Advanced Medical Management module, for which our customers purchase five-year term licenses and which we recognize as revenue at the time we enter into the contract. In 1999, we began licensing modules that provide transaction or annual recurring revenue that are recorded ratably over the contract term. In 2005, we began delivering a Patient Clinical Summary for eight managed care organizations. We intend to emphasize modules with transaction oriented and annual recurring revenue, as these streams provide us with greater revenue visibility and higher gross margins and operating margins. We have developed a scalable network infrastructure to deliver a high volume of transactions (such as authorizations, referrals and Patient Clinical Summaries) to providers and patients. An increase in transaction volume will require some additional technology infrastructure, but we believe the cost of network expansion will be substantially lower than the increase in revenue. In addition, we expect some investment initially in sales and marketing to educate and assist in the initial deployment of transaction-based modules, but less, as a percentage of revenue, than the increase in revenue.

Prior to 2003, we licensed our software module separately to payer organizations. Beginning in 2003, we began marketing and licensing our modules as an integrated solution, providing the payer an ability to license the entire Integrated Medical Management suite, or certain components initially, based upon the payer’s business needs at that time. We believe there are at least 300 additional managed care organizations in the United States, self-insured companies and Medicare and Medicaid organizations that could benefit from licensing and deploying our entire Integrated Medical Management suite, or selected modules. We license our solutions to new customers through our direct sales force, and our marketing initiatives generally have included conferences, trade shows, healthcare industry events and direct mail campaigns. We will continue to invest in additional sales personnel and marketing programs to increase awareness of our integrated solution, but not at the same rate of our revenue growth.

Through our customer sales operation, we have expanded our penetration within our customer base by including more members and by increasing the number of modules licensed by our customers. We intend to develop additional cross-selling programs to aid our customer relationship staff to continue to increase the number of modules utilized by our customers in the provision of care to their membership. The large cross-selling opportunity is based on the adoption of the Patient Clinical Summary transactions, which benefit the payer, patient and provider. This adoption will require some investment in marketing, but we expect it to be less than the direct sales costs associated with the sales of our historical software solutions.

     Trends in Sales of our Solutions

Our Integrated Medical Management suite consists of four major modules: (i) Analytics and Disease Management; (ii) Advanced Medical Management; (iii) Clinical Rules and Process; and (iv) Transaction and Information Exchange. As discussed above, prior to 2003, we marketed and sold these modules individually rather than as a suite of products. Since that time, we have marketed these modules as the Integrated Medical Management suite, although we continue to license the modules individually in order to offer our customers an individualized solution. In general, customers license the Advanced Medical Management module as the core of their solution. Prior to 2004, our customers generally initiated their relationships with us by licensing just that one module. However, since 2004 we believe that our customers have focused more on implementing integrated multi-functional systems and have looked for products that offer more than a claims management system. As a result, a significant number of our new customers now license one or two modules in addition to our Advanced Medical Management module. We anticipate that this will remain the case for the foreseeable future.

40


Back to Contents

As a result of the shift in market focus to more integrated software solutions, we anticipate that new customers will license an increasing number of modules and existing customers will continue to expand their product suites by licensing additional modules. However, given that most of our customers initially license our Advanced Medical Management module, revenue related to that module is a significant portion of our overall revenue. We anticipate that this significance will diminish as customers license additional modules and our transaction fee revenue increases as a percentage of overall revenue.

Cost of Revenue

Our costs of revenue are broken down into cost of term licenses, cost of subscription, maintenance and transaction fees and cost of professional services.

Our cost of term licenses primarily consists of:

 
amortization of internally developed and purchased capitalized software; and
     
 
third-party license fees for the third-party software incorporated in our Advanced Medical Management module.

Our cost of subscription, maintenance and transaction fees consist of:

 
compensation and related employee benefits of our product support, product maintenance and product hosting staff;
     
 
third-party maintenance fees associated with the third-party software incorporated into our Advanced Medical Management module;
     
 
solution hosting costs associated with a third-party secured facility;
     
 
depreciation associated with our hosting network; and
     
 
communication costs associated with our hosting network.

Our cost of professional services consists of:

 
compensation and related employee benefits for our professional services staff;
     
 
costs of independent contractors that provide consulting and professional services to our customers; and
     
 
travel, lodging and other out-of-pocket expenses for our staff and independent consultants to perform work at a customer’s site for which we receive reimbursement.

The costs associated with each of our modules, as a percentage of revenue, is different. Therefore, changes in the mix of modules and services will result in fluctuations in gross margin. We expect the percentage of our revenue derived from our Analytics and Disease Management module, Clinical Rules and Processes module, Transaction and Information Exchange module and Collaborative Care Management solutions to increase in the future. As a result, we expect our gross margins to increase in the future.

Operating Expenses

We classify our operating expenses as follows:

     Sales and Marketing

Sales and marketing expenses primarily consist of:

 
personnel and related costs for employees engaged in sales, corporate marketing, product marketing and product management, including salaries, commissions, other incentive compensation and related employee benefit costs;

 

41


Back to Contents

 
travel related expenses to meet with existing and potential customers, and for other sales and marketing related purposes;
     
 
costs associated with trade shows and industry conventions;
     
 
fees and other expenses related to public relations consultants; and
     
 
costs associated with our annual user conference and other marketing related activities.

We expense our sales commissions proportionately over the same period that the related revenue is recognized. We expect our sales and marketing expense to increase in the future as we increase the number of direct sales professionals and invest in marketing programs to encourage provider adoption of Collaborative Care Management solutions. However, we expect sales and marketing expenses to remain relatively constant as a percentage of revenue for the foreseeable future.

     Research and Development

Research and development expenses consist primarily of:

 
personnel and related costs, including salaries and employee benefits for software engineers, software quality assurance engineers and clinical systems engineers;
     
 
consulting fees paid to independent consultants who provide software or quality engineering services to us; and
     
 
costs of medical panels and research for annual clinical updates to our solutions.

To date, our research and development efforts have been devoted to new product offerings and increases in features and functionality of our existing suites. We expect research and development expenses to increase in the future as we continue to develop innovative new solutions for our customers. However, we expect research and development expenses to remain consistent as a percentage of revenue, fluctuating slightly depending on our product development initiatives.

Historically, we have capitalized a portion of our research and development expenses related to purchased and internally developed software. Capitalized research and development expenses totaled $2.0 million and $0.9 million for the years ended December 31, 2005 and 2004, respectively. No research and development expenses were capitalized in 2003. Otherwise, we expense research and development as those costs are incurred.

     General and Administrative

General and administrative expenses represent the complete, unallocated costs and expenses of managing and supporting our entire operations. General and administrative expenses consist primarily of:

 
personnel and related costs for our executives, finance, human resources, corporate information technology systems, strategic business, corporate quality, corporate training and administrative personnel;
     
 
legal and accounting professional fees;
     
 
facilities and related costs;
     
 
recruiting and training costs;
     
 
depreciation;
     
 
travel related expenses for executives and other administrative personnel; and
     
 
computer maintenance and support for our internal information technology system.

We expect general and administrative expenses to increase in the future as we absorb expenses related to being a publicly traded company and invest in an infrastructure to support our continued growth. However, we expect general and administrative expenses to decrease as a percentage of revenue for the foreseeable future.

42


Back to Contents

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates.

We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements:

     Revenue Recognition

We derive revenue primarily from three sources: (i) initial term and renewal license fees for our Advanced Medical Management and Clinical Rules and Processes modules; (ii) recurring revenue consisting of annual recurring subscription fees for our Analytics and Disease Management and Transactions and Information Exchange modules; transaction revenue associated with member eligibility verification, clinical adjudication of treatment requests and access of on-demand member health information; and technical and clinical maintenance and support fees; and (iii) fees for discrete professional services. Our standard license agreement typically provides a time-based license, which is typically five years in duration, to use our solutions. We may license our software in multiple element arrangements if the customer purchases any combination of maintenance, consulting, training, subscriptions or hosting services in conjunction with the software product license.

We recognize revenue pursuant to the requirements of AICPA Statement of Position, or SOP, 97-2, Software Revenue Recognition; as amended by SOP 98-9, Software Revenue Recognition, With Respect to Certain Transactions; SOP 81-1, Accounting for Performance of Construction-type and Certain Production-type Contracts; the Securities and Exchange Commission’s Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition; Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements With Multiple Deliverables; EITF Issue No. 00-03, Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware; EITF Issue No. 03-05, Applicability of AICPA Statements of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software; and other authoritative accounting guidance.

We enter into transactions that represent multiple-element arrangements, which may include a combination of professional services, hosting, PCS and software. In instances where certain arrangements include both software and non-software related elements, we apply the principles of SOP 97-2 to software elements. If the elements of the arrangement fall outside the scope of SOP 97-2, then we apply the principles of EITF 00-21. In accordance with EITF 00-21, multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met:
     
  the delivered item(s) has value to the client on a stand-alone basis.
     
  there is objective and reliable evidence of the fair value of the undelivered item(s).
     
  if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the company.
     
If these criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value. There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s) but no such evidence for the delivered item(s). In those cases, the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item(s). We apply the revenue recognition policies discussed below to each separate unit of accounting.
 
     

We recognize revenue using the residual method when vendor-specific objective evidence, or VSOE, of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more delivered elements, and all revenue recognition criteria in SOP 97-2, other than the requirement for VSOE of fair value of each delivered element of the arrangement, are satisfied. We allocate revenue to each undelivered element based upon its respective fair value determined by either (a) the price charged when that element is sold separately, (b) the price established by management if that element is not yet sold separately and it is probable that the price will not change before the element is sold separately or (c) substantive renewal rates. We defer revenue for all undelivered elements and recognize the residual amount of the arrangement fee, if any, when the basic criteria in SOP 97-2 have been met.

Under SOP 97-2, provided that the customer’s contract does not require significant production, modification or customization of our basic software code, we recognize revenue when the following four criteria have been met:

 
persuasive evidence of an arrangement exists;

43


Back to Contents

 
delivery of our basic software code has occurred;
     
 
the license fee is fixed or determinable; and
     
 
collection of the license fee is probable.

For arrangements where we provide software hosting services, we record revenue in accordance with SOP 97-2 unless:

 
the customer cannot take possession of the software at any time during the hosting period without significant penalty;
     
 
the customer cannot contract with another hosting provider without significant effort or expenditure; or
     
 
the software’s functionality is compromised by the termination of hosting services.

Under these circumstances, we record revenue ratably over the longer of the contract period or the maintenance period under EITF Issue No. 00-03.

For those arrangements that meet the criteria for SOP 97-2 accounting, we establish fair value for all undelivered elements and use the residual method to determine the fair value of the license fee that is recorded upon achievement of the four revenue recognition criteria mentioned above and included in term license revenue in the consolidated statement of operations. VSOE is established for hosting services under such arrangements based on the price charged when hosting services are sold separately as a renewal. Hosting revenue is included with subscription, maintenance and transaction fee revenue in the consolidated statements of operations.

If at the outset of an arrangement we determine that the arrangement fee is not fixed or determinable, then revenue is deferred until the arrangement fee becomes due and payable by the customer, assuming all other revenue recognition criteria have been met. If at the outset of an arrangement we determine that collectibility is not probable, then revenue is deferred until payment is received. Our license agreements typically do not provide for a right of return other than during the standard 90-day warranty period. Historically, we have not incurred warranty expense or experienced returns of its products. If an arrangement allows for customer acceptance of the software or services, then we defer revenue recognition until the earlier of customer acceptance or when the acceptance rights lapse.

We also offer subscriptions to access software which is hosted at our ASP facility. We categorize these fees as subscriptions. The fees related to these subscription arrangements are recognized as revenue ratably over the subscription term, which is typically 12 months. Revenue for multiyear time-based licenses that include maintenance, whether separately priced or not, is recognized ratably over the license term and included in subscription, maintenance and transaction fee revenue unless a substantive maintenance renewal rate exists, in which case the residual amount is recognized as software revenue and included in term license fee revenue when the basic criteria in SOP 97-2 have been met.

Our initial maintenance term is generally in the range of one to five years, renewable by the customer on an annual basis thereafter. Our customers typically prepay maintenance for periods of one to 12 months. Maintenance revenue is deferred and recognized ratably over the term of the maintenance contract and is included in subscription, maintenance and transaction fee revenue. Should a customer on maintenance be specifically identified as a bad debtor, then we would cease recognizing maintenance revenue except to the extent that maintenance fees have already been collected.

While the statements of work with our customers may specify multiple elements, we believe that the service elements included in our contractual arrangements with customers are not essential to the functionality of our software, which can operate in a standalone fashion upon installation. These service elements do not include significant modification or customization of our software, but may include configuring, designing and implementing simple interfaces with other customer software, installation and configuration of third-party software, and training in the use of both our software and third-party software. The timing of payments for software is independent of the payment terms for the service elements in our contractual arrangements with customers. In multi-element arrangements involving software and consulting, training or other services that are not essential to the functionality of the software, the services revenue is accounted for separately from the software revenue. VSOE for services did not exist during 2004 and prior. As a result, revenue attributable to all elements in a multi-element arrangement, including software and services, in 2004 and 2003 were deferred until the related services were completed and only then recognized as revenue, assuming VSOE exists for all other undelivered elements. In situations when revenue is deferred as a result of ongoing services, the costs associated with all delivered elements are also deferred and recognized as expense when the services are completed. As of September 30, 2006, December 31, 2005 and 2004, $0, $0 and $0.5 million, respectively, of deferred costs were included within prepaid expenses and other current assets for such periods. In late 2004, we introduced package pricing for the various service elements of our contractual arrangements with customers, and now recognize VSOE for service elements based on the prices of those packages, which are based on hourly rates consistent with those used in the separate sales of services.

44


Back to Contents

Consulting, training and other services are typically sold under fixed-price arrangements and are recognized using the proportional performance method based on direct labor hours incurred to date as a percentage of total estimated project costs required to complete the project. Consulting services primarily comprise implementation support related to the installation and configuration of our products and do not typically require significant production, modification or customization of the software. In arrangements that require significant production, modification or customization of the software and where services are not available from third-party suppliers, the consulting and license fees are recognized concurrently. When total cost estimates exceed revenue in a fixed-price arrangement, the estimated losses are recognized immediately in cost of revenue.

The assumptions, risks and uncertainties inherent with the application of the proportional performance method affect the timing and amounts of revenue and expenses reported. Numerous internal and external factors can affect estimates, including direct labor rates, utilization and efficiency variances.

Where contractual arrangements with customers include the sale of third-party software, revenue is recognized for the sale of the third-party software and the related expense is included in cost of revenue.

In accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred, we account for out-of-pocket expenses rebilled to customers as maintenance, consulting and training revenue with related costs included in cost of revenue. For the nine months ended September 30, 2006 and 2005, and for the years ended December 31, 2005, 2004 and 2003, reimbursement expenses totaled $0.3 million, $0.3 million, $0.4 million, $0.4 million and $0.3 million, respectively.

We also generate revenue from transactions that are processed through our web portal. Fees from these transactions are billed to customers in arrears on a monthly basis and are recognized in the period in which the transactions occur. The Company establishes VSOE for these transaction fees based on the rates charged for transactions in separate sales.

We believe that our accounting estimates used in applying our revenue recognition are critical because:

 
the determination that it is probable that the customer will pay for the products and services purchased is inherently judgmental;
     
 
the allocation of proceeds to certain elements in multiple-element arrangements is complex;
     
 
the determination of whether a service is essential to the functionality of the software is complex;
     
 
establishing company-specific fair values of elements in multiple-element arrangements requires adjustments from time-to-time to reflect recent prices charged when each element is sold separately; and
     
 
the determination of the stage of completion for certain consulting arrangements is complex.

Changes in the aforementioned items could have a material effect on the type and timing of revenue recognized.

 

45


Back to Contents

     Accounts Receivable and Allowance for Doubtful Accounts

The majority of our accounts receivable are due from trade customers. Credit is extended based on evaluation of each customer’s financial condition. Collateral is not required. Accounts receivable payment terms are typically 30 days and are stated in the financial statements at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the payment terms are considered past due. We determine our allowance by considering a number of factors including the length of time trade accounts receivable are past due, our previous loss history, customers’ current ability to pay their obligations to us and the condition of the general economy and the industry as a whole. We write off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

     Capitalized Software Research and Development Costs

We record capitalized software costs on the balance sheet at the lower of unamortized capitalized costs or net realizable value. We capitalize purchased and internally developed software in accordance with Statement of Financial Accounting Standards, or SFAS, No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. We identify projects that typically represent significant improvements in features and functionality. The costs incurred in the preliminary stages of development are expensed as research and development costs as they are incurred. Once a solution has reached the development stage where technological feasibility has been established, internal and external costs will be capitalized based upon the development hours charged against the project. Amortization begins and capitalization ends when the product is available for general release to our customers. Annual amortization of capitalized software costs is the greater of the amount computed using (i) the ratio that the current gross revenue for a product bears to the total of current and anticipated future gross revenue for that product or (ii) on a straight-line basis over the estimated economic life of the product, which ranges from three to five years. We evaluate the useful lives of these assets quarterly and test for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets.

     Stock-Based Compensation

Prior to January 1, 2006, stock-based compensation was measured in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — An Amendment of FASB Statement No. 123, which permitted companies to continue to apply the provisions of Accounting Principles Board Opinion, or APB, No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board, or FASB, Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25. Under this method, compensation expense is measured as the excess, if any, of the fair market value of our common stock at the date of the grant over the exercise price of the option. In accordance with the provisions of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation–Transition and Disclosure, we disclosed pro forma results of operations as if the minimum value- based method had been applied in measuring compensation expense for stock-based incentive awards.

As required by FASB under SFAS No. 123R, Share-Based Payment, effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R which requires us to apply the provisions of SFAS 123R to new awards granted, and to awards modified, repurchased, or cancelled after the effective date. We began recognizing stock-based compensation expense under a fair value computation effective January 1, 2006. The fair value of stock options will be recognized as expense in our financial statements over the remaining vesting period of the stock options. The adoption of SFAS No. 123R resulted in $0.5 million of expense in the first nine months of 2006, based upon options outstanding as of December 31, 2005 and the options granted in the first nine months of 2006. In addition, the adoption of this standard will result in difficulties comparing our operating results for future periods to those of our prior periods, since prior periods through 2005 will not reflect stock-based compensation expense under SFAS No. 123R.

 

46


Back to Contents

At the time that options were granted during the years 2001, 2002, 2003, 2004, 2005 and in January and April of 2006, the fair value of the common stock for the options was estimated by the board of directors, with input from management. Given the absence of an active market for our common stock, our board of directors, the members of which we believe had extensive business and finance experience, was required to estimate the fair value of our common stock at the time of each option grant. In July 2006, we engaged an independent valuation specialist to perform a retrospective valuation of our common stock as of and for the years ended December 31, 2001, 2002, 2003, 2004 and 2005. As a result of this retrospective valuation, it was determined that the exercise prices for the stock options granted in 2001, 2002, 2003, the first half of 2004 and for April and July 2006 exceeded the fair value of our common stock at those dates. The exercise prices for stock option grants in the second half of 2004, all of 2005 and January 2006 were below the retrospective fair values determined for those dates. Accordingly, as required by APB Opinion 25, for the difference by which the fair value of the underlying common stock exceeded the option exercise price of the grants in 2004 and 2005, we recognized stock-based compensation expense in our consolidated statements of operations for the years ended December 31, 2005 and 2004 in the amounts of $0.3 million and $21,000, respectively.

 
Significant Factors, Assumptions and Methodologies Used in Determining Fair Value.

We used the market approach (one of three generally used valuation approaches) to estimate the value of the enterprise at each date at which options were granted. The market approach uses direct comparisons to other enterprises and their equity securities to estimate the fair value of privately issued securities. The fair value measured by the market approach is based on a comparison to similar enterprises or similar transactions. Our board of directors considered the market values of comparable software companies in public and private sales, conducted discussions of value with outside equity investors (including those who had purchased shares of our Series A, Series B and Series C preferred stock) and potential strategic business partners and considered our business trends in determining our market-based value. Our board of directors then deducted the liquidation preferences of the preferred stock, including accrued and unpaid dividends, to determine the value remaining for the holders of our common stock. Given the objective and subjective factors utilized in this valuation methodology, there is inherent uncertainty in these estimates. Of the three generally accepted valuation methodologies, our board of directors believed that the market approach was the most appropriate approach to utilize because of its focus on value based on a sale or public offering liquidity events. At the time, it was more likely a liquidity event would involve the sale of us or an initial public offering of our common stock.

The independent valuation specialist also used a market approach to value our common stock. The specialist estimated the retrospective fair values of our common stock using a probability-weighted analysis of the present value of returns afforded to common shareholders in each of three possible future liquidity events – an initial public offering, sale or dissolution. Given the structure of our shareholder base, the valuation expert did not analyze our value in a scenario where we continue as a private company indefinitely with no liquidity transaction. For each of the three transaction scenarios, estimated future and present values for the shares of our common stock were calculated using assumptions, including: (i) the expected pre-money valuation (pre-initial public offering, pre-sale or pre-dissolution); (ii) the expected probability distribution of values relating to the expected pre-money valuation, which not only demonstrates the level of volatility of expected values, but is particularly important for a junior security – such as the common stock in an enterprise that has preferred stock – which demonstrates an asymmetrical distribution of returns; and (iii) an appropriate risk-adjusted discount rate to the present rate.

The valuation expert’s initial public offering valuation was based primarily on the following: (i) an analysis of companies comparable to us, including their valuation at a trailing year multiple and one-year forward revenue multiple; (ii) an analysis of a broader range of software companies, broken down into certain key criteria, including size, profitability and growth; and (iii) since detailed multi-year projections were available only for 2005 analysis, the valuation expert performed a discounted cash flow analysis for the December 31, 2005 valuation. Such projections were not available in prior years, and as a result, no discounted cash flow analysis was performed for those years. Using the foregoing, low, median and high values of the common equity were estimated and the common equity per share value was calculated. A weighted-average estimate of values was calculated using weightings of 0% (for the low case), 50% (for the median case) and 50% (for the high case) in the valuation analysis for 2005, 2004 and 2003, as well as June 30, 2006. A weighted-average estimate of values was calculated using weightings of 0% (for the low case), 25% (for the median case) and 75% (for the high case) in the valuation analysis for 2001 and 2002.

47


Back to Contents

The sale valuation was based primarily on the following: (i) an analysis of merger and acquisition transactions involving companies comparable to us, including their valuation as a trailing year revenue multiple; (ii) an analysis of a broader range of software company acquisitions, segmented by certain key criteria, including size and profitability; (iii) an estimated calculation of the common equity per share value by utilizing the foregoing, low, median and high values of the common equity; and (iv) a weighted-average estimate of values was calculated using weightings of 25% (for the low case), 50% (for the median case) and 25% (for the high case).

The dissolution valuation was based primarily on the following: (i) the valuation expert’s estimate (with management input) regarding expected dissolution proceeds; (ii) upon subtracting our liabilities from our assets, the net value to equity shareholders was estimated; (iii) after deducting accrued dividends, liquidation and preferences from the net equity value, the value to common shareholders was calculated. Since our management has represented that the dissolution scenario is highly unlikely, but not impossible, the valuation expert only assigned a 5% probability weighting on this scenario in its calculations.

The valuation expert applied weightings to each of the three indicated values based upon its estimate of the likelihood of the various scenarios, as of the valuation date. Its estimate of the likelihood of any given scenario was based on: (i) the initial public offering and merger and acquisition transaction market conditions; (ii) the relative size, based on trailing revenue, of the issuers which successfully completed initial public offerings during the relevant time period; (iii) our profitability; and (iv) the likelihood that an initial public offering would qualify as a Qualified Initial Public Offering under the terms of our preferred stock.

As a result of the foregoing, the following weightings were assigned for the applicable periods:

      June 30,   Year ended December 31,
   

 













 
    2006   2005   2004   2003   2002   2001  
   

 

 

 

 

 

 
Sale / Merger
    25 %   70 %   85 %   90 %   90 %   90 %
IPO
    70 %   25 %   10 %   5 %   5 %   5 %
Dissolution
    5 %   5 %   5 %   5 %   5 %   5 %
   

 

 

 

 

 

 
Total
    100 %   100 %   100 %   100 %   100 %   100 %
   

 

 

 

 

 

 

 

Significant Factors Contributing to the Difference between Fair Value as of the Date of Each Grant and Estimated Initial Public Offering Price.

As disclosed more fully in Note 8 to our Consolidated Financial Statements, we granted stock options with exercise prices of $0.50 during the years ended December 31, 2001 through 2005, $2.50 in January 2006 and $22.00 in April and July 2006. The independent valuation specialist determined in its retrospective valuation that the fair value of our common stock was, as of each date indicated:

    December 31,
2001
  December 31,
2002
  December 31,
2003
  December 31,
2004
  December 31,
2005
  June 30,
2006
 
   

 

 

 

 

 

 
Fair value per share
  $ 0.14   $ 0.10   $ 0.14   $ 2.02   $ 4.52   $ 6.34  
                                       

For the periods 2001 through 2005, the fair value determined contemporaneously by our board of directors differs from the retrospective valuation by the valuation expert, which in turn differs significantly from the expected valuation in this offering. The primary reason for the difference between the market-based fair value determined by our board of directors and the retrospective valuation by the valuation expert relates to the number and composition of the comparison companies used by our board of directors and the valuation expert, and the more comprehensive approach used by the valuation expert in that the valuation expert used a probability-weighted estimate of the values from each of the three scenarios posed (sale of the company, IPO or dissolution). The primary reason for the difference between the expected valuation in this offering and the fair values determined by the independent valuation expert as of June 30, 2006 and December 31, 2005, 2004, 2003, 2002 and 2001 is that during these periods, the valuation expert and we determined that it was highly unlikely that we could have completed an initial public offering due to (i) weak initial public offering conditions, (ii) our relative small size in terms of revenue compared to companies that completed initial public offerings during such periods, and (iii) prior to 2005, our lack of profitability. As a result, a liquidity event in the form of a sale or merger was determined to be most likely. Our sale or merger would trigger liquidation payments of approximately $40.0 million to the holders of our Series A, Series B and Series C preferred stock plus accrued dividends, greatly diminishing, or even eliminating, the value of our shares of common stock.

48


Back to Contents

As of June 30, 2006, the independent valuation expert determined that the fair value of our common stock was $6.34 per share. As of the date of the preliminary prospectus, the estimated initial public offering price was $12.50. This increase in fair value between that determined by the valuation expert and that determined by our underwriters is attributable to the following factors: an increase in the valuation of comparable public companies included in the independent valuation expert's report; an increase in the probability of completing our initial public offering; and, as our initial public offering becomes more likely, the removal of the discount related to the uncertainty associated with a shareholder liquidity event. In addition, there was also a difference in the methodology utilized by the independent valuation expert and our underwriters. The valuation expert used a broader group of healthcare software companies that, overall, had valuation multiples that were lower than the group included in the underwriters' valuation. In addition, the valuation expert included as comparable companies only those companies whose revenue base is most closely comparable to our current business model, despite the fact that we anticipate increased subscription, maintenance and transaction fee based revenues in the future from our Patient Clinical Summary product.

Based on an estimated initial public offering price of $12.50, the mid-point of the range set forth on the cover page of this prospectus, the intrinsic value of the options outstanding at September 30, 2006 was $29.3 million, of which $21.8 million related to vested options and $7.5 million related to unvested options (out-of-the-money options for 479,375 shares at $22.00 per share are not included in these amounts). Although it is reasonable to expect that the completion of this offering will add value to our common stock because they will have increased liquidity and marketability, the amount of additional value cannot be measured with precision or certainty.

Accounting for Preferred Shares and Derivative Shares

We account for our preferred stock and related instruments in accordance with EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock; EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingent Adjustable Conversion Ratios; EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments; SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities; and other applicable professional standards. The carrying value of our Series A, Series B and Series C preferred stock is increased, or accreted, using the interest method, to redemption or liquidation value, from the date of issuance to the earliest redemption date. The carrying value of our Series A, Series B and Series C preferred stock are also accreted for the value of accrued and unpaid cumulative dividends.

In accordance with the provisions of SFAS No. 133, we identified the conversion feature of our Series B and Series C preferred stock as an embedded derivative. Under the criteria of EITF 00-19, these embedded derivatives are classified as a liability, with changes in fair value of the derivatives at each balance sheet date reflected in our results of operations. For our Series A preferred stock, for which accrued and unpaid dividends may, at the option of the holder, be paid in additional shares of Series A preferred stock, when the fair value of our common stock (into which the dividend shares may be converted) exceeded the conversion price, a beneficial conversion option was recognized for the difference between the fair value of the common stock and the conversion price on the Series A preferred stock dividends, in accordance with EITF 00-27. Changes in the value of this beneficial conversion option are recorded in additional paid in capital in our consolidated balance sheet.

     Accounting for Income Taxes

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, under the asset-and-liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any change in the enacted tax rate and its effect on deferred assets and liabilities is recognized in the period that includes the enactment date. A valuation allowance is recorded against deferred tax assets if it is more likely than not that such assets will not be realized.

The realization of deferred tax assets is evaluated quarterly by assessing the valuation allowance and by adjusting the amount of the allowance, if necessary. We make estimates and judgments to calculate our tax liabilities and determine the realization of our deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a deferred tax asset valuation allowance if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective.

In evaluating our ability to realize deferred tax assets, we consider all available positive and negative evidence. Our positive evidence includes our projections of future taxable income, the remaining life of the net operating loss carryforwards and cumulative taxable income over the three most recent fiscal years. Our negative evidence includes operating losses generated from 2000 through 2003 and the taxable losses generated in the first six and nine months of 2006. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

49


Back to Contents

We operate within multiple state taxing jurisdictions and are subject to audit in each jurisdiction. No audits have been made to date, and any audit may require an extended period of time to resolve. In our opinion, adequate provisions for income taxes have been made for all periods.

Significant Customer Contracts

Two of our customers, HealthCare Services Corporation, or HCSC, and Horizon Blue Cross Blue Shield, accounted for 27% and 22%, respectively, of our revenue for the nine months ended September 30, 2006. HCSC accounted for 25% of our revenue for 2005. Each of these contracts contains a term license component, an annual subscription and maintenance fee component. As is the case generally with all of our term license arrangements, a significant amount of the revenue of the contract is recognized in the initial year of the contract, with the remaining year revenue composed predominantly of annual subscription and maintenance fees and services relating primarily to implementation. See the discussion of “Sources of Revenue” above in this section of the prospectus. As a result, while these two contracts represent a material portion of our revenue in the nine months ended September 30, 2006, we can not determine at this time whether these contracts will represent a material portion of our revenue in the future.

     HCSC Agreement

On November 15, 2005, we entered into a Master Product Agreement with HCSC. This agreement, which we refer to as the HCSC Agreement, is a software license and support agreement pursuant to which we license certain software products to HCSC and provide software support and hosting services to HCSC in connection with these software products. The initial term of the license under the HCSC Agreement is for three years, with a yearly option for HCSC to renew for two additional years until expiration in November 15, 2010. The HCSC Agreement may only be terminated by either party for a breach of the agreement, but the support services may be terminated by HCSC at any time with proper notice to us. Annual support fees and annual ASP hosting fees will not increase during the initial three year term, but may increase each year thereafter by no more than a fixed pre-negotiated rate. The agreement sets forth the support services to be provided, including technical support, business support and product upgrades.

The HCSC Agreement accounted for a significant portion of our 2005 revenue primarily as a result of the initial license fee that was recognized at the end of 2005. The implementation for the project was scheduled for the beginning of 2006. As a result, the revenue in connection with the implementation of the project resulted in the HCSC Agreement accounting for a significant portion of our revenue for the nine months ended September 30, 2006. Given that services are provided on an as requested basis, we can not determine at this time whether the HCSC Agreement will account for a material portion of our revenue in the future.

     Horizon Agreement

On June 30, 2005, we entered into a Master Product and Services Agreement with Horizon Blue Cross Blue Shield of New Jersey, or Horizon. This agreement, which we refer to as the Horizon Agreement, is a software license and support agreement pursuant to which we license certain software products to Horizon and provide software support services to Horizon in connection with these software products. The initial term of the license under the Horizon Agreement is for five years. The Horizon Agreement may be terminated for convenience by Horizon under certain circumstances or for breach of the agreement by either party. Horizon may choose to terminate the support services on a yearly basis by choosing not to renew these services. The Horizon Agreement sets forth the support services to be provided, including technical support, business support and product upgrades. These support services have specific performance targets, metrics and escalation levels for each of our support services.

The Horizon Agreement accounted for less than 10% of our 2005 revenue. The Horizon Agreement accounted for a significant portion of our revenue for the nine months ended September 30, 2006 as a result of the initial license fees that were recognized in that period. Given that services are provided on an as requested basis, we can not determine at this time whether the Horizon Agreement will account for a material portion of our revenue in the future.

50


Back to Contents

 
Consolidated Results of Operations

The following table sets forth key components of our results of operations for the periods indicated as a percentage of total revenue:

    Nine Months Ended September 30,

  Year Ended December 31,

 
    2006   2005   2005   2004   2003  
   

 

 

 

 

 
    (unaudited)                    
Revenue
                               
Term license revenue
    22 %   28 %   25 %   22 %   12 %
Subscription, maintenance and
transaction fees
    49     45     45     53     61  
Professional services
    29     27     30     25     27  
   

 

 

 

 

 
Total revenue
    100     100     100     100     100  
Cost of revenue:
                               
Term licenses
    3     3     4     5     4  
Subscription, maintenance and transaction fees
    17     25     22     24     23  
Professional services
    13     16     14     18     18  
Total cost of revenue
    33     44     40     47     45  
   

 

 

 

 

 
Gross margin
    67     56     60     53     55  
Operating expenses
                               
Sales and marketing
    23     22     20     17     16  
Research and development
    17     8     7     12     19  
General and administrative
    27     23     25     22     21  
   

 

 

 

 

 
Total operating expenses
    67     53     52     51     56  
   

 

 

 

 

 
(Loss) income from operations
        3     8     2     (1 )
(Gain) loss on change in fair value of redeemable convertible preferred stock conversion options
    7     4     2     2      
Interest expense, net
    1     1     1         1  
   

 

 

 

 

 
(Loss) income before benefit for income taxes
    (8 )   (2 )   5         (2 )
Benefit (provision) for income taxes
        (1 )   17          
   

 

 

 

 

 
Net (loss) income
    (8 )   (3 )   22         (2 )
Accretion of convertible preferred shares and redeemable convertible preferred shares
    (11 )   (14 )   (10 )   (22 )   (39 )
   

 

 

 

 

 
(Loss) income available to common shareholders
    (19 )%   (17 )%   12  %   (22 )%   (41 )%
   

 

 

 

 

 
 
Comparison of Nine Months Ended September 30, 2006 and 2005
 
     Revenue

Consolidated revenue increased 38% to $33.5 million for the nine months ended September 30, 2006 from $24.3 million for the nine months ended September 30, 2005. This increase resulted primarily from an increase in subscription, maintenance and transaction revenue and professional services revenue. Subscription, maintenance and transaction revenue increased $5.3 million to $16.3 million for the nine months ended September 30, 2006 from $11.0 million for the nine months ended September 30, 2005. Professional services revenue increased $3.4 million to $9.8 million for the nine months ended September 30, 2006 from $6.4 million for the nine months ended September 30, 2005.

 

51


Back to Contents

For the nine months ended September 30, 2006 we entered into a total of 19 contracts compared to 13 for the nine months ended September 30, 2005. In the 2006 period, five contracts were with new customers who licensed our Advanced Medical Management module and at least one other module. The remaining 13 contracts were with existing customers that have already implemented our Advanced Medical Management module and were adding an additional module. In the 2005 period, we entered into a total of 13 contracts, of which four were with new customers who licensed our Advanced Medical Management module. Three of these four customers also licensed at least one additional module. During the 2006 period, Horizon Blue Cross licensed our Clinical Care Pathways solution and expanded, its utilization of our Advanced Medical Management module to an increased membership base. For the nine months ended September 30, 2006, Horizon Blue Cross represented approximately 22% of our total revenue.

The subscription, maintenance and transaction revenue increase reflects the revenue from contracts signed in late 2005 for our Clinical Care Pathways and Analytics and Disease Management product (approximately $2.9 million of which was associated with our agreement with HCSC), hosting contracts signed in early 2005 for which the customers did not complete implementation until the fourth quarter of 2005 and increased maintenance and support revenue associated with contracts executed in late 2005 and early 2006. The increase in professional services revenue reflects several implementation projects associated with HCSC in connection with their contract executed in the fourth quarter of 2005.

     Cost of Revenue

Cost of revenue increased 5% to $11.2 million for the nine months ended September 30, 2006 from $10.7 million for the nine months ended September 30, 2005.

This net increase resulted from an increase in the cost of term licenses of $0.4 million and professional services of $0.5 million, partially offset by a decrease in costs of subscription, maintenance and transaction fees of $0.5 million.

The increase in cost of term licenses is principally due to an increase in the amortization of capitalized software costs of $0.3 million and secondarily to an increase in the cost of third-party software licenses associated with new term license contracts.

The cost of subscription, maintenance and transaction fees decreased primarily due to a reallocation of personnel from product maintenance to product development resulting in a $0.7 million decrease in costs. This was partially offset by increased personnel in product support and hosted operations of $0.3 million.

The cost of professional services increased $0.5 million due to additional personnel and independent consultants to support our increased services work.

     Gross Margin

Gross margin increased 65% to $22.3 million for the nine months ended September 30, 2006 from $13.5 million for the nine months ended September 30, 2005. As a percentage of revenue, gross margin increased to 67% for the nine months ended September 30, 2006 from 56% for the nine months ended September 30, 2005.

Gross margin from term license fee revenue increased 2% to $6.2 million for the nine months ended September 30, 2006 from $6.1 million for the nine months ended September 30, 2005. As a percentage of term license fee revenue, gross margin from term license fee revenue decreased to 84% for the nine months ended September 30, 2006 from 88% for the nine months ended September 30, 2005. This decrease is attributable to an increase in capitalized software amortization for our Advanced Medical Management product and third-party software costs associated with new term licenses contracts.

52


Back to Contents

Gross margin from subscription, maintenance and transaction fee revenue increased 114% to $10.7 million for the nine months ended September 30, 2006 from $5.0 million for the nine months ended September 30, 2005. As a percentage of subscription, maintenance and transaction fee revenue, gross margin from subscription, maintenance and transaction fee revenue increased to 66% for the nine months ended September 30, 2006 from 45% for the nine months ended September 30, 2005. This increase is a result of revenue from contracts signed in late 2005 for Clinical Care Pathways, hosting contracts signed in early 2005 for which customers did not complete implementation until the fourth quarter of 2005 and increased maintenance and support revenue associated with contracts signed in the late part of 2005. In addition, lower amortization of capitalized software related to products licensed on a subscription basis and a reallocation of personnel from product maintenance to product development contributed to the increased gross margin on subscription, maintenance and transaction fee revenue.

Gross margin from professional services revenue increased 116% to $5.4 million for the nine months ended September 30, 2006 from $2.5 million for the nine months ended September 30, 2005. As a percentage of professional services revenue, gross margin from professional services revenue increased to 55% for the nine months ended September 30, 2006 from 39% for the nine months ended September 30, 2005. This increase is a result of continued operational efficiency in our professional services operations from new project management methodologies which were implemented in late 2004.

     Sales and Marketing

Sales and marketing expenses increased 45% to $7.7 million for the nine months ended September 30, 2006 from $5.3 million for the nine months ended September 30, 2005. This $2.4 million increase is due to increased sales and product marketing personnel that increased sales and marketing expense $1.1 million, increased commission expense of $1.0 million attributable to the increased revenue and increased corporate marketing expenses of $0.3 million for public relations, user conference and tradeshows.

     Research and Development

Research and development expenses increased 190% to $5.8 million for the nine months ended September 30, 2006 from $2.0 million for the nine months ended September 30, 2005. The material change of the $3.8 million increase reflects increased personnel and personnel-related costs and increased independent contractor costs of $3.5 million. For the nine months ended September 30, 2006, we capitalized $1.1 million of software development costs related to specific projects which will add new product features and functionality, a decrease of 15% from $1.3 million capitalized for the nine months ended September 30, 2005. Total research and development expenditures increased 92% to $6.9 million (including capitalized software development costs of $1.1 million) for the nine months ended September 30, 2006 from $3.6 million (including capitalized software development costs of $1.6 million) for the nine months ended September 30, 2005.

     General and Administrative

General and administrative expenses increased 56% to $8.9 million for the nine months ended September 30, 2006 from $5.7 million for the nine months ended September 30, 2005 or $3.2 million. This increase is due to an increase of $0.6 million in personnel and personnel related costs within the corporate operations, increased depreciation expense of $0.7 million, an increase in legal and consultant costs of $0.4 million associated with the development of Collaborative Data Exchange strategic relationships, $0.4 million related to recruiting costs for new personnel and a $0.3 million increase in facility costs resulting from the additional space leased in the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. In addition, approximately $0.3 million of the increase is related to stock compensation expense and the adoption of SFAS No. 123R, Share Based Payment, as of January 1, 2006.

     (Gain) Loss on Change in Fair Value of Redeemable Convertible Preferred Stock Conversion Options

The fair value of conversion options changed by $1.4 million to a $2.4 million loss for the nine months ended September 30, 2006 from a $1.0 million loss for the nine months ended September 30, 2005. The change resulted from the increase in the fair value of the conversion options calculated using the Black-Scholes model.

 

53


Back to Contents

     Interest Expense, Net

Interest expense, net increased 50% to $0.3 million for the nine months ended September 30, 2006 from $0.2 million for the nine months ended September 30, 2005. This $0.1 million increase is attributable to higher overall average borrowings outstanding as well as higher average costs of borrowing for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005.

 
     Provision for Income Taxes

We project our taxable income for the year ending December 31, 2006 by calculating our effective tax rate for the period. For interim period reporting purposes, we calculate an income tax provision (benefit) using the effective tax rate for the full-year.

     Net (Loss) Income

We recorded a net loss of $2.6 million for the nine months ended September 30, 2006 compared to a net loss of $0.8 million for the nine months ended September 30, 2005. The increase in term license and subscription, maintenance and transaction revenue and improving efficiency in professional services all contributed to an increase in gross margin of $8.8 million. Increases in expenses for the nine months ended September 30, 2006 of $9.4 million over the nine months ended September 30, 2005 offset the improved margin. We had a $0.1 million loss from operations for the nine months ended September 30, 2006 compared to $0.5 million in income from operations for the nine months ended September 30, 2005. An increase in interest expense combined with an increase in the provision for income taxes reduced the increase in income from operations, thereby resulting in a change in net loss of $1.8 million for the nine months ended September 30, 2006 over the nine months ended September 30, 2005.

 
     Accretion of Convertible Preferred Shares and Redeemable Preferred Shares

The accretion of convertible and redeemable convertible preferred shares for the nine months ended September 30, 2006 increased $0.5 million to $3.8 million from $3.3 million for the nine months ended September 30, 2005. This increase is attributable to the increase in the fair value of our common stock and the associated value of the embedded conversion feature of the preferred shares. Under accounting rules, this accretion of value to the preferred stock reduces the net income available to common shareholders.

     (Loss) Income Available to Common Shareholders

For the reasons described above, the loss available to common shareholders increased by $2.3 million to $6.4 million for the nine months ended September 30, 2006 from $4.1 million for the nine months ended September 30, 2005. This resulted from a net loss of $2.6 million for the nine month ended September 30, 2006 compared to a net loss of $0.8 million for the nine months ended September 30, 2005.

Comparison of Years Ended December 31, 2005 and 2004
 
     Revenue

Consolidated revenue increased 38% to $38.6 million for the year ended December 31, 2005 from $28.0 million for the year ended December 31, 2004. The $10.6 million increase in consolidated revenue was attributable to an increase in the number and average size of sales of our Integrated Medical Management suite closed during 2005 compared to 2004, an increase of $4.6 million in professional services fees attributable to increased volume of services work for existing customers and an increase in transaction fees and hosting revenue. Term license revenue increased 55% for the year ended December 31, 2005 over the year ended December 31, 2004 resulting from the sale of our complete Integrated Medical Management suite to a large healthcare insurance company. Revenue derived from transaction fees and hosting fees increased 76%, or $2.2 million, for the year ended December 31, 2005 over the year ended December 31, 2004 due to the licensing in late 2004 of our solutions to several customers on a hosted basis, resulting in 2005 revenue of $1.3 million, and an increase in the volume of authorizations and referrals transmitted over the Transactions and Information Exchange module resulting in $0.3 million revenue in 2005.

 

54


Back to Contents

For the year ended December 31, 2005, we entered into a total of 18 product contracts compared to 12 contracts executed in the year ended December 31, 2004. In the 2005 period, four contracts were with new customers who licensed our Advanced Medical Management module, and three of whom licensed at least one other module. For the year ended December 31, 2004, we signed contracts with seven new customers, five of whom licensed our Advanced Medical Management module and one of whom also licensed at least one additional module.

Beginning in the second quarter of 2003, we began to market our Integrated Medical Management solution. Prior to that date, we marketed and licensed modules individually. Our customers have historically licensed our Advanced Medical Management module. Since 2003, new customers license our Advanced Medical Management solution, and may license one or two additional products. For the year ended December 31, 2005, we entered into a total of 19 product contracts. Six contracts were for new customers that licensed multiple products. The existing customer contracts contain a license for one additional product.

For the year ended December 31, 2005, approximately 55% of the professional services revenue was from projects for existing customers.

     Cost of Revenue

Cost of revenue increased 17% to $15.3 million for the year ended December 31, 2005 from $13.1 million for the year ended December 31, 2004. This increase resulted from an increase in cost of term licenses of $0.2 million to $1.7 million for the year ended December 31, 2005 from $1.5 million for the year ended December 31, 2004, an increase in the cost of subscription, maintenance and transaction fees of $1.4 million to $8.2 million for the year ended December 31, 2005 from $6.8 million for the year ended December 31, 2004 and an increase of $0.7 million to $5.5 million for the year ended December 31, 2005 from $4.8 million for the year ended December 31, 2004.

The increase in the cost of subscription, maintenance and transaction fees is largely attributable to increased personnel and personnel related costs and increased temporary consultants for product support of $0.5 million and $0.4 million, respectively, and increased cost of network support and maintenance associated with the hosted operations of $0.2 million.

The increase of $0.6 million in cost of professional services results from increased personnel and personnel related costs.

     Gross Margin

Gross margin increased 55% to $23.3 million for the year ended December 31, 2005 from $15.0 million for the year ended December 31, 2004. As a percentage of revenue, gross margin increased to 60% for the year ended December 31, 2005 from 53% for the year ended December 31, 2004.

Gross margin from term license revenue increased 67% to $8.0 million for the year ended December 31, 2005 from $4.8 million for the year ended December 31, 2004. As a percentage of term license revenue, gross margin from term license revenue increased to 82% for the year ended December 31, 2005 from 76% for the year ended December 31, 2004. This increase is a result of the licensing of our Integrated Medical Management suite to HCSC.

Gross margin from subscription, maintenance and transaction fee revenue increased 14% to $9.0 million for the year ended December 31, 2005 from $7.9 million for the year ended December 31, 2004. As a percentage of subscription, maintenance and transaction fee revenue, gross margin from subscription, maintenance and transaction fee revenue decreased to 52% for the year ended December 31, 2005 from 54% for the year ended December 31, 2004. This decrease is a result of increased personnel and personnel related costs related to product support and increased cost of network support and maintenance associated with our hosting operations offset by higher subscription fees and hosting fees from customers who signed contracts in the late part of 2004.

55


Back to Contents

Gross margin from professional services revenue increased 170% to $6.2 million for the year ended December 31, 2005 from $2.3 million for the year ended December 31, 2004. As a percentage of professional services revenue, gross margin from professional services revenue increased to 53% for the year ended December 31, 2005 from 32% for the year ended December 31, 2004. This increase is due to increased utilization of personnel from reduced turnover and new project management methodologies which we began implementing in late 2004.
 
     Sales and Marketing

Sales and marketing expenses increased 66% to $7.8 million for the year ended December 31, 2005 from $4.7 million for the year ended December 31, 2004. The material components of the $3.1 million increase include increased commission expense due to the increase in consolidated revenue in 2005 over 2004 of $1.0 million, increased sales personnel and personnel-related costs of $1.4 million resulting from the reorganization of our sales organization and creation of a sales team focused on cross-selling, increased travel-related expenditures of $0.2 million and increased trade show expenses and other marketing-related costs of $0.4 million.

     Research and Development

Research and development expenses decreased 19% to $2.6 million for the year ended December 31, 2005 from $3.2 million for the year ended December 31, 2004. The net decrease of $0.6 million reflects an increase in capitalization of software development partially offset by increased development efforts adding new product features and functionality prior to establishing technological feasibility, which required increased personnel and personnel-related costs as well as increased use of independent contractors. For the year ended December 31, 2005, we capitalized $2.4 million of software development costs, an increase of $1.2 million over the $1.2 million of software development costs capitalized for the year ended December 31, 2004. Total research and development expenditures for the year ended December 31, 2005 were $5.0 million (including capitalized software development costs of $2.4 million) in aggregate, a 14%, or $0.6 million increase over total research and development expenditures of $4.4 million (including capitalized software development costs of $1.2 million) for the year ended December 31, 2004.

 
     General and Administrative

General and administrative expenses increased 54% to $9.7 million for the year ended December 31, 2005 from $6.3 million for the year ended December 31, 2004. The $3.4 million increase is primarily attributable to the accrual of a special incentive pool of $1.1 million based upon our results of operations for the year ended December 31, 2005, the creation of a strategic business development operation focused on developing Collaborative Care Management opportunities increasing costs $0.5 million in 2005 compared to 2004, increased travel-related expenses of $0.2 million (primarily attributable to the strategic business development operation), increased facilities and facilities-related expenses of $0.4 million relating to increased office space, increased depreciation of $0.2 million related to increased capital expenditures, increased recruiting and retention costs of $0.3 million and increased legal and consulting costs of $0.3 million.

     (Gain) Loss on Change in Fair Value of Redeemable Convertible Preferred Stock Conversion Options

The fair value of conversion options changed by $0.1 million to $0.7 million for the year ended December 31, 2005 from $0.6 million for the year ended December 31, 2004. The change resulted from the change in the fair value of the conversion options calculated using the Black-Scholes model.

 
     Interest Expense, Net

Interest expense, net increased 50% to $0.3 million for the year ended December 31, 2005 from $0.2 million for the year ended December 31, 2004. The $0.1 million increase is attributable to increased average borrowings for capital expenditures, primarily through capital leases, offset by lower average borrowings for working capital and secondarily to increased average interest rates on borrowings in 2005 compared to 2004.

 

56


Back to Contents

     Provision for Income Taxes

We realized an income tax benefit of $6.5 million for the year ended December 31, 2005 as compared to no provision or benefit for the year ended December 31, 2004. The $6.5 million increase was primarily attributable to the utilization of our net operating loss carryforward and the reduction in our tax valuation allowance of approximately $7.5 million with a consequent increase in our net deferred tax asset of $6.5 million. These changes resulted from management’s evaluation of our positive and negative evidence bearing upon the ability to realize our deferred tax assets and we believe that it is more likely than not that we will realize a portion of the benefits of federal and state tax assets.

     Net (Loss) Income

We recorded net income of $8.7 million for the year ended December 31, 2005 compared to a net loss of $26,000 for the year ended December 31, 2004. The increase in term license and subscription, maintenance and transaction revenue, as well as an increase in the volume of professional services work performed for customers, contributed to an increase in gross margin of $8.3 million. Increases in expenses for the year ended December 31, 2005 of $5.9 million over the year ended December 31, 2004 partially offset the improved margin. Our income from operations for the year ended December 31, 2005 increased $2.4 million over the year ended December 31, 2004. An increase of $0.1 million in the valuation of the embedded conversion feature of the preferred shares for the year ended December 31, 2005 over the year ended December 31, 2004 and an increase in interest expense resulted in a change in pre-tax income of $2.2 million for the year ended December 31, 2005 over the year ended December 31, 2004. For the year ended December 31, 2005, we had pre-tax income of $2.2 million compared to a pre-tax loss of $26,000 for the year ended December 31, 2004. In 2005, we realized an income tax benefit of $6.5 million from the utilization of net operating loss carryforwards and a reduction in the tax valuation allowance. This resulted in net income for the year ended December 31, 2005 of $8.7 million compared to a net loss of $26,000 for the year ended December 31, 2004.

 
     Accretion of Convertible Preferred Shares and Redeemable Preferred Shares

The accretion of convertible and redeemable convertible preferred shares for the year ended December 31, 2005 decreased $2.1 million to $4.0 million from $6.1 million for the year ended December 31, 2004. This increase is attributable to the increase in the fair value of the Company’s common stock and the associated value of the beneficial conversion feature of the preferred shares. Under accounting rules, this accretion of value to the preferred stock reduces the net income available to our common shareholders.

     (Loss) Income Available to Common Shareholders

For the reasons described above, for the year ended December 31, 2005, we recorded net income available to common shareholders of $4.7 million compared to a net loss available for common shareholders for the year ended December 31, 2004 of $6.1 million. This $10.8 million change resulted from an increase in net income of $8.7 million plus a reduction in the accretion of preferred stock conversion value of $2.1 million.

Comparison of Years Ended December 31, 2004 and 2003
 
     Revenue

Consolidated revenue increased 37% to $28.0 million for the year ended December 31, 2004 from $20.5 million for the year ended December 31, 2003. The major components of the $7.5 million increase are an increase in the number and average size of sales of our Integrated Medical Management suite closed during 2004 compared to 2003, the recognition of $2.5 million fees from term licenses entered into during 2003 but only recognized in 2004 when all services work was completed, a $1.5 million increase in the volume of authorizations and referrals transmitted over the Transactions and Information Exchange module resulting from new contracts closed in 2003 and a $1.6 million increase in volume of professional services work in 2004.

 

57


Back to Contents

For the year ended December 31, 2004, we entered into a total of 12 product contracts compared to ten product contracts executed in the year ended December 31, 2003. Beginning in the second quarter of 2003, we began to market our Integrated Medical Management solution. Prior to that date, we marketed and licensed modules individually. In 2003, 80% of the product contracts we executed were for one of our products. In 2004, we entered into contracts with one new customer and two existing customers for our entire Integrated Medical Management solution. In 2004, four new customers licensed our Advanced Medical Management module and two new customers licensed two products, one of which was our Advanced Medical Management module.

For the year ended December 31, 2004, approximately 63% of the professional services revenue relates to projects for existing customers.

 
     Cost of Revenue

Cost of revenue increased 41% to $13.1 million for the year ended December 31, 2004 from $9.3 million for the year ended December 31, 2003. The $3.8 million increase results from an increase in the cost of term licenses of $0.6 million to $1.5 million for the year ended December 31, 2004 from $0.9 million for the year ended December 31, 2003, an increase in the cost of subscription, maintenance and transaction fees of $2.0 million to $6.8 million for the year ended December 31, 2004 from $4.8 million for the year ended December 31, 2003 and an increase in the cost of professional services of $1.2 million to $4.8 million for the year ended December 31, 2004 from $3.6 million for the year ended December 31, 2003.

The $2.0 million increase in the cost of subscription, maintenance and transaction fees primarily results from increased personnel and personnel-related costs in product support of $1.3 million and an increase in personnel and personnel-related costs associated with our hosted operations of $0.2 million.

     Gross Margin

Gross margin increased 34% to $15.0 million for the year ended December 31, 2004 from $11.2 million for the year ended December 31, 2003. As a percentage of revenue, gross margin decreased to 53% for the year ended December 31, 2004 from 55% for the year ended December 31, 2003.

Gross margin from term license revenue increased 220% to $4.8 million for the year ended December 31, 2004 from $1.5 million for the year ended December 31, 2003. As a percentage of term license revenue, gross margin from term license revenue increased to 76% for the year ended December 31, 2004 from 63% for the year ended December 31, 2003. This increase is a result of license fees from contracts executed in 2003 but not recognized until 2004 upon delivery of the products and services.

Gross margin from subscription, maintenance and transaction fee revenue increased 1% to $7.9 million for the year ended December 31, 2004 from $7.8 million for the year ended December 31, 2003. As a percentage of subscription, maintenance and transaction fee revenue, gross margin from subscription, maintenance and transaction fee revenue decreased to 54% for the year ended December 31, 2004 from 62% for the year ended December 31, 2003. This decrease is a result of increased costs for personnel and personnel-related costs related to our product support and hosting operations.

Gross margin from professional services revenue increased 21% to $2.3 million for the year ended December 31, 2004 from $1.9 million for the year ended December 31, 2003. As a percentage of professional services revenue, gross margin from professional services revenue decreased to 32% for the year ended December 31, 2004 from 35% for the year ended December 31, 2003. This decrease is a result of inefficiencies related to high staff and management turnover within the professional services organization.

     Sales and Marketing

Sales and marketing expenses increased 47% to $4.7 million for the year ended December 31, 2004 from $3.2 million for the year ended December 31, 2003. The $1.5 million increase is attributable to increased sales commissions associated with the increased revenue of $1.1 million, additional sales personnel and personnel-related costs of $0.1 million and increased trade show and other marketing costs of $0.3 million.

 

58


Back to Contents

     Research and Development

Research and development expenses decreased 18% to $3.2 million for the year ended December 31, 2004 from $3.9 million for the year ended December 31, 2003. The net decrease of $0.7 million reflects increased development efforts adding new product features and functionality prior to establishing technological feasibility, which required increased personnel and personnel related costs as well as increased use of independent contractors, both offset by increased capitalized software development. For the year ended December 31, 2004, we capitalized $1.2 million of software development costs. For the year ended December 31, 2003, we did not capitalize any software development costs. We began offering our Integrated Medical Management suite in early 2003 and our research and development operation was focused primarily on maintenance of the new product offering. Total research and development expenditures for the year ended December 31, 2004 aggregated $4.4 million (including capitalized software development costs of $1.2 million), a 13%, or $0.5 million increase over total research and development expenditures of $3.9 million for the year ended December 31, 2003.

     General and Administrative

General and administrative expenses increased 47% to $6.3 million for the year ended December 31, 2004 from $4.3 million for the year ended December 31, 2003. The material components of the $2.0 million increase include the addition in 2004 of a Chief Medical Officer to our executive team that increased personnel costs by $0.3 million, increased recruiting costs of $0.3 million, increased depreciation expense of $0.1 million associated with capital purchases and increased costs of $0.1 million for maintenance and support of our communications infrastructure.

     (Gain) Loss on Change in Fair Value of Redeemable Convertible Preferred Stock Conversion Options

The fair value of conversion options was $0.6 million for the year ended December 31, 2004 compared to a $38,000 gain for the year ended December 31, 2003. The increase resulted from the increase in the fair value of the conversion option calculated using the Black-Scholes model.

 
     Interest Expense, Net

Interest expense, net decreased 30% to $175,000 for the year ended December 31, 2004 from $249,000 for the year ended December 31, 2003. The $74,000 net decrease reflects lower average borrowings under our working capital facility partially offset by higher average borrowings for capital expenditures.

     Provision for Income Taxes

We made no provision for income taxes in 2003 or 2004.

     Net (Loss) Income

We recorded a net loss of $26,000 for the year ended December 31, 2004 compared to a net loss of $0.5 million for the year ended December 31, 2003. The increase in term license and subscription, maintenance and transaction revenue, as well as an increase in the volume of professional services work performed for customers, contributed to an increase in gross margin of $3.8 million. Increases in expenses for the year ended December 31, 2004 of $2.7 million over the year ended December 31, 2003 partially offset the improved margin. Our income from operations for the year ended December 31, 2004 increased $1.0 million over the year ended December 31, 2003 to $0.7 million. An increase of $0.6 million in the Black-Scholes valuation of the embedded conversion feature of the preferred shares for the year ended December 31, 2004 over the year ended December 31, 2003 and a reduction in interest expense resulted in a change in pre-tax income of $0.4 million for the year ended December 31, 2004 over the year ended December 31, 2003. For the year ended December 31, 2004, we had a pre-tax loss of $26,000 compared to a pre-tax loss of $0.5 million for the year ended December 31, 2003.

 

59


Back to Contents

     Accretion of Convertible Preferred Shares and Redeemable Preferred Shares

The accretion of convertible and redeemable convertible preferred shares for the year ended December 31, 2004 decreased $1.9 million to $6.1 million from $8.0 million for the year ended December 31, 2003. This decrease is attributable to completion of the accretion of preferred stock issuance costs and accretion to redemption value as of June 30, 2004. Under accounting rules, this accretion of value to the preferred stock reduces the net income available to common shareholders.

     (Loss) Income Available to Common Shareholders

For the reasons described above, the loss available for our common shareholders decreased $2.3 million to $6.1 million for the year ended December 31, 2004 from $8.4 million for the year ended December 31, 2003. The net loss for the year ended December 31, 2004 declined $0.5 million from the year ended December 31, 2003. In addition, the accretion of preferred redemption and conversion option values decreased $1.8 million to $6.1 million for the year ended December 31, 2004 from $7.9 million for the year ended December 31, 2003.

Unaudited Quarterly Statements of Operations

The following tables present our unaudited quarterly results of operations for each of the nine quarters beginning September 30, 2004 and ending September 30, 2006. You should read the following table in conjunction with our audited consolidated financial statements and related notes appearing at the end of this prospectus. We have prepared the unaudited information on a basis consistent with our audited consolidated financial statements and have included all adjustments, which, in the opinion of management, are necessary to fairly present our operating results for the quarters presented. Our historical unaudited quarterly results of operations are not necessarily indicative of results for any future quarter or for a full year.

60


Back to Contents

We have reflected on a pro forma basis the effect on historical basic and diluted earnings per share of the 1-for-2 reverse stock split effected prior to the consummation of its initial public offering.

    Three Months Ended

 
    Sept. 30,
2006
  June 30,
2006
  Mar. 31,
2006
  Dec. 31,
2005
  Sept. 30,
2005
  June 30,
2005
  Mar. 31,
2005
  Dec. 31,
2004
  Sept. 30,
2004
 
   

 

 

 

 

 

 

 

 

 
    (unaudited)
(in thousands)
 
Consolidated Statement of Operations Data:
                                                       
Revenue
                                                       
Term license revenue
  $ 3,479   $ 3,509   $ 415   $ 2,862   $ 5,032   $ 1,183   $ 652   $ 797   $ 2,279  
Subscription, maintenance and transaction fees
    5,502     5,501     5,308     6,226     3,926     3,493     3,542     3,623     3,695  
Professional services
    3,046     3,676     3,103     5,235     2,646     2,013     1,786     1,867     2,568  
   

 

 

 

 

 

 

 

 

 
Total revenue
    12,027     12,686     8,826     14,323     11,604     6,689     5,980     6,287     8,542  
Cost of revenue:
                                                       
Term licenses
    519     473     212     878     502     180     93     181     549  
Subscription, maintenance and transaction fees
    1,959     1,879     1,722     2,117     2,366     1,895     1,785     1,820     1,633  
Professional services
    1,341     1,473     1,621     1,588     1,208     1,313     1,390     1,340     1,354  
   

 

 

 

 

 

 

 

 

 
Total cost of revenue
    3,819     3,825     3,555     4,583     4,076     3,388     3,268     3,341     3,536  
   

 

 

 

 

 

 

 

 

 
Gross margin
    8,208     8,861     5,271     9,740     7,528     3,301     2,712     2,946     5,006  
                                                         
Operating expenses
                                                       
Sales and marketing
    2,873     2,614     2,205     2,444     2,238     1,846     1,250     1,081     1,179  
Research and development
    2,118     2,149     1,561     676     580     771     600     946     738  
General and administrative
    3,262     3,167     2,475     3,980     2,005     1,918     1,804     1,705     1,658  
   

 

 

 

 

 

 

 

 

 
Total operating expenses
    8,253     7,930     6,241     7,100     4,823     4,535     3,654     3,732     3,575  
   

 

 

 

 

 

 

 

 

 
(Loss) income from operations
    (45 )   931     (970 )   2,640     2,705     (1,234 )   (942 )   (786 )   1,431  
(Gain) loss on change in fair value of redeemable convertible preferred stock conversion options
    2,979     (281 )   (285 )   (299 )   1,213     (116 )   (104 )   (113 )   697  
Interest expense, net
    147     80     60     100     78     55     41     56     51  
   

 

 

 

 

 

 

 

 

 
(Loss) income before benefit for income taxes
    (3,171 )   1,132     (745 )   2,839     1,414     (1,173 )   (879 )   (729 )   683  
Benefit (provision) for income taxes
    75     (343 )   416     6,630     (1,032 )   507     386          
   

 

 

 

 

 

 

 

 

 
Net (loss) income
  $ (3,096 ) $ 789   $ (329 ) $ 9,469   $ 382   $ (666 ) $ (493 ) $ (729 ) $ 683  
Accretion of convertible preferred shares and redeemable convertible preferred shares
    (2,431 )   (684 )   (684 )   (684 )   (2,022 )   (644 )   (644 )   (644 )   (644 )
   

 

 

 

 

 

 

 

 

 
(Loss) income available to common shareholders
  $ (5,527 ) $ 105   $ (1,013 ) $ 8,785   $ (1,640 ) $ (1,310 ) $ (1,137 ) $ (1,373 ) $ 39  
   

 

 

 

 

 

 

 

 

 
(Loss) income per share available to common shareholders, basic
  $ (0.61 ) $ 0.02   $ (0.15 ) $ 1.35   $ (0.25 ) $ (0.20 ) $ (0.18 ) $ (0.21 ) $ 0.01  
   

 

 

 

 

 

 

 

 

 
Income (loss) per share available to common shareholders, diluted
  $ (0.61 ) $ 0.02   $ (0.15 ) $ 0.31   $ (0.20 ) $ (0.20 ) $ (0.18 ) $ (0.21 ) $ 0.00  
   

 

 

 

 

 

 

 

 

 
Weighted average shares used to compute (loss) income available to common shareholders per common share, basic
    8,993,495     6,552,958     6,549,699     6,498,829     6,445,686     6,445,643     6,441,869     6,435,536     6,427,538  
   

 

 

 

 

 

 

 

 

 
Weighted average shares used to compute (loss) income available to common shareholders per common share, diluted
    8,993,495     6,951,554     6,549,699     29,206,908     8,070,266     6,445,643     6,441,869     6,435,536     8,378,438  
   

 

 

 

 

 

 

 

 

 
Pro forma stock split (unaudited)
                                                       
Pro forma earnings per share available to common shareholders - basic
    (1.23 )   0.03     (0.31 )   2.70     (0.51 )   (0.41 )   (0.35 )   (0.43 )   0.01  
Pro forma earnings per share available to common shareholders - diluted
    (1.23 )   0.03     (0.31 )   0.63     (0.41 )   (0.41 )   (0.35 )   (0.43 )   0.01  
Weighted average shares used to compute pro forma (loss) income available to common shareholders - basic
    4,496,747     3,276,479     3,274,850     3,249,415     3,222,843     3,222,822     3,220,934     3,217,768     3,213,769  
Weighted average shares used to compute pro forma (loss) income available to common shareholders - diluted
    4,496,747     3,475,777     3,274,850     14,603,454     4,035,133     3,222,822     3,220,934     3,217,768     4,189,219  

 

61


Back to Contents

Comparison of Unaudited Quarterly Results
 
     Revenue

Our total consolidated revenue has increased over the periods presented based on new sales of our Integrated Medical Management suite and increased utilization of the solutions from which we derive transaction fees. Our total consolidated revenue has varied from quarter to quarter based on new sales and renewals of term licenses for our Advanced Medical Management module and the volume of services work contracted from both existing and new customers.

     Cost of Revenue

Our cost of revenue has varied on a quarterly basis reflecting third-party software fee costs associated with new sales of our Advanced Medical Management module, amortization of capitalized software as projects are completed and software is deployed for general use and the addition of personnel and/or independent contractors to support the contracted services revenue.

     Gross Margin

Our gross margins have varied on a quarterly basis primarily due to the mix of revenue and the proportion of license revenue and transaction fees to the total revenue for the quarter and the impact of training and other non-billable time of resources added to the professional services operations.

     Sales and Marketing

Sales and marketing expenses have generally increased over the periods presented due to the addition of sales and product marketing personnel. Quarterly fluctuations are the result of the timing of marketing expenditures and sales commission expense associated with license revenue recognized during the quarter.

     Research and Development

Research and development expenses have generally increased over the periods presented due to the increased focus on new product features and functionality and the associated addition of personnel and independent consultants.

     General and Administrative

General and administrative expenses have generally increased over the periods presented reflecting expansion of executive management, addition of strategic business development operations, increased costs of recruiting staff for the entire organization, increased facilities cost and increased depreciation expense. In the three months ended December 31, 2005, we recorded an accrual of $1.1 million for a special incentive, based upon our results of operations for the year ended December 31, 2005.

Liquidity and Capital Resources

Since our inception, we financed our operations primarily through internally generated cash flows, borrowings from banks and the issuance of preferred stock. As of September 30, 2006 and December 31, 2005, we had cash of $0.4 million and $2.4 million, respectively, and receivables of $13.0 million and $10.4 million, respectively. As of each of September 30, 2006 and December 31, 2005, we had $3.8 million and $0, respectively, of borrowings under our bank working capital facility. As of September 30, 2006 and December 31, 2005, we had $4.8 million and $3.8 million, respectively, in total capital equipment financing, primarily capital leases, outstanding. As of September 30, 2006 and December 31, 2005, we had accumulated dividends on our preferred stock of $12.2 million and $14.5 million, respectively. In connection with this offering, all of our outstanding preferred stock will be converted to common stock under the terms of each class of preferred stock, the Series A accrued dividend as of the date of this offering will be converted to common stock pursuant to an election of each holder as provided under the rights, preferences and designations of the Series A preferred stock and the Series B and Series C accrued dividends as of the date of this offering will be paid in cash from the proceeds of this offering.

 

62


Back to Contents

Upon the agreement of the holders of 60% of the then outstanding Series B and Series C preferred stock, such holders, after March 31, 2007, can require us to redeem the preferred stock. We anticipate that this offering will become effective prior to March 31, 2007. Upon the effectiveness of this offering, all Series B and Series C preferred stock will convert to common stock, and we will have no preferred stock outstanding. Additionally, upon the conversion of all the Series B and Series C preferred stock, any right to require us to redeem such shares will become null and void.

In the event that this offering is not consummated prior to March 31, 2007, or is withdrawn, and the redeemable preferred shareholders obtain the agreement of the holders of 60% of the outstanding Series B and Series C preferred stock to require us to redeem such shares, we likely would be unable to immediately pay the redemption amount. In that event, a liability would be recorded on our books and repaid as funds became available.

We have a working capital facility with Silicon Valley Bank that is collateralized by all our assets. Our borrowings under this facility can be no more than the lesser of $8.0 million or 80% of eligible receivables, as such term is defined in the bank agreement, minus the total amounts then undrawn on all outstanding letters of credit, or any other accommodations issued or incurred by Silicon Valley Bank for our benefit. The working capital facility terminates on September 29, 2007. As of September 30, 2006, we had $3.8 million outstanding under the working capital facility and remaining availability of $1.4 million. We also have a $1.0 million equipment line of credit with Silicon Valley Bank that is collateralized by our assets. As of September 30, 2006, we had no outstanding borrowings under this equipment line. We may borrow under this facility at any time prior to December 31, 2006 to finance the acquisition cost of capital equipment purchased after January 31, 2006. At December 31, 2006, all advances under this facility will be converted to a 30-month amortizing term loan.

 
Operating Activities

Net cash used in operating activities was $2.8 million and $0.2 million for the nine months ended September 30, 2006 and 2005, respectively. The net decrease in cash flow from operations for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 resulted from increased payments to vendors, including the professional services, fees and expenses associated with this offering. Accounts receivable increased $2.6 million to $13.0 million at September 30, 2006 from $10.4 million at December 31, 2005. This increase in accounts receivable results from an increase in revenue, the timing of the signing of product contracts and the timing of payments from our customers. Revenue for the quarter ended September 30, 2006 increased 22% over revenue for the quarter ended December 31, 2005, excluding approximately $4.5 million of term license and services revenue recorded in the quarter ended December 31, 2005 that had been fully paid prior to that quarter and had been in deferred revenue. Customers typically make software purchases near the end of a calendar quarters which results in a significant amount of our quarterly revenue being reflected in accounts receivable at the end of each quarter. Net cash used in operating activities for the nine months ended September 30, 2006 consisted of a net loss of $2.6 million, partially offset by non-cash depreciation and amortization of $2.2 million, stock compensation expense of $0.5 million, a decrease of $1.6 million in deferred revenue and by changes in working capital. Net cash used in operating activities for the nine months ended September 30, 2005 consisted of a net loss of $0.8 million, non-cash depreciation and amortization of $1.6 million, an increase in deferred revenue of $3.7 million and a reduction in working capital of $6.3 million. Deferred revenue consists of annual maintenance and subscription fees for the software solutions that are paid in advance and recorded over the service period and advance billings for professional services projects that are recorded using the proportional performance method based upon labor hours expended compared to estimated labor hours to complete the project. Deferred revenue declined $1.6 million to $8.0 million at September 30, 2006 from $9.6 million at December 31, 2005. The reduction was attributable to the amortization of prepaid annual maintenance and subscription fees of $3.0 million partially offset by an increase in advance payments for professional services projects of $1.4 million.

Net cash provided by operating activities was $5.7 million and $2.5 million for the years ended December 31, 2005 and 2004, respectively. Net cash provided from operating activities for the year ended December 31, 2005 primarily resulted from net income of $5.1 million, plus non-cash depreciation and amortization of $2.1 million, and an increase in deferred revenue of $3.7 million, partially was offset by changes in working capital of $5.2 million. Net cash provided from operations for the year ended December 31, 2004 consisted of a net loss of $1.3 million, offset by non-cash depreciation and amortization of $1.9 million and an increase in deferred revenue of $2.0 million, partially offset by changes in working capital of $0.1 million.

63


Back to Contents

Investing Activities

Net cash used in investing activities was $2.0 million and $2.0 million for the nine months ended September 30, 2006 and 2005, respectively. The net change in investing activities resulted from a slightly lower investment in the development of new product features and functionality as the Company focused on the implementation of software products for contracts closed. Net cash used in investing activities for the nine months ended September 30, 2006 related to development activities to enhance our product offering and the capitalization of the cost associated with those projects of $1.1 million and the purchase of office equipment and computer equipment of $0.9 million. Net cash used in investing activities for the nine months ended September 30, 2005, related to development activities to enhance our product offering and the capitalization of the cost associated with those projects of $1.6 million and the purchase of office equipment and computer equipment of $0.4 million.

Net cash used in investing activities was $3.2 million and $2.0 million for the years ended December 31, 2005 and 2004, respectively. Net cash used in investing activities for the year ended December 31, 2005 related to development activities to enhance our product offering and the capitalization of the cost associated with those projects of $2.0 million, the capitalization of contingent payments of $0.1 million related to the acquisition of clinical decision support software at the end of 2002, the capitalization of software developed by an independent firm of $0.8 million and the purchase of office equipment and computer equipment of $0.8 million. Net cash used in investing activities for the year ended December 31, 2004 related to development activities to enhance our product offering and the capitalization of the cost associated with those projects of $0.9 million, the capitalization of contingent payments related to the acquisition of clinical decision support software at the end of 2002 of $0.3 million and the purchase of office equipment and computer equipment of $0.9 million.

Financing Activities

Net cash provided by financing activities was $2.8 million and $1.8 million for the nine months ended September 30, 2006 and 2005, respectively. The net change in financing activities resulted from increased borrowing under the line of credit in 2006 partially offset by higher loan payments in 2006. Net cash provided by financing activities for the nine months ended September 30, 2006 consisted of borrowing against our line of credit of $3.8 million offset by repayments against our capital leases outstanding and our equipment line of credit. Net cash provided by financing activities for the nine months ended September 30, 2005 consisted of borrowing against our line of credit of $2.1 million and borrowing against our equipment line of credit of $0.2 million offset by repayments against our capital leases outstanding.

Net cash used in financing activities was $0.5 million and $0.8 million for the years ended December 31, 2005 and 2004, respectively. Net cash used in financing activities for the year ended December 31, 2005 consisted of borrowings against our equipment line of credit of $0.2 million and repayments against our capital leases outstanding. Net cash used in financing activities for the year ended December 31, 2004 consisted of repayments on our capital leases outstanding and repayment of borrowings on our working capital facility.

<R>

We believe that our cash balances, cash flows from operations and available borrowings under our working capital line of credit, equipment line of credit and capital leases will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next 12 months. We will use approximately $9.5 million of the estimated net proceeds of this offering to pay the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares to common stock upon the consummation of this offering. We intend to use the balance of the net proceeds of this offering for general corporate purposes, including working capital needs. We believe opportunities may exist to expand our current business through strategic acquisitions and investments in technology, and we may use a portion of the proceeds for these purposes. Changes in our operating plans, lower than anticipated revenue, increased expenses or other events, including those described in “Risk Factors” may cause us to seek additional debt or equity financing on an accelerated basis. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans, our financial condition and results of operations. Additional equity financing would be dilutive to the holders of common stock, and debt financing, if available, may involve significant cash payment obligations and covenants or financial ratio requirements that restrict our ability to operate our business. We do not, however, have any current plans to issue additional equity, including preferred stock, in the near future. After this offering and payment of accrued dividends, we expect to have cash and cash equivalents in excess of $29.9 million.

</R>

64


Back to Contents

Contractual Obligations and Commitments

The following table summarizes our contractual arrangements at December 31, 2005, after giving effect to the completion of this offering, and our application of the net proceeds and the timing and effect that such commitments are expected to have on our liquidity and cash flows in future periods:

    Payments Due by Period

 
    2006   2007   2008   2009   2010   Thereafter,
through 2016
 
   

 

 

 

 

 

 
    (in thousands)  
Contractual Obligations:
                                     
Capital leases
  $ 1,428   $ 1,343   $ 988   $ 299   $ 79      
Operating leases
    1,136     1,130     1,009     1,038     1,076   $ 6,874  
Note payable(1)
    100     75                  
Other long term liabilities
        22                  
Third-party software agreements
    588     150     200              
   

 

 

 

 

 

 
Total
  $ 3,252   $ 2,720   $ 2,197   $ 1,337   $ 1,155   $ 6,874  
   

 

 

 

 

 

 
                                       

 
(1)
Excludes interest which is calculated at prime (7.25% at December 31, 2005) plus 1.75%.

The amounts listed above for capital leases represent payments that we are required to make for equipment. If we fail to remain current with our obligations for any of these capital leases, we would be in default, and our continued failure to cure such default would cause our remaining obligations under the defaulted capital lease to become immediately due.

The amounts listed above for operating leases represent base monthly rent on leases for office space and copier and fax equipment, and do not include required variable facility operating expense reimbursements to the landlord. If we fail to make payments on our office space, we will be required to pay all remaining lease payments immediately.

In May 2006, we entered into an operating lease for additional premises. The amounts listed above do not include base monthly rent amounts due under this lease.

We are party to an Amended and Restated Loan and Security Agreement with Silicon Valley Bank dated September 28, 2006 pursuant to which Silicon Valley Bank provides senior debt financing to us. Our obligations under the Amended and Restated Loan and Security Agreement are secured by a lien on all of our assets. The Amended and Restated Loan and Security Agreement includes covenants requiring us to maintain a minimum amount of liquidity and net income. From and after completion of this offering, we must maintain cash and cash equivalents of at least $2.0 million. In addition, our net loss for the quarter ended September 30, 2006 could not exceed $275,000. We are also required to have a minimum net income of $750,000 for the quarter ended December 31, 2006, $1,250,000 for the quarter ended March 31, 2007, $1,600,000 for the quarter ended June 30, 2007 and $2,000,000 for each quarter thereafter. We were in compliance with the net loss requirement as of September 30, 2006 and, given the anticipated proceeds of this offering, we anticipate complying with the liquidity requirement upon the consummation of this offering.

65


Back to Contents

In the event that we make a misrepresentation, breach a warranty or fail to perform a covenant set forth in the Amended and Restated Loan and Security Agreement or if there is a material adverse change in our business, operations or condition (each of which is defined in the agreement as an event of default), Silicon Valley Bank may, among other things, cease making loans to us, accelerate the date for payment of all of our outstanding obligations to the bank and/or take possession of and sell all of our assets. Additionally, from and after the occurrence and during the continuance of an event of default, the then current interest rate on the outstanding loans under the Amended and Restated Loan and Security Agreement will increase by 5%.

We are party to a contract to purchase third-party licenses from a software vendor. The agreement expired on December 31, 2005; however, the agreement automatically renews on an annual basis, unless terminated by either party. Expense of $0.5 million and $0.5 million was incurred under this agreement in each of 2005 and 2004 and is included in cost of revenue in the accompanying financial statements. Scheduled future minimum payments as of December 31, 2005 under this contract are $0.5 million in 2006.

We are party to a contract whereby we are obligated to make minimum royalty payments on an annual basis. Total minimum royalty payments under this agreement aggregate $0.5 million and are recorded ratably over the four year term of the agreement. We recorded $0.1 million and $0.1 million of expense under this agreement for each of the years ended December 31, 2005 and 2004. Scheduled future minimum payments as of December 31, 2005 under this contract are $0.5 million.

 
Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates. We do not hold or issue financial instruments for trading purposes.

Interest Rate Risk

The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we may invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities, certificates of deposit and money market funds. Money market funds are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. However, a decline in interest rates would result in reduced future investment income.

Our interest expense, generally, is not sensitive to changes in prevailing interest rates since the majority of our borrowings outstanding, capital leases, are at a fixed rate. Borrowings under our working capital and equipment lines of credit are subject to adjustments in prevailing interest rates. Future increases in prevailing rates will increase future interest expense. However, we do not believe a 10% increase in prevailing interest rates will have a material effect on our interest expense.

Recent Accounting Pronouncements

In December 2004 the FASB issued SFAS No. 123R, Share-Based Payment, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123R is a revision to SFAS No. 123 and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires companies to recognize the fair value of stock options and other stock-based compensation to employees, including grants of employee stock options, effective January 1, 2006. SFAS No. 123R requires us to measure the cost of employee services received in exchange for stock compensation based upon the grant-date fair value of the employee stock options. Incremental compensation costs arising from subsequent modifications of awards after the grant date must also be recognized as compensation expense.

 

66


Back to Contents

Prior to January 1, 2006, we measured stock-based compensation in accordance with APB No. 25. Beginning January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R and have reflected share-based compensation of $0.5 million in the results of operations for the nine months ended September 30, 2006. Based upon the stock options outstanding at December 31, 2005 and options granted in January 2006, we will recognize compensation expense in future consolidated statements of income of approximately $0.7 million and $0.8 million for the years ended December 31, 2006 and 2007, respectively, based upon the option vesting schedule. Under the prospective-transition method of SFAS No. 123R, results for prior periods have not been restated. The impact on our financial condition or results of operations will depend on the number and terms of share-based payments granted in the future.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3. Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (i) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle and (ii) a correction of errors in previously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. We do not expect adoption of SFAS No. 154 to have a material effect on our results of operations or financial condition.

In June 2005, the EITF reached a consensus on EITF Issue No. 04-10, Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds. This guidance requires that individual operating segments that do not meet the quantitative thresholds set forth in SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, for separate reporting may be aggregated only if the segments meet certain requirements. These requirements are applicable for fiscal years ending after October 13, 2004. The adoption of EITF Issue No. 04-10 does not affect us because we currently operate in only one segment.

In September 2005, the EITF reached consensus on EITF Issue No. 05-02, The Meaning of “Conventional Convertible Debt Instrument” in EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. EITF Issue No. 05-02 is effective for new instruments entered into and instruments modified in reporting periods beginning after June 29, 2005. The adoption of EITF Issue No. 05-02 is expected to have no impact on our financial statements.

At the June 15-16, 2005 EITF meeting the EITF discussed EITF Issue No. 05-04, The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. EITF Issue No. 05-04 addresses how a liquidated damages clause payable in cash affects the accounting for a freestanding financial instrument subject to the provisions of EITF Issue No. 00-19. The guidance discussed (i) whether a registration rights penalty meets the definition of a derivative and (ii) whether the registration rights agreement and the financial instrument to which it pertains should be considered as a combined instrument or as separate freestanding instruments. At the September 15, 2005 EITF meeting, the EITF postponed further deliberations on EITF Issue No. 05-04, and the FASB staff requested that the FASB consider a separate Derivatives Issue Guide, or DIG, issue that addresses whether a registration rights agreement is a derivative in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging. Following the resolution of that DIG issue, the FASB staff will request that the EITF reconvene deliberations on EITF Issue No. 05-04. While EITF Issue No. 05-04 remains unresolved, we have determined that the liquidated damage clauses contained in our convertible note agreements have been properly considered and accounted for in accordance with the prevailing guidance.

In July 2006, FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, or FIN 48, which clarifies the accounting for uncertainty in tax positions. This interpretation requires the financial statement recognition of a tax position taken or expected to be taken in a tax return if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that the adoption of FIN 48 will have on its financial condition and results of operations.

67


Back to Contents

In July 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements. This statement provides guidance for using fair value to measure assets and liabilities, and applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. This statement will become effective for us as of January 1, 2007, and while expected to result in additional disclosures, is not expected to have a material effect on our results of operations or financial condition.

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued to provide consistency between how registrants quantify financial statement misstatements.

Historically, there have been two widely-used methods for quantifying the effects of financial statement misstatements. These methods are referred to as the “roll-over” and “iron curtain” method. The roll-over method quantifies the amount by which the current year income statement is misstated. Exclusive reliance on an income statement approach can result in the accumulation of errors on the balance sheet that may not have been material to any individual income statement, but which may misstate one or more balance sheet accounts. The iron curtain method quantifies the error as the cumulative amount by which the current year balance sheet is misstated. Exclusive reliance on a balance sheet approach can result in disregarding the effects of errors in the current year income statement that results from the correction of an error existing in previously issued financial statements. We currently use the rollover method for quantifying identified financial statement misstatements, but we will use both methods after adoption of SAB 108.

SAB 108 established an approach that requires quantification of financial statement misstatements based on the effects of the misstatement on each of a registrant’s financial statements and the related financial statement disclosures. This approach is commonly referred to as the “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods.

SAB 108 allows registrants to initially apply the dual approach either by (1) retroactively adjusting prior financial statements as if the dual approach had always been used or (2) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. Use of this “cumulative effect” transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose.

We initially applied SAB 108 using the retroactive transition method in connection with the preparation of our interim financial statements for the nine months ending September 30, 2006. When we initially applied the provisions of SAB 108, we did not record a material adjustment as of September 30, 2006.

 
Controls and Procedures; Material Weaknesses in Internal Controls and Changes in Accountants

On March 14, 2006, upon the authorization of our board of directors acting on the recommendation of the audit committee of the board of directors, we selected Grant Thornton LLP as our independent registered public accounting firm. We did not consult with Grant Thornton on any financial or accounting reporting matters before its appointment. All of the audited financial statements included in this prospectus have been audited by Grant Thornton.

In connection with the audits of our financial statements for the years ended December 31, 2005, 2004 and 2003, Grant Thornton identified and informed us that we had material weaknesses (as defined under the standards established by the Public Company Accounting Oversight Board – U.S.) with respect to our accounting and reporting of certain complex transactions, as more specifically described below. As a result of these material weaknesses, we restated our financial statements as of and for the years ended December 31, 2005, 2004 and 2003. Our selected financial data as of and for the years ended December 31, 2002 and 2001 were derived from financial statements, which we restated as a result of these material weaknesses and which were audited by Grant Thornton.

 

68


Back to Contents

KPMG LLP (KPMG) was previously the principal accountants for the Company. On March 14, 2006, upon the authorization of our board of directors acting on the recommendation of our audit committee, we dismissed KPMG as our independent registered public accounting firm. The audit report of KPMG on our consolidated financial statements as of and for the year ended December 31, 2004 did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles, except that such report contained a separate paragraph stated as follows: “We also audited the adjustments described in Note 3 to the accompanying consolidated financial statements that were applied to restate the 2003 financial statements. The consolidated financial statements of the Company as of December 31, 2003 were audited by other auditors whose report thereon dated February 25, 2004, expressed an unqualified opinion on those statements, before the restatement described in Note 3 to the consolidated financial statements.”

In connection with the audit of the year ended December 31, 2004, and the subsequent interim period through March 14, 2006, there were (i) no disagreements with KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of KPMG, would have caused KPMG to make reference in connection with its report to the subject matter of the disagreements, and (ii) no reportable events of the type listed in paragraphs (A) through (D) of Item 304(a)(1)(v) of Regulation S-K, except that KPMG reported orally to and discussed with our audit committee on December 16, 2005 that during its audit of the consolidated financial statements as of and for the year ended December 31, 2004, it noted material weaknesses in internal controls related to accounting for revenue recognition, accounting for the accretion of costs and dividends related to preferred stock and accounting for income taxes, as more specifically described below. We have authorized KPMG to respond fully to any inquiries by our successor independent registered accounting firm, Grant Thornton, regarding these material weaknesses.

On May 27, 2005, upon the authorization of our board of directors, acting on the recommendation of our audit committee, we dismissed Goldenberg Rosenthal, LLP and engaged KPMG as our independent registered public accounting firm. We did not consult with KPMG on any financial or accounting reporting matters before its appointment.

In connection with the audit of the year ended December 31, 2003 and the subsequent interim period through May 27, 2005, there were no disagreements with Goldenberg Rosenthal on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Goldenberg Rosenthal, would have caused them to make reference thereto in their report on our financial statements for such years. The audit report of Goldenberg Rosenthal on our consolidated financial statements as of and for the year ended December 31, 2003 did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principle.

In connection with the audit of our financial statements as of and for the years ended December 31, 2005, 2004 and 2003, in July 2006, our independent auditors reported to our audit committee and informed us that we had material weaknesses (as defined under the standards established by the Public Company Accounting Oversight Board – U.S.) with respect to our accounting and reporting of certain complex transactions. In addition, in December 2005, in connection with their audit of our financial statements as of and for the year ended December 31, 2004, our previous independent auditors reported material weaknesses in our internal controls as defined under auditing standards generally accepted in the United States of America. A material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

69


Back to Contents

As a result of the material weakness reported by our independent auditors, we restated our financial statements as of and for the years ended December 31, 2005, 2004 and 2003 as summarized in the following table:

Change in:
(amounts in $ millions):
    December 31,
2005
    December 31,
2004
    December 31,
2003
 

 

 

 

 
Total assets
        (0.9 )   (1.1 )
Liability for fair value of conversion options
    (4.9 )   0.6     0.02  
Additional paid-in capital—beneficial conversion feature
    (2.2 )        
Shareholders’ deficiency
    (6.1 )   (51.7 )   (12.5 )
Net revenue
        (0.5 )   1.6  
Income from operations
        (0.09   1.7  
Change in fair value of conversion option
    (3.6 )   0.6     (0.04 )
Net income or loss
    3.6     (0.7 )   1.7  
Accretion of convertible preferred and redeemable convertible preferred shares
    (2.2 )   6.1     8.0  
Increase (decrease) in net income available to common shareholders
    5.8     (6.8 )   (6.2 )

The following material weaknesses were reported by our independent auditors in connection with their audit of our financial statements as of and for the year ended December 31, 2005 and re-audit of the financial statements as of and for the years ended December 31, 2004 and 2003:

 
We did not have adequate controls to provide reasonable assurance that all elements of contractual arrangements with customers were being recorded in accordance with generally accepted accounting principles. Specifically, we did not have adequate controls to properly determine that persuasive evidence of contractual arrangements with customers existed before recording revenue. Errors in determining that contracts had been signed by customers resulted in the premature recognition of revenue that should have been deferred to later periods, in accordance with Statement of Position 97-2 (SOP 97-2), “Software Revenue Recognition,” and related interpretations. As a result of these identified deficiencies, material revenue-related audit adjustments were recorded to our financial statements to defer revenue from the periods in which they were originally recorded until such time as the appropriate revenue recognition criteria were met.
     
 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for our Series A convertible preferred stock and Series B and C redeemable convertible preferred stock to provide reasonable assurance that all transactions were being appropriately recorded and summarized in the financial statements. Specifically, we did not properly identify and record the beneficial conversion option relating to the accrued and unpaid dividends on our Series A convertible preferred stock. We did not identify and record the embedded derivative conversion option on our Series B and C redeemable convertible preferred stock and reflect the changes in the fair value of those conversion options in earnings. We did not accrete the carrying value of the Series C redeemable convertible preferred stock to liquidation value, which was three times the stated value. As a result of these identified deficiencies, we recorded material post-closing audit adjustments to our financial statements for the years ended December 31, 2005, 2004 and 2003.

As a result of the material weakness reported by our previous independent auditors in we restated our financial statements as of and for the year ended December 31, 2003, which resulted in a $8.1 million decrease in total assets, a $43.3 million increase in shareholders’ deficiency, a $2.8 million decrease in income from operations, a $10.8 million decrease in net income before and after taxes and a $2.0 million decrease in net income available to common shareholders.

The following material weaknesses were reported by our previous independent auditors in connection with their audit of our financial statements as of and for the years ended December 31, 2004 and 2003:

 
Errors in revenue recognition were identified that resulted primarily from a lack of secondary review over the application of accounting principles to specific contract terms as well as the analysis and estimates supporting the amounts recorded. These errors resulted from the lack of a systematic process for accumulating information supporting VSOE and underlying recorded revenue as well as the lack of appropriate levels of review. As a result, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.

 

70


Back to Contents

 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for our Series A convertible preferred stock and Series B and C redeemable convertible preferred stock to provide reasonable assurance that all transactions were being appropriately recorded and summarized in the financial statements. Specifically, we did not accrete the carrying value to redemption value at the earliest redemption date and did not properly record the accrued and unpaid dividends on Series A convertible preferred stock and Series B and C redeemable convertible preferred stock. As a result of these identified deficiencies, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.
     
 
We did not have appropriate accounting personnel who possessed an appropriate level of experience in the selection and application of generally accepted accounting principles with respect to the accounting for income taxes, specifically the appropriate valuation allowance for deferred tax assets. As a result of this material weakness, we recorded material post-closing audit adjustments to our financial statements for the year ended December 31, 2003.

These material weaknesses may have contributed to the errors corrected in the restatement of our financial statements as of and for the years ended December 31, 2005, 2004 and 2003.

We have begun our remediation efforts and we believe that our actions in this regard have strengthened our internal controls over financial reporting. Our efforts include the following:

 
Expanding our accounting staff to add additional skills and experience, specifically experience in revenue recognition for software sales and services to address the weaknesses related to revenue recognition, income taxes and complex accounting transactions, as well as to document, test and enhance our overall internal control environment, and we will continue the expansion of our accounting staff, as well as the use of qualified outside professionals as necessary to enhance and maintain our internal accounting controls;
     
 
To address the material weakness in internal controls over revenue recognition, we have instituted new internal accounting controls, including a detailed review of new contracts by qualified accounting personnel to appropriately recognize and record revenue from term license sales as well as the sales from professional services and subscription and maintenance. In addition, we have instituted new internal accounting controls over the pricing of our separate software and service offerings;
     
 
Instituted new accounting procedures to accrete the value of our preferred stock to its redemption value at the earliest redemption date and to accrete the value of our preferred stock for accrued but unpaid dividends by class to address the weaknesses related to recording complex transactions; and
     
 
To help address the material weaknesses related to revenue recognition, preferred stock, income taxes and accounting for complex transactions, we have engaged qualified outside professionals to assist our accounting staff in analyzing and recording current and deferred income tax provisions and benefits, assets and liabilities, and will continue to do so as necessary to improve, enhance and maintain our system of internal accounting controls.

Although initiated, our plans to improve the effectiveness of our internal controls and processes are not complete. We anticipate that it will take some time to establish the disclosure controls and procedures desired by our management and our board of directors. While we expect to complete this remediation process as quickly as possible, we cannot at this time estimate how long it will take to complete the remedial steps identified above because doing so depends on several factors beyond our control, including the hiring of additional qualified personnel.

As of September 30, 2006, we have incurred approximately $0.1 million of costs related to our efforts to remediate our material weaknesses. While the costs associated with our remediation efforts to date have not been material, we cannot assure you that we will not incur material costs in remediation in the future. We will continue to evaluate the effectiveness of the control environment and will continue to refine existing controls. We cannot assure you that the measures we have taken to date or any future measures will remediate the material weaknesses reported by our independent auditors. Additional deficiencies in our internal controls may be discovered in the future. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our prior period financial statements. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our common stock.

71


Back to Contents

In addition, these material weakness and any other deficiencies in internal controls that we identify in the future will need to be addressed as part of the evaluation of our internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and may impair our ability to comply with Section 404.

For a description of risks associated with our internal controls, please see “Risk Factors – If we fail to develop or maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our common stock.”

72


Back to Contents

BUSINESS

Company Overview

We are a provider of software, services and clinical content to healthcare payers that allow them to improve the quality and affordability of healthcare provided to their members and increase their administrative efficiency. Our Collaborative Care Management solution analyzes data, automates payer workflow processes and electronically connects payers, providers and patients, providing them with a common view of the patient’s health that helps to foster better clinical decision making. Our solution is built around a suite of modular and easily configurable software applications and utilizes the Internet to link our payer customers to their members and their members’ chosen healthcare providers.

Our Collaborative Care Management solution is comprised of two related suites of products – Integrated Medical Management and Collaborative Data Exchange. Our Integrated Medical Management suite allows our healthcare payer customers to identify active care management opportunities among their members and automate an intervention process based on clinical best practices. Our Integrated Medical Management suite also helps our customers reduce internal administrative costs by automating traditionally manual processes. Our Collaborative Data Exchange suite allows our customers to securely transmit health records containing critical patient information in an easily understood format to patients and providers at the time they are making treatment decisions. We refer to these health records as Patient Clinical Summaries, and believe that they are a critical first step to developing Electronic Health Records. In the future, we expect our Patient Clinical Summaries to integrate additional information provided by patients and a broad range of providers, thereby increasing their value to all constituents.

As of September 30, 2006, our customers included approximately 56 regional and national managed care organizations, including the largest organizations in more than 27 regional markets. Based on our review of publicly available information and our customers’ enrollment data, we believe that, in the aggregate, our customers insure or manage care for approximately one out of every six insured persons in the United States. Depending on the application, we provide our solutions on an annual subscription basis, under limited term licenses or on a per-transaction basis, both of which provide us with recurring revenue. We primarily license our solutions through direct sales to customers in the United States. Our revenue has increased at a compound annual growth rate of 32.8% since 2001, to $38.6 million for the year ended December 31, 2005, from $12.4 million for the year ended December 31, 2001.

Industry Overview

The Centers for Medicare & Medicaid Services, or CMS, projected that more than $2.0 trillion was spent on healthcare in 2005, representing 16% of the U.S. Gross Domestic Product, or GDP. CMS estimates that spending will grow to $4.0 trillion by 2015, or 20% of the GDP, representing 7.2% annual growth since 2004. Healthcare costs are increasing in part due to improvements in medical technology and medical treatments, but also because of increases in general utilization of healthcare products and services. Rising healthcare costs negatively impact a wide array of constituencies, including federal and state governments, employers, consumers and healthcare providers. However, we believe that the broad array of healthcare payers is the most directly impacted. Payers include federal and state government programs like Medicare, Medicaid and public employee health benefit plans, large commercial insurers and numerous other national, regional and local health plans and administrators and self-insured corporations. Rising healthcare costs consistently threaten to negatively impact these payers.

We believe that payers have two options if they are to maintain their viability. First, payers can proactively manage the delivery of healthcare services and products to their members to improve the quality and cost of care. Second, they can offset rising healthcare costs by reducing their internal administrative costs through efficiency gains. To the extent they are not successful at proactively managing care more effectively and reducing their internal administrative costs, payers must pass the rising cost of healthcare on to their customers and their members. Passing on these costs ultimately threatens the payers’ relationships with their customers and/or members as enterprises and consumers also seek to lower their healthcare-related expenditures. Accordingly, payers are consistently seeking new strategies to more effectively manage the care delivery process for their members and reduce their internal operating costs. According to a Gartner survey entitled “Healthcare Payers’ IT Budgets Continue to Climb,” published on April 17, 2006, health plans’ information technology budgets increased by over 25% on a per member basis from 2002 to 2004. We believe, based on our research, that the market for care management solutions is currently in excess of $1 billion per year and is growing at a compound annual growth rate in excess of 15.8%.

73


Back to Contents

 
Overuse, underuse and misuse of medical services and treatments is widespread.

We believe that one of the material contributors to rising healthcare costs is overuse, underuse and misuse of medical services and treatments caused by providers lacking timely access to necessary patient information and providers consistently failing to apply clinical best practices, which we refer to as poor-quality care. We believe that this combination has led to avoidable medical errors, injuries and fatalities. For example, The Institute of Medicine reported in November 1999 that as many as 98,000 people die in hospitals each year as a result of preventable medical errors. Additionally, an article in the Wall Street Journal dated May 23, 2006 reported that the Institute for Healthcare Improvement found that poor communication is responsible for as many as 50% of all medication errors and up to 20% of adverse drug events in hospitals.

Providers Generally Lack Necessary Patient Information. We believe that a primary contributor to medical errors is generally the lack of information exchange among different providers treating the same patients. Generally, providers have access to only the patient information contained in their own files and systems. For providers seeing a patient for the first time, the information is often limited to information provided by the patient, which is generally rudimentary, incomplete or inaccurate. We believe that this issue is particularly acute in emergency room situations where physicians need to make quick decisions about how to treat a patient, and generally lack the critical information that they need to provide the patient with optimal care. We believe that this absence of complete patient information has a negative impact on the quality and cost of care by causing providers to misdiagnose medical conditions, prescribe medications that negatively interact with each other, and order duplicative or medically unnecessary tests and procedures.

In an effort to address this critical roadblock to improving quality of care, in 2004, President Bush appointed a National Coordinator for Health Information Technology to develop a strategy for a national health information infrastructure. Largely as a consequence, we believe that electronic health information networks are gaining popularity as a potential means to foster the exchange of healthcare data by linking payers, providers and patients to the same network. Both the Nationwide Health Information Network and its regional counterparts, the Regional Health Information Organizations, depend on the existence of Electronic Health Records, or EHRs, for their success. EHRs are intended to provide a comprehensive view of a patient’s health status and care history compiled from an individual patient’s information across the healthcare system. We believe that EHRs will eventually consolidate information supplied by payers (Payer Based Health Records), information supplied by providers (Electronic Medical Records, or EMRs) and information supplied by patients (Personal Health Records, or PHRs).

However, an impediment to creating EHRs in the near term is the relative scarcity of detailed electronic patient data. According to a U.S. Department of Health and Human Services study, published by the Centers for Disease Control in March 2005, only 17% of physicians were utilizing EMR systems in their practices in 2003, and under a third of hospitals were utilizing EMRs in 2002. In terms of patient-supplied data, we believe that PHRs are in their infancy. Based on our analysis of industry reports and our customers’ experience with Internet applications they provide to their members, we believe that fewer than 1% of the population of the United States has created and maintains an electronic PHR for themselves and/or their families. As a result, we believe that today’s only reliable source of comprehensive patient data comes from payers, which have vast amounts of member data contained in their legacy claims processing and care management systems.

74


Back to Contents

Clinical Best Practices Are Not Universally Applied by Providers. Even when physicians have a reasonably complete picture of a patient’s status, physicians often do not have all of the medical information that would help them treat the patient, thereby putting the patient’s health at unnecessary risk. A wide array of medical organizations, such as the American Medical Association, American Diabetes Association and American Heart Association, consistently update clinical best practices for treatment of medical conditions and chronic diseases. Although providers have access to this information, based on a RAND study published in the New England Journal of Medicine in June 2003, we believe that clinical best practices are not employed approximately 45% of the time. Failure to apply clinical best practices can raise healthcare costs by decreasing the quality and cost effectiveness of the treatment. We believe that these failures occur for a variety of reasons, including provider inability to keep up with clinical best practices due to the volume of medical conditions and diseases and the frequency that clinical best practices change.

Given the magnitude of the challenges facing the healthcare system, the need for payers to respond to rapid increases in medical costs, and the capital requirements for information systems to address the challenges, we believe that the payers are the logical drivers of change. Payers, however, face their own challenges.

Payers generally lack systems to effectively and efficiently address poor-quality care.

Due to their role in the healthcare system, payers are uniquely positioned to identify poor-quality care and have an interest in improving outcomes for their members to reduce the cost of care. As the financial intermediary between the provider and patient, payers have the opportunity to monitor the care provided to their members through active care management programs. Payers have a large volume of patient information in electronic format contained in their legacy claims processing and care management systems. However, we believe that payers generally lack the information technology systems to play these roles effectively and efficiently. Based on our experience, we believe that payers generally rely on a combination of manual processes, third-party point solutions and proprietary systems for many components of the care management process. As a result, we believe that these processes generally suffer from the following critical weaknesses:

Payers Cannot Effectively and Efficiently Identify High-Risk Patients. In order for payers to identify poor-quality care, they must monitor the care provided to their members. Payers widely rely on manual processes, third-party providers or their own proprietary systems with limited functionality and scalability to identify high-risk members. The administrative cost of using clinical staff to closely monitor every member is prohibitively expensive and materially outweighs the financial benefits. For payers to have a positive influence on quality and cost of care at an acceptable administrative cost, we believe that they must have the technology to identify members with a high risk of substantial healthcare costs, including members with chronic diseases such as diabetes, or severe medical conditions such as breast cancer. While identifying patients whose historical costs have been high is relatively easy, the challenge is to identify those patients who will incur high costs in the next 12 to 18 months. We believe that less than 20% of payers’ most seriously ill members are responsible for a majority of the payers’ healthcare costs.

Payers Lack Information Systems to Optimally Manage Member Care. Payers employ teams of doctors and nurses, who are in short supply and highly compensated, to monitor the care provided to high-risk members and often intervene where necessary. These professionals review each patient’s treatment plan against clinical best practices and intervene with the treating provider and patient to the extent poor-quality care exists. This process is referred to as care management. In our experience, these care management professionals lack comprehensive information technology systems to support their workflow processes. Furthermore, they often rely on manual, ad-hoc processes to interject clinical best practices into their workflow. As a result, we believe that the traditional care management process suffers from the following weaknesses:

 
care managers fail to consistently identify poor-quality care;
     
 
care managers’ intervention processes have a high risk of manual error;
     
 
care managers cannot consistently apply the most recent clinical best practices;
     
 
payers fail to capture and analyze valuable historical data; and
     
 
payers can only apply care management to the most obvious, highest cost members.

75


Back to Contents

Payers Lack Systems Necessary to Share Critical Patient Information Internally and With Providers. We believe that payers have the most comprehensive base of patient information in electronic format. Their legacy claims and care management systems contain basic member identification information as well as raw data on the member’s historical medical conditions, inpatient facility admissions, emergency room visits, tests and procedures, medications and providers. This information, once processed and validated, can be utilized throughout a payer’s organization to help to improve the quality of care. However, this generally does not occur, because many payers’ legacy systems are not integrated with other systems. Therefore, data housed in one system cannot be leveraged by other functional departments without direct access to that system. The information contained in payers’ legacy systems can be even more valuable at the point of care. For example, we believe that this basic information would increase an emergency room doctor’s ability to provide high quality care when presented with an unconscious patient. However, in order for this information to positively influence care decisions, providers must have on-demand access to this information in an easily understood format. To date, payers have lacked the systems necessary to automatically assemble the data, review the data for inconsistencies, analyze and summarize the data and disseminate the data internally and to providers in real time.

 
Benefits of Our Solutions

Our Collaborative Care Management solution is comprised of two related suites of products – Integrated Medical Management and Collaborative Data Exchange. Our Integrated Medical Management suite is a seamless payer-based care management system that analyzes, applies, administers and automates healthcare programs based on actionable intelligence. It assembles current and historical data and transforms it into an easily understood format. Our Integrated Medical Management suite also provides comprehensive, automated tools to ensure the most efficient handling of the information and consistent application of rules throughout the collaborative care management decision making process. Our Collaborative Data Exchange suite enables providers to obtain a Patient Clinical Summary, which includes the patient’s demographic information, medical conditions, medications, providers and treatment opportunities in an on-demand, easy to use format. As a result, the Patient Clinical Summary allows patients and providers to leverage the same actionable intelligence at the point of care as the care manager. We believe that these solutions promote collaborative health care management where all healthcare stakeholders – the payer, the provider and the patient – participate in helping to obtain the best outcome at the best cost.

We believe our solutions allow our payer customers to improve the quality of care and reduce costs by enabling payers to:

 
Identify high-risk members. Our solutions automatically organize the data contained in our customers’ legacy claims processing and care management systems and apply proprietary algorithms to that data to classify their members based on their risk of incurring material medical costs. We believe that these solutions increase the effectiveness of our customers’ care management programs by more accurately and efficiently identifying members that would benefit from active disease or case management, thereby helping to improve the quality and to reduce the cost of care.
     
 
Promote consistency and reduce manual errors and administrative costs through automation. Our solutions automate the workflow process for utilization management, case management and disease management. With respect to utilization management, our solutions automate workflow processes to enable our customers to adjudicate approximately 85% of healthcare authorization requests from providers without manual intervention and guides utilization management specialists through the workflow process for the remaining, more complex cases. By doing so, these solutions allow our customers’ specialists to handle more cases and to focus on more complex value-added tasks, thereby reducing administrative costs. With respect to case management and disease management, our solutions guide care management specialists through a systematic intervention process specifically tailored to the member’s medical condition or disease based on clinical best practices and our customers’ internal rules and guidelines. By doing so, we believe our solutions promote consistent utilization and care management processes that are less prone to manual error, thereby helping to improve the quality and to reduce the cost of care.
     

76


Back to Contents

   •
Promote the consistent application of clinical best practices. Our solutions enable care management professionals to apply clinical best practices and best processes when adjudicating the medical appropriateness of requested services, evaluating treatment plans and creating intervention plans. Accordingly, adjudications are more accurate and care management intervention plans are more consistently based on clinical best practices helping to improve the quality and to reduce the cost of care.
     
 
Utilize analytics to improve processes. The reporting tools contained in our solutions allow our customers to analyze historical results to determine which care management interventions were generally the most effective in improving the quality of care and cost efficiency. These tools allow our customers to continually refine and improve their internal care management rules and guidelines.
     
 
Enable enhanced information access. Our solutions establish a single source of clinical information that supports integration with our customers’ other operational systems to ensure that care managers have access to the most current information. By providing access to all relevant data, we allow more effective care management programs. Our solutions also allow patients and providers to obtain a Patient Clinical Summary, which includes patient demographic information, medical conditions, providers and treatment opportunities in an on-demand, easy to use format. By providing this critical patient information to patients and providers in an easily understood format in real time, we believe that we improve the quality and reduce the cost of care. For example, in a recently completed study dated July 24, 2006 that we commissioned to be conducted on our behalf by HealthCore, Inc., a data analysis company owned by Wellpoint, the sharing of Patient Clinical Summaries by BlueCross BlueShield of Delaware with the staff at the emergency department for Christiana Care Health System greatly reduced the cost of care for patients seen in the emergency room. The study compared the costs of services delivered in the emergency department, and for those patients admitted to the hospital during their first day of hospitalization. HealthCore included data on 918 emergency room visits where Patient Clinical Summaries were retrieved and 3,590 matched “control” visits where no Patient Clinical Summaries were used. The conclusion was that overall costs paid by the health plan and the patient dropped by an average of approximately $545 per emergency department visit, or 19.7% of the average cost of the control visits that did not utilize this information.
 
Our Strategy

Our goal is to be the leading provider of care management solutions and to encourage market-wide adoption of our Patient Clinical Summaries. Key elements of our strategy include:

 
Continue to expand our relationships with customers. We have developed strong customer relationships, which we believe provide us with both recurring revenue streams from those customers and cross-selling opportunities. During 2005, we renewed approximately 100% of our customer contracts which were subject to renewal. Historically, our revenue per customer has increased as we have expanded our penetration within those customers by including more members and increasing the number of solutions purchased by those customers. We will further strengthen relationships with our existing customers to ensure a consistent renewal rate in the future. We also intend to develop innovative cross-selling programs to continue to increase our revenue per customer.
     
 
Innovate new solutions and lead the next generation of Collaborative Care Management. Over the past seven years, we have introduced several new solutions and expanded our clinical content in response to the unique needs of our customers. We have accomplished this expansion through internal development, as well as acquisitions. We intend to further develop innovative solutions, both internally and through acquisitions, to improve the quality and cost of care and increase administrative efficiency. In particular, we intend to lead the market in the development of the next generation of Collaborative Care Management solutions. To that end, we are currently developing two new software modules, called MEDeWeaver and MEDePathway, which we expect will allow providers and patients to populate Patient Clinical Summaries with additional information. We expect these expanded solutions to serve as the foundation for electronic health records by aggregating payer, provider and patient-contributed information.
     

77


Back to Contents

  • 
Apply resources to ensure provider adoption of Patient Clinical Summaries. We released our Collaborative Data Exchange suite in 2005 and currently are deploying it for eight managed care organizations. We generate a transaction fee for each Patient Clinical Summary delivered to a provider. Therefore, the growth in revenue for our Collaborative Data Exchange suite is contingent upon adoption of Patient Clinical Summaries by providers. In order to cultivate provider adoption, we created a specialized marketing and training team and worked with our customers’ provider relations departments to strengthen our ability to increase usage of our Patient Clinical Summaries. We intend to continue to creatively apply resources in order to encourage provider adoption of Patient Clinical Summaries.
     
 
Expand our customer base. We have grown our annual revenue to $38.6 million in 2005 by licensing our solutions to approximately 56 customers. We estimate that there are at least 300 additional managed care organizations in the United States that could benefit from our solutions. Because they share the same challenges as our existing customers, we believe that self-insured companies and Medicare and Medicaid organizations are also attractive target customers. Our strategy also includes committing resources to license our solutions into smaller payers in markets where our larger customers have rolled out our principal connectivity module, Transactions and Information Exchange. We believe these smaller payers can achieve high productivity gains from the already established provider adoption of our self-service tools. Furthermore, we expect that the emerging Regional Health Information Organizations will provide us with a new market opportunity. We intend to continue to invest in sales and marketing to increase awareness of our solutions within the payer market and obtain additional payer customers.
     
 
Continue to build recurring and predictable revenue streams. Historically, we derived most of our revenue from our Advanced Medical Management module, for which our customers purchase five-year term licenses. Although this module provides us with a recurring revenue stream, the size of the license fee and the fact that we recognize the license fee at the time we enter into the contract has caused this revenue stream to fluctuate, sometimes significantly, from quarter to quarter. In 1999, we began offering our customers additional solutions and clinical content for which they pay annual subscription fees or transaction fees. These revenue streams provide us with greater quarterly revenue visibility as we recognize the revenue from annual subscription fees ratably over the term of the license and from transactions as they occur. We intend to continue to develop new solutions for which our customers will pay annual subscription fees or transaction fees.
 
Our Collaborative Care Management Solution
 
Our Integrated Medical Management Suite

Our Integrated Medical Management suite consists of four major modules: Analytics and Disease Management, Advanced Medical Management, Clinical Rules and Processes and Transactions and Information Exchange.

 

78


Back to Contents

Analytics and Disease Management. Our Analytics and Disease Management module is a decision support module which provides our customers with the patient identification, clinical analysis and risk stratification tools necessary to identify diseases and conditions that materially affect cost and clinical utilization.

 
Payer Based Health Record. Our Analytics and Disease Management module automates the creation of an electronic Payer Based Health Record for each of a payer’s members. It does so by aggregating the data contained in the payer’s legacy claims processing systems, capturing all of the raw data related to a specific member and combining that information with the care management data that exists in the Advanced Medical Management module. After gathering the data, our module applies proprietary algorithms and embedded clinical content to analyze the data for inconsistencies. For example, the existence of one test for diabetes without corresponding evidence of treatment for diabetes does not result in the listing of diabetes on the member’s list of medical conditions. Once the Payer Based Health Record has been created, it is available for use in all of our other solutions, as well as for reporting and further analysis.
     
 
Risk stratification. Leveraging the same data utilized to create the Payer Based Health Record, our Analytics and Disease Management module automatically identifies members who could immediately benefit from active disease or case management to help to improve clinical or cost outcomes. After patients have been identified and their clinical information analyzed, proprietary algorithms, and in some cases third-party applications, contained in our module classify members, enabling our customers to match the intensity of the case or disease management resources with the patient’s need. In conjunction with the stratification methodology, our Analytics and Disease Management module establishes a set of triggers for specific events that indicate whether a member is likely to become a cost or utilization outlier. These triggers can be customized to match the specific clinical criteria used by our customers, or provided as part of the Clinical Rules and Processes module.
     
 
Integration with Advanced Medical Management and reporting. When integrated with our Advanced Medical Management module, the data derived by our Analytics and Disease Management module is then electronically integrated with our customers’ care management workflow system. After a care management program has been established, the reporting tools provided in our Analytics and Disease Management module allow our customers to determine which interventions were the most efficient in meeting the plan’s goals, which were the most cost effective and which led to the best health outcomes for their members. This information allows the payers’ medical directors to begin to develop best practice models, monitor their effectiveness and then modify the best practice models as necessary.

Advanced Medical Management. Our Advanced Medical Management module serves as the core of the Integrated Medical Management suite, enabling our customers to manage all aspects of their care management programs, providing centralized reporting and establishing a single source of clinical information leveraged by each component of the integrated suite. The module supports integration with our customers’ other operational systems, such as claims and eligibility systems, to ensure that payers’ care managers have access to the most current data and that those operational systems have access to the most current care management data. It also assists our customers with meeting regulatory and accreditation requirements for consistent care management processes.

 
Workflow automation. Leveraging this comprehensive data repository, our Advanced Medical Management module automates workflow across the continuum of the care management process including:
     
 
Utilization management. This quality assurance process allows payers to confirm the medical necessity of healthcare services and products. Utilization management generally includes the clinical review of hospital admissions, organ transplants, elective surgeries, high-tech diagnostic tests and expensive medications, often before the service or product is delivered to the patient.

79


Back to Contents

     
 
Case management. This care and financial benefits coordination process supports patients with multiple conditions and/or traumatic injuries by ensuring that the patient receives the appropriate care from different members of the patient’s care team at the appropriate time and in the appropriate setting, even when the patient’s health benefit plan might require modification to provide coverage for such treatment.
     
 
Disease management. These coaching and care coordination processes support patients with chronic conditions by helping to ensure that the patient understands the nature of the condition and the best ways to minimize the impact of the condition, and that the patient complies with the established treatment regimen. The disease manager also helps coordinate the patient’s interaction with the healthcare system to ensure that the patient receives the appropriate care from different members of the patient’s care team at the most appropriate time and in the most appropriate setting.
     
 
Interoperability with Analytics and Disease Management. When payers utilize our Advanced Medical Management module in combination with our Analytics and Disease Management module, workflows are automatically populated with care management data generated by the Analytics and Disease Management module. Additionally, since the same data also is used to create the Patient Clinical Summary for the provider, everyone on the care management team is working with consistent data.
     
 
Interoperability with Transactions and Information Exchange. When payers utilize our Advanced Medical Management module with our Transaction and Information Exchange module, most authorizations and referrals that traditionally would be handled by a payer care manager for approval over the telephone are automatically, clinically adjudicated with the same rules that the payer care manager would have used. Only the referrals and authorizations that are considered too complicated or questionable are presented to a payer care manager, having automatically populated their work queue, when the exception occurs. The case is then presented with all of the pertinent history and relevant clinical guidelines to help the payer care manager adjudicate the request manually.

We license a database module from InterSystems Corporation that is material to our Advanced Medical Management module. The license expires on December 31, 2006, and can be renewed only by mutual consent. In addition, the license may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. If we fail to license the InterSystems Corporation database module, it could adversely affect our ability to sell our solutions and lead to a decline in revenue and the future growth of our business.

Clinical Rules and Processes. Our Clinical Rules and Processes module is a content solution consisting of clinical best practices, which have been validated by evidence-based medicine, and care management best processes, which we have defined based on our customers’ shared experience. When deployed as part of our Integrated Medical Management suite, our Clinical Rules and Processes module supplements a payer’s existing rules and guidelines by populating the system with reliable, evidence-based clinical rules. This supplements our customers’ ability to automate processes and promotes the clinical consistency required to provide the best diagnostics and treatment recommendations. We continually update our Clinical Rules and Processes module based on evolving clinical best practices and best processes and distribute the updated content to our customers annually for lower priority changes and more frequently for higher priority changes.

Our Clinical Rules and Processes module consists of two primary categories of content:

 
Medical Appropriateness Criteria. This category consists of clinical content for utilization management regarding the medical appropriateness of a proposed healthcare service or treatment. These rules are used to manually or automatically adjudicate requests for authorizations and referrals.
     
 
Clinical Care Pathways. This category consists of content for case and disease management that automatically populates questionnaires, goal templates and other correspondence to patients and providers. This information is integrated with the Advanced Medical Management module and is exposed to the payer care manager when they bring up a case in their workflow. We support clinical care pathways for 28 medical conditions, which we believe address the majority of healthcare spending.

80


Back to Contents

Transactions and Information Exchange. Our Transactions and Information Exchange module creates a necessary bridge electronically linking physicians, hospitals and other providers to payers. Using this module, providers can electronically submit referrals, authorizations and extensions requests through multiple communication sources including the Internet, interactive voice response and electronic data interchange. As a result, payers can reach all of their provider community regardless of the technology infrastructure on the provider’s side. When combined with our Clinical Rules and Processes module, the module provides payers with the ability to automatically process requests from physicians and hospitals. The automatic approval of routine requests significantly reduces a payer’s administrative costs because requests are initiated, processed and completed without human intervention on behalf of the payer. Payers using the Internet and interactive voice response paths have been able to automate and approve up to 85% of their referral requests. Requests that require human intervention are flagged for further review and immediately routed to a care manager at the payer for resolution.

Our Collaborative Data Exchange Suite

Our Collaborative Data Exchange suite leverages the connectivity of our Transactions and Information Exchange module to deliver Patient Clinical Summaries electronically and on-demand to providers at the point of care.

Patient Clinical Summaries

Our Patient Clinical Summary is an Electronic Health Record that is currently built from the data contained in the Payer Based Heath Record. The Patient Clinical Summaries present in an easily digested format:

 
patient demographic information, including name, date of birth, contact information and the name of the patient’s primary care physician;
     
 
a summary of the patient’s medical conditions categorized by severity;
     
 
a complete log of the patient’s facility admissions and emergency room visits;
     
 
a summary of historical tests and healthcare services provided to the patient;
     
 
a summary of medications taken by the patient;
     
 
a list of the patient’s historical providers, their specialty and contact information;
     
 
a schedule of early detection flags and potential treatment opportunities; and
     
 
an evaluation of the patients’ risk of needing treatment for a serious medical condition in the next 12 months.
 
Future Solutions

We are currently developing two additional components that we believe will increase the value of our Collaborative Data Exchange suite.

MEDeWeaver. We believe that our MEDeWeaver module will enable the next generation of the Electronic Health Record by weaving together all available sources of patient information, including the Payer Based Health Record, the Electronic Medical Record and the Personal Health Record. MEDeWeaver is a module that gathers patient data stored in several different databases, analyzes the data for inconsistencies, and combines the data into one report. This product is currently in development and we expect it to be available for testing by the fourth quarter of 2006.

MEDePathway. We believe that our MEDePathway module will allow our payer customers to leverage the data contained in the Patient Clinical Summary for other uses. For example, if a payer has a member portal through which they allow their members to access information, MEDePathway would allow the payer to expose the data contained in the Patient Clinical Summary to the patient through the portal. The data is provided as a standardized transmission allowing the payer to decide how to present the data within the portal. In effect, MEDePathway will manage incoming requests for information and outgoing responses. It will validate the requestor, manages the communications and security for accepting the request from outside sources, and then delivers the data to the recipient. The data sent is based on the needs of the receiver and complies with the relevant state and federal data privacy requirements. This product is currently in development.

81


Back to Contents

Professional Services

Our professional services personnel have extensive domain expertise and use our proprietary technology and content to provide implementation and consulting services, and training. Many of our professional service personnel have held positions at healthcare organizations or senior level consulting positions at major consulting firms and other enterprise software companies.

Implementation and Consulting Services

Our implementation services begin with an evaluation of a customer’s current information technology infrastructure, which includes process engineering to optimize the configuration of our solutions and integration with existing applications to fit each organization’s dynamic business requirements. We support a consulting certification program and have a project management office that equips our consultants with a library of toolkits, forms, training documentation and workshop templates. We also oversee the management of customer deployments to help enable smooth, systematic and on-time implementations and maximize success and financial returns for our customers. After the initial deployment of our solutions, we provide ongoing strategic consulting services to help our customers achieve desired results in quality improvement, increased productivity, cost savings and operational effectiveness. We collaborate with customer project leaders to establish an ongoing process for continual evolution and solution optimization so that our customers can promote best practice usage and end user adoption long after we deploy our solutions.

Training

We offer a full range of educational services including pre-deployment classroom training, train-the-trainer programs, system administrator training, post-deployment specialty training, upgrade training and eLearning/web-based training. We also offer a variety of training tools to drive user adoption, including solution user manuals, process user guides, feature training exercises, a self-service website for training scheduling and registration, post-training assessments and synchronous, web-based training tools for remote users.

Technology, Development and Operations
 
Technology

Our Integrated Medical Management suite and Collaborative Data Exchange suite are built on a multi-tier, independent Java 2 Platform, Enterprise Edition, or J2EE, architecture using a standards-based Struts (Model-View-Controller) Framework that consists of open source components, commercially available products and our own proprietary tools. This framework incorporates a fully defined services-orientated architecture that allows for the continued extension and adaptability of our Integrated Medical Management suite through an underlying collection of highly cohesive, loosely coupled components. We use this programming model to abstract interfaces, standardize messaging and increase the versatility and the value of our solutions. This approach allows for platform independence coupled with high scalability and availability.

We have implemented the following guiding principles into our development methodology:

 
flexible architecture to accommodate customer change requests built upon solid business domain models and solution architecture;
     
 
modular solution architecture to facilitate reuse and enhance marketability;
     
 
database independence achieved through integration and resource tiers with no dependency on encapsulated and loosely coupled business logic;
     
 
leverage open community standards; and

 

82


Back to Contents

 
incremental migration from legacy to new architecture to preserve the customer experience.
 
Development

We believe that three primary factors drive our innovation: our clients, our domain experts and our research and development employees. We use the feedback gained through our customer interactions and from all of our employees to add value added enhancements to the model products. We also leverage the experience of our domain experts, who produce white papers, case studies and thought pieces, which form the foundation for our innovation. Our research and development team maintains a repository of ideas, and selected ideas are presented to the market validation team. Market validated ideas progress to the prototype stage. The executive team reviews prototypes and selects those with the highest potential, which then enter the product development phase. Once in the product development stage, our team of internal software engineers develop, test and implement the applicable code for stand-alone deployment or integration into our existing solutions, as applicable.

Operations

Our primary service delivery datacenter is managed by MEDecision within a SunGard hardened datacenter facility in Philadelphia, Pennsylvania. This datacenter serves as the primary facility for our transaction based solutions and also for delivery of Patient Clinical Summaries to payers, providers and patients. A physically separate segment of this facility is used to deliver our hosted solutions for customers who subscribe to this service offering. We also have a secondary datacenter in Wayne, Pennsylvania for our Analytics and Disease Management module service bureau offering and a disaster recovery site located within another SunGard facility in Carlstadt, New Jersey. We adhere to industry standards and best practices in our domestic operations. The transaction environment is shared across clients to reduce costs for each individual client. Each client’s network connectivity is highly secured. Data backups are completed over the wide area network to our disaster recovery facility in Carlstadt, New Jersey.

Our datacenters are continuously monitored by a comprehensive set of tools and personnel, 24 hours a day, seven days a week. Our datacenters have built-in power redundancy, with two uninterrupted power supplies backed up by an industrial strength generator to provide uninterrupted service to our clients. We have documented our network, server and database management procedures including backup and recovery.

Customer Support

We believe that superior customer support is critical to our customers. Our customer support group assists our customers by answering questions and troubleshooting our solutions. Customer support is available 24 hours a day, seven days a week by telephone, email and over the Internet from a member of our customer support team. Each member of our customer support team receives comprehensive training and orientation to ensure that our customers receive high-quality support and service. Each of our customers is assigned a single point of contact. When an issue is reported to us, our customer support personnel follow a clearly defined escalation process to ensure that mission-critical issues are resolved to the satisfaction of the client. We believe that our customer service model has materially contributed to our client retention rate. As of September 30, 2006, our customer support group consisted of 20 employees located in Wayne, Pennsylvania.

Customers

As of September 30, 2006, we had contracts with 45 entities that represented approximately 56 regional and national managed care plans. Our customers include the largest managed care organizations in more than 27 regional markets.

In late 2005, Health Care Service Corporation, or HCSC, selected our Collaborative Care Management solution for use by its enterprise. As part of that contract, HCSC consolidated three separate agreements with us: BlueCross BlueShield of Illinois, Texas, New Mexico and Oklahoma. On an aggregated basis, the healthcare plans covered by the HCSC agreement accounted for 25% of our revenue in 2005, and included a five-year term license fee that accounted for 13% of revenue. If the healthcare plans currently covered by the HCSC agreement are aggregated in similar fashion for the purpose of comparison with prior years, the plans also accounted for 10% of our revenue in 2004 and 17% of revenue in 2003. In 2004, PacifiCare accounted for 15% of our total revenue and BCBS of Massachusetts accounted for 14% of our total revenue. Our sales to HCSC and Horizon Blue Cross Blue Shield accounted for approximately 27% and 22%, respectively, of our revenue for the nine months ended September 30, 2006. No other customer accounted for greater than 10% of our revenue in the years 2005, 2004 or 2003 or for the nine months ended September 30, 2006. We have described in more detail our contractual relationships with HCSC and Horizon Blue Cross Blue Shield in “Management’s Discussion and Analysis of Financial Conditions and Results of Operations—Significant Customer Contracts.”

83


Back to Contents

Sales and Marketing

Our target customers include the leading regional health insurance companies and national health insurance companies. We license our solutions to new customers primarily through our direct sales force. We manage our relationships with our existing customers, including cross-selling and up-selling activities, through client relationship managers. Our sales office is located in Wayne, Pennsylvania.

Our marketing initiatives are generally targeted toward increasing awareness of our solutions within the healthcare payer market. In order to do so, we participate in conferences, trade shows and healthcare industry events, conduct direct mail and email campaigns, advertise in industry-specific trade magazines and Internet websites, distribute white papers, case studies and thought pieces, and use our website to provide product and Company information.

Intellectual Property

Our intellectual property rights are important to our business. We rely on a combination of copyright, trade secret, trademark and other common laws in the United States and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. However, we believe that the following factors are more essential to our ability to maintain a competitive advantage:

 
our domain expertise;
     
 
frequent enhancements to our solutions;
     
 
continued expansion of our healthcare content; and
     
 
the technological skills of our research and development personnel.

Others may develop products that are similar to and that compete with our technology. We generally enter into confidentiality and other written agreements with our employees and third-party partners, whereby we attempt to control access to and distribution of our software, documentation and other proprietary technology. Despite our efforts to protect our proprietary technology, third-parties may, in an unauthorized manner, attempt to use, copy or otherwise obtain and market or distribute our intellectual property or proprietary technology or may otherwise develop a product with similar functionality as our solutions and services. Policing unauthorized use of our intellectual property and proprietary technology is difficult, and nearly impossible on a worldwide basis. Therefore, we cannot be certain that the steps we have taken or will take in the future will prevent misappropriation of our technology or intellectual property.

Litigation regarding intellectual property is prevalent in the software industry. From time to time, in the ordinary course of our business, we may be subject to claims relating to our intellectual property rights or those of others, and we expect that third-parties may commence legal proceedings or otherwise assert intellectual property claims against us in the future, particularly if we expand the scope of our business, increase the number of products we offer that compete with third-parties in the industry or the functionality of our solutions or services overlap with those of third-parties. We cannot be certain that a third-party does not have a patent or other intellectual property rights that could result in a future claim against us. These actual and potential claims and any resulting litigation could subject us to significant liability for damages. In addition, even if we prevail, litigation could be expensive, time consuming and require additional Company resources to defend and could affect our business materially and adversely. Any third-party claims or litigation may also limit our ability to use various business processes, software and hardware, other systems, technologies or intellectual property, unless we are able to enter into a license agreement with such third-party, which may not be available on commercially reasonable terms, if at all.

84


Back to Contents

Competition

We have experienced, and expect to continue to experience, intense competition from a number of companies. Our Integrated Medical Management suite competes with Landacorp, Inc., McKesson Corporation and The TriZetto Group, Inc., each of which offer products that compete with one or more modules in our suite of solutions. The principal competitive factors in our industry include:

 
solution breadth and functionality;
     
 
ease of deployment, integration and configuration;
     
 
domain expertise;
     
 
depth of clinical content;
     
 
service support;
     
 
solution price;
     
 
breadth of sales infrastructure; and
     
 
breadth of customer support.

We believe that we generally compete favorably with respect to all of these factors.

We may face future competition from large, established healthcare information technology companies, as well as from emerging companies. Barriers to entry into our industry are relatively low, new software products are frequently introduced and existing products are continually enhanced. In addition, we expect that there is likely to be consolidation in our industry, which would lead to increased price competition and other forms of competition. Established companies not only may develop their own competitive products, but may also acquire or establish cooperative relationships with current or future competitors, including cooperative relationships between both larger, established and smaller public and private companies. In addition, our ability to license our solutions will depend, in part, on the compatibility of our software with software provided by our competitors. Our competitors could alter their products so that they will no longer be compatible with our software or they could deny or delay access by us to advance software releases, which would limit our ability to adapt our software to these new releases. If our competitors were to bundle their products in this manner or make their products non-compatible with ours, our ability to license our solutions might be harmed and could reduce our gross margins and operating income.

Employees

As of September 30, 2006, we had 235 employees, consisting of 46 employees in sales and marketing, 95 employees in research and development, 67 employees in delivery and support of our solutions and 27 employees in general and administrative positions. None of our employees are represented by a union. We consider our relationship with our employees to be good and have not experienced any interruptions of our operations as a result of labor disagreements.

Facilities

We lease our headquarters in Wayne, Pennsylvania, which consists of approximately 90,000 square feet. The leases for our headquarters expire in August 2016. We believe that our facilities are in good operating condition and will adequately serve our needs for at least the next 18 months. We also anticipate that, if required, suitable additional or alternative space will be available on commercially reasonable terms, in office buildings we currently occupy or in space nearby, to accommodate expansion of our operations.

Litigation

There are no material legal proceedings to which we are a party or to which any of our property is subject. We may, however, become subject to lawsuits in the ordinary course of our business.

85


Back to Contents

MANAGEMENT

Executive Officers and Directors

The following table sets forth information concerning our executive officers and directors as of the date of this prospectus:

 

Name
    Age     Position  

 

 

 
Executive officers and directors:
             
David St. Clair
    54     Chairman of the Board and Chief Executive Officer  
John H. Capobianco
    54     President, Chief Operating Officer and Director  
Ronald D. Nall
    60     Executive Vice President and Chief Information Officer  
Henry A. DePhillips, III, M.D.
    46     Executive Vice President and Chief Medical Officer  
Carl E. Smith
    58     Executive Vice President and Chief Financial Officer  
Danielle Russella Bantivoglio
    40     Executive Vice President, Client Solutions  
Kristel L. Schimmoller
    43     Senior Vice President, Product Marketing  
Mary Jo Timlin-Hoag
    48     Senior Vice President, Client Operations  
               
Non-management directors:
             
Frank A. Adams(1)
    61     Director  
Paul E. Blondin(2)
    55     Director  
Charles P. Cullen(1)
    42     Director  
Elizabeth A. Dow(2)
    55     Director  
Thomas R. Morse
    55     Director  
Timothy W. Wallace
    49     Director  
               

 
(1)
This director will resign immediately prior to the consummation of this offering.
(2)
This person will join our board of directors upon the consummation of this offeirng.

David St. Clair founded MEDecision in 1988 and has served as the Chairman of our board of directors and Chief Executive Officer since 1988. From 1985 until 1988, Mr. St. Clair served as the Vice President of GMIS, Inc., which was subsequently acquired by McKesson Corporation. From 1981 until 1985, Mr. St. Clair served as a Principal for Hay Associates in its Strategic Management Group. Mr. St. Clair received a B.A.S. in Mechanical Engineering from the University of Pennsylvania and a M.B.A. from Harvard University.

John H. Capobianco joined us in 2002 as our Executive Vice President, Sales and Marketing. In 2003, Mr. Capobianco was promoted to President and Chief Operating Officer, and he continues to serve in such capacity. Mr. Capobianco has served as a director since 2002. Since September 2001, Mr. Capobianco has served as President and Chief Executive Officer for TekTite Ltd., a consulting practice that he owns. From February 2001 until August 2001, Mr. Capobianco served as a General Manager for Hewlett-Packard Company. From March 1998 until January 2001, Mr. Capobianco served as Chief Marketing Officer and then Executive Vice President, Strategic Planning, for Bluestone Software. From 1997 until 1998, Mr. Capobianco served as Senior Vice President, Marketing, for SAP America. From 1996 until 1997, Mr. Capobianco served as Senior Vice President, Corporate Marketing, for Sybase, Inc. From 1995 until 1996, Mr. Capobianco served as Vice President, Marketing, for PRIMAVERA Systems, Inc. From 1985 to 1995, Mr. Capobianco served as Vice President, Marketing, for Computer Associates International, Inc., now known as CA, Inc.

Ronald D. Nall joined us in April 2006 and has served as our Executive Vice President and Chief Information Officer since that time. From 2004 until April 2006, Mr. Nall served as Principal for RN Consulting. From 2000 until 2002, Mr. Nall served as Executive Vice President, Services and Product Delivery, for SynQuest, Inc. From 1997 until 1999, Mr. Nall served as Senior Vice President, Services and Products for PowerCerv Inc. From 1995 until 1997, Mr. Nall served as Senior Vice President, Product Research, Marketing and Development, for Datalogix International Inc. From 1988 until 1995, Mr. Nall served as Vice President and Product Owner for Computer Associates International. Mr. Nall received a B.S. in Management and a M.B.A. from the University of West Florida.

86


Back to Contents

Henry A. DePhillips, III, M.D. joined us in 2004 and has served as our Executive Vice President and Chief Medical Officer since that time. From 2000 until 2004, Dr. DePhillips served as Medical Director and then Senior Medical Director of Independence Blue Cross. Also from 2000 until 2004, Dr. DePhillips served as the Senior Medical Director of AmeriHealth Administrators. From 1996 until 2000, Dr. DePhillips was Regional Medical Director of AmeriHealth Insurance Company. Prior to that time, Dr. DePhillips was a private physician practicing in Wilmington, Delaware. Dr. DePhillips received a B.S. in Biochemistry from Trinity College and a M.D. from Hahnemann University.

Carl E. Smith joined us in 2001 as our Vice President, Finance and Chief Financial Officer. In 2002, Mr. Smith became our Secretary, and he continues to serve in such capacity. In 2004, Mr. Smith was promoted to Executive Vice President, Finance and Chief Financial Officer, and he continues to serve in such capacity. From 1998 until 2001, Mr. Smith served as the Vice President, Finance, and then the Chief Financial Officer of Personnel Data Systems, Inc. From 1994 until 1998, Mr. Smith served as the Senior Vice President, Finance and Administration, of ICT Group, Inc. From 1992 until 1994, Mr. Smith served as the Controller and then the Vice President, Finance for DNA Plant Technology Corporation. From 1990 until 1992, Mr. Smith served as the Chief Financial Officer for Envirosafe Services, Inc. From 1987 until 1989, Mr. Smith served as the Chief Financial Officer for Environmental Control Group, Inc. From 1974 until 1987, Mr. Smith served as the Vice President, Controller, and then the Vice President, Finance, of Advanta Corporation. Mr. Smith received a B.S. in Business and Accounting from the Pennsylvania State University and is a Certified Public Accountant.

Danielle Russella Bantivoglio joined us in 2002 as our Senior Vice President, Sales. In March 2006, Ms. Bantivoglio was promoted to Executive Vice President, Client Solutions, and she continues to serve in such capacity. From January 2001 until December 2001, Ms. Bantivoglio served as the General Manager, Americas Independent Software Vendor/Original Equipment Manufacturer Sales, and then General Manager, Worldwide Independent Software Vendor/Original Equipment Manufacturer Sales, of Hewlett-Packard Company. From April 2000 until January 2001, Ms. Bantivoglio served as the Vice President, Worldwide Sales Operations, for Bluestone Software Inc., which was acquired by Hewlett-Packard Company. From September 1991 until April 2000, Ms. Bantivoglio served as the Vice President, Sales & Marketing, of Momentum Systems. Ms. Bantivoglio received a B.S. in Business Administration with a concentration in Finance from Drexel University.

Kristel L. Schimmoller joined us in 1989, and has held several positions of increasing responsibility, including Director, Product Marketing, from 2001 until 2004, and Vice President, Product Marketing, from 2004 until April 2006. In April, 2006, Ms. Schimmoller was promoted to Senior Vice President, Product Marketing, and she continues to serve in such capacity. Ms. Schimmoller received a B.S. in Computer Science and Mathematics from Elizabethtown College and a M.B.A. from Villanova University.

Mary Jo Timlin-Hoag joined us in November 2005 as our Vice President, Client Operations. In April 2006, Ms. Timlin-Hoag was promoted to Senior Vice President, Client Operations, and she continues to serve in such capacity. From 2003 until 2005, Ms. Timlin- Hoag served as Executive Director, Business Development and Business Partners of McKesson Health Solutions. From 2002 until 2003, Ms. Timlin-Hoag served as Project/Operations Manager, Clinical Encounter Solutions for Welch Allyn. From 2000 until 2002, Ms. Timlin- Hoag served as Senior Director, Strategic Alliances and Business Solutions for G.E. Medical-MedicaLogic. From 1998 until 2000, Ms. Timlin-Hoag served as Director, Medical Call Centers for Patient InfoSystems. From 1994 until 1998, Ms. Timlin-Hoag served as Director, Patient Management, Mid-Atlantic Region for Aetna US Healthcare. Prior to that time, Ms. Timlin-Hoag was a staff nurse for Frankford Hospital in Philadelphia, Pennsylvania. Ms. Timlin-Hoag received a B.S. in Nursing and a Masters Degree in Public Health from Pennsylvania State University. Ms. Timlin-Hoag also received certifications in Project Management and Finance and Accounting from Villanova University.

 

87


Back to Contents

Non-Management Directors

Frank A. Adams has served as a member of our board of directors since 2004. Mr. Adams will resign as a director immediately prior to the consummation of this offering. Since 1984, Mr. Adams has served as Managing General Partner for Grotech Capital Group, a venture capital company. Mr. Adams received a B.S. in Business and a J.D. from the University of Baltimore.

Paul E. Blondin has been elected to the board of directors, effective upon the consummation of this offering. Mr. Blondin has been the Chairman and Chief Executive Officer of Pactolus Communications Software Corp. since 2001. From 1999 until 2001, Mr. Blondin was the Chief Executive Officer of IP Highway. Mr. Blondin received a B.S. in Accounting from Boston College and a M.B.A. from Babson College.

Charles P. Cullen has served as a member of our board of directors since 2001, and is a member of the audit committee and compensation committee. Mr. Cullen will resign as a director immediately prior to the consummation of this offering. Since 2000, Mr. Cullen has worked for Grotech Management Company. Mr. Cullen received a B.B.A. in Accounting from Loyola College, a J.D. from the University of Notre Dame and a M.M. in Business from Northwestern University.

Elizabeth A. Dow has been elected to the board of directors, effective upon the consummation of this offering. Since 1993, Ms. Dow has been the President and Chief Executive Officer of Leadership Philadelphia. Ms. Dow received a B.A. in Psychology from the University of Minnesota, an M.A. in Counseling from Cornell University and a M.B.A. from the Wharton School of Business at the University of Pennsylvania.

Thomas R. Morse has served as a member of our board of directors since 1997, and is a member of the audit committee and compensation committee. Since 1998, Mr. Morse has served as President of Liberty Advisors, Inc., a venture capital company. Mr. Morse currently serves on the board of directors of Othera Pharmaceuticals, GCA Corporation and ANI Pharmaceuticals. Mr. Morse is a Chartered Financial Analyst. Mr. Morse received a B.S. in Mechanical Engineering from the United States Naval Academy and a M.B.A. from the Wharton School of Business at the University of Pennsylvania.

Timothy W. Wallace has served as a member of our board of directors since March 2002, and is the Chairperson of the audit committee and a member of the compensation committee. Since April 2000, Mr. Wallace has been Chief Executive Officer of FullTilt Solutions, Inc., an enterprise product information management software company. Mr. Wallace currently serves on the board of directors of Knova Software, for which he also serves as the Chairperson of the audit committee, and Migo Software, for which he also serves as the Chairperson of the audit committee. Mr. Wallace is a Certified Public Accountant (inactive). Mr. Wallace received a B.S. in Accounting from Indiana University of Pennsylvania and a M.B.A. from Miami University.

Composition of Board of Directors

Our board of directors currently consists of six members – Messrs. St. Clair, Capobianco, Morse, Wallace, Adams and Cullen. Messrs. Adams and Cullen intend to resign from our board of directors effective immediately prior to the consummation of this offering. We have elected two additional members to our board of directors, Paul E. Blondin and Elizabeth A. Dow, each of whom will join the board of directors effective upon the consummation of this offering. Our directors, other than Mr. St. Clair and Mr. Capobianco, are not, and never have been, our employees or employees of any of our subsidiaries. Each of Messrs. Blondin, Morse and Wallace and Ms. Dow are “independent directors,” as defined by the NASDAQ Global Market’s listing standards.

Effective upon the consummation of this offering, we will divide the terms of office of the directors into three classes:

 
Class I, whose term will expire at the annual meeting of shareholders to be held in 2007;
     
 
Class II, whose term will expire at the annual meeting of shareholders to be held in 2008; and
     
 
Class III, whose term will expire at the annual meeting of shareholders to be held in 2009.

88


Back to Contents

A classified board of directors may have the effect of deterring or delaying any attempt by any person or group to obtain control of us by a proxy contest since such third-party would be required to have its nominees elected at two separate annual meetings of our board of directors in order to elect a majority of the members of our board of directors. See “Risk Factors—Anti-takeover provisions of Pennsylvania law and our articles of incorporation and bylaws could delay and discourage takeover attempts that shareholders may consider to be favorable.”

Our board of directors will observe all applicable criteria for independence established by the NASDAQ Global Market and other governing laws and applicable regulations. No director will be deemed to be independent unless our board of directors determines that the director has no relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

Effective upon the consummation of this offering, Class I will consist of Messrs. Morse and Wallace, Class II will consist of Messrs. Blondin and Capobianco and Class III will consist of Ms. Dow and Mr. St. Clair. At each annual meeting of our shareholders after the initial classification, the successors to directors whose terms will then expire shall serve from the time of election and qualification until the third annual meeting following election and until their successors are duly elected and qualified. A resolution of our board of directors may change the authorized number of directors. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one third of the directors.

Committees of the Board of Directors

Upon the consummation of this offering, the committees of our board of directors will include the audit committee, compensation committee and nominating and corporate governance committee. These committees will have the composition and responsibilities as described below as of the consummation of this offering. Our board of directors may also establish various other committees to assist the board of directors in its responsibilities from time to time.

     Audit Committee

Our audit committee oversees our corporate accounting and financial reporting process. Our audit committee:

 
evaluates the qualifications, independence and performance of our independent auditors;
     
 
determines the engagement of our independent auditors;
     
 
approves the retention of our independent auditors to perform any proposed permissible non-audit services;
     
 
ensures the rotation of the partners of our independent auditors on our engagement team as required by law;
     
 
review our financial reports and other financial information that we prepare;
     
 
reviews our systems of internal controls established for finance, accounting, legal compliance and ethics;
     
 
reviews our accounting and financial reporting processes;
     
 
provides for effective communication between our board of directors, our senior and financial management and our independent auditors;
     
 
discusses with management and our independent auditors the results of our annual audit and the review of our quarterly financial statements;
     
 
reviews the audits of our financial statements;
     
 
reviews legal matters that may have a material impact on our financial statements; and
     
 
implements a pre-approval policy for certain audit and non-audit services performed by our independent auditors.

89


Back to Contents

Effective upon the consummation of this offering, our audit committee will be comprised of Messrs. Blondin, Morse and Wallace, each of whom is a non-employee member of our board of directors. Mr. Wallace is the chairman of the audit committee. Our board of directors has determined that each member of our audit committee meets the requirements for independence under the current requirements of the listing standards of the NASDAQ Global Market and that Messrs. Blondin and Wallace meet the requirements for independence under Section 10A-3 of the Securities Exchange Act of 1934. Our board of directors has determined that Mr. Morse does not meet the requirements for independence under Section 10A-3 of the Securities Exchange Act of 1934 because he is an affiliate of each of Liberty Ventures I, L.P., Liberty Ventures II, L.P. and Commonwealth Venture Partners II, L.P. who collectively hold greater than 10% of our common stock (on an as converted basis). We intend to replace Mr. Morse on our audit committee with an additional director who will meet the requirements for independence under Section 10A-3 of the Securities Exchange Act of 1934 within the timeframe required by the Securities and Exchange Commission rules and NASDAQ Global Market listing standards. Our board of directors also has determined that each of Messrs. Blondin and Wallace is an “audit committee financial expert” as defined under Securities and Exchange Commission rules and regulations implementing Section 407 of the Sarbanes-Oxley Act of 2002. We intend to comply with future requirements regarding our audit committee to the extent they become applicable to us.

     Compensation Committee

Our compensation committee reviews and recommends policy relating to the compensation and benefits of our executive officers. Our compensation committee:

 
reviews and approves corporate goals and objectives relevant to the compensation and the benefits of our Chief Executive Officer and our other executive officers;
     
 
evaluates the performance of these officers in light of those goals and objectives; and
     
 
sets compensation of these officers based on such evaluations.

Our compensation committee also administers the issuance of stock options and other awards under our 2006 Equity Incentive Plan and our Amended and Restated Stock Option Plan. Upon the consummation of this offering, the compensation committee will be comprised of Ms. Dow and Mr. Morse (chair). We believe that the composition and functioning of our compensation committee complies with all applicable requirements of the Sarbanes-Oxley Act of 2002, the NASDAQ Global Market and Securities and Exchange Commission rules and regulations, including those regarding the independence of our compensation committee members. We intend to comply with future requirements to the extent that they become applicable to us.

     Nominating and Corporate Governance Committee

Our board of directors has not yet selected any of its members to join our nominating and governance committee. Upon such selection, which may be completed after the consummation of this offering, the composition of our nominating and corporate governance committee will comply with any applicable requirements of the Sarbanes-Oxley Act of 2002, the NASDAQ Global Market and Securities and Exchange Commission rules and regulations, including those regarding the independence of the members of our nominating and corporate governance committee. The functions of the nominating and governance committee are currently being performed by our entire board of directors, a majority of which, upon the consummation of this offering, will satisfy the independence requirements of the NASDAQ Global Market. Our nominating and corporate governance committee’s responsibilities will include the selection of potential candidates for our board of directors. It will also make recommendations to our board of directors concerning the structure and membership of the other committees of our board of directors. The nominating and corporate governance committee will be responsible for implementing policies and procedures with regard to consideration of any director candidates recommended by our shareholders.

90


Back to Contents

Compensation Committee Interlocks and Insider Participation

Effective upon the consummation of this offering, the members of our compensation committee will be Ms. Dow and Mr. Morse (chair). Neither of these individuals was at any time during fiscal year 2005 an officer or employee of ours. In addition, none of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee.

Director Compensation

Following the completion of this offering, we intend to compensate each member of our board of directors, other than those who are our employees or are employees or affiliates of our affiliates, with an annual retainer of $15,000 for service on the board of directors. The chair of the compensation committee will receive an additional annual fee of $4,000 while each other member of the compensation committee will receive an annual fee of $2,000. In addition, the audit committee chair will receive an additional annual fee of $5,000 and each other member of the audit committee will receive an additional annual fee of $3,000. The chair of the nominating and corporate governance committee will receive an additional $3,000 while each other member of the nominating and corporate governance committee will receive an additional fee of $1,500. In addition, those members of our board of directors who are not our employees or are employees or affiliates of our affiliates will receive an annual grant of 10,000 shares of common stock.

Executive Compensation

The following table sets forth summary information concerning compensation of our Chief Executive Officer and each of the next four most highly compensated current executive officers whose total annual salary and bonus exceeded $100,000 during our fiscal year ended December 31, 2005. We refer to these persons as our named executive officers.

Summary Compensation Table

 

        Annual Compensation

  Long-Term
Compensation
Awards

 
Name and Principal Position
  Year
  Salary
  Bonus
  Other
Compensation
  Shares
Underlying
Options
 

 
 
 
 
 
 
                                 
David St. Clair
    2005   $ 300,000   $ 182,500 (1)       87,500  
Chairman and Chief
    2004     287,500     30,280         125,000  
Executive Officer
    2003     275,000              
                                 
John H. Capobianco
    2005   $ 260,427   $ 220,072 (2)       87,500  
President and Chief
    2004     250,000     101,202 (3)       130,000  
Operating Officer
    2003     250,000             3,500  
                                 
Carl E. Smith
    2005   $ 208,333   $ 100,000 (4)       80,000  
Executive Vice President,
    2004     191,666             30,000  
Chief Financial Officer and
    2003     148,333             54,500  
Secretary
                               
                                 
Henry A. DePhillips, III, M.D.
    2005   $ 310,000   $ 140,000 (5)       50,000  
Executive Vice President and
    2004     234,231 (6)           75,000  
Chief Medical Officer
    2003                  
                                 
Danielle Russella Bantivoglio
    2005   $ 185,418   $ 416,291 (7)        
Executive Vice President,
    2004     160,338     403,856 (8)        
Client Solutions
    2003     151,250     90,740 (8)        


 
(1)
Represents Mr. St. Clair’s portion of a special incentive bonus approved by the compensation committee of our board of directors based on our 2005 performance. For more information, see “Certain Relationships and Related Party Transactions.”

91


Back to Contents

(2)
Represents a $107,572 annual incentive bonus paid pursuant to Mr. Capobianco’s employment agreement based upon the net increase in our annual revenue, as well as a payment of $112,500 representing Mr. Capobianco’s portion of a special incentive bonus pool approved by the compensation committee of our board of directors based on our 2005 performance.
(3)
Represents the annual incentive pursuant to Mr. Capobianco’s employment agreement based upon the net increase in our annual revenue.
(4)
Represents Mr. Smith’s portion of a special incentive bonus pool approved by the compensation committee of our board of directors based on our 2005 performance.
(5)
Represents Dr. DePhillips’ portion of a special incentive bonus pool approved by the compensation committee of our board of directors based on our 2005 performance.
(6)
Dr. DePhillips’ 2004 compensation is based on a partial year of employment, as he joined us in March 2004.
(7)
Represents commissions of $391,291 earned in 2005 under the commission plan with Ms. Bantivoglio, as well as a payment of $25,000 representing Ms. Bantivoglio’s portion of a special incentive bonus pool approved by the compensation committee of our board of directors based on our 2005 performance.
(8)
Represents commissions earned in each period under the commission plan with Ms. Bantivoglio.
 
Option Grants in Last Fiscal Year

The following table sets forth information regarding grants of stock options to purchase shares of our common stock to each of the named executive officers during the year ended December 31, 2005. All options included on the table have an exercise price equal to no less than the fair market value of our common stock, as determined by our board of directors, on the date of grant.

Potential realizable value is based upon an assumed initial public offering price of our common stock of $12.50 per share, the midpoint of the range set forth on the cover page of this prospectus. Potential realizable values are net of exercise prices, but before taxes associated with exercise. Amounts representing hypothetical gains are those that could be achieved if options are exercised at the end of the option term. The assumed 5% and 10% rates of stock price appreciation are provided in accordance with the rules of the Securities and Exchange Commission based on the assumed initial offering price of $12.50, the midpoint of the range set forth on the cover page of this prospectus, and do not represent our estimate or projection of our future stock price. We cannot assure you that any of the values in the table will be achieved. Actual gains, if any, on stock option exercises will depend on the future performance of our common stock and overall stock market conditions.

92


Back to Contents

The percentage of total options granted to our employees in 2005 is based on options to purchase an aggregate of 548,500 shares of common stock granted under our equity incentive plans to our employees in 2005.

    Individual Grants   Potential Realizable Value at
Assumed Annual Rates of
Stock Price Appreciation for
Option Term(1)
 
   
 
 
Name
  Number of
Securities
Underlying
Options/
SARs
Granted (#)
  Percentage
of Total
Options/
SARs
Granted
To
Employees
In Fiscal
Year
  Exercise
of Base
Price
($/Sh)
  Fair
Market
Value
On Date
of Grant
($/Sh)(2)
  Expiration
Date
  5%   10%  

 

 

 

 

 

 

 

 
                                             
David St. Clair
    87,500     15.95 % $ 0.550   $ 2.02     5/3/2010   $ 1,347,808   $ 1,713,370  
John H. Capobianco
    87,500     15.95 % $ 0.500   $ 2.02     5/3/2015   $ 1,737,853   $ 2,793,156  
Carl E. Smith
    80,000     14.59 % $ 0.500   $ 5.52     8/23/2015   $ 1,588,895   $ 2,553,742  
Henry A, DePhillips, III, M.D.
    50,000     9.12 % $ 0.500   $ 5.52     8/23/2015   $ 993,059   $ 1,596,089  
Danielle Russella Bantivoglio
                             

 
 
(1)
Potential net realizable values are net of exercise price, but before any applicable taxes associated with the exercise. The assumed rates of stock appreciation are provided in accordance with the Securities and Exchange Commission rules based upon an assumed initial public offering price of $12.50 per share, the midpoint of the range set forth on the cover page of this prospectus, and do not represent our estimate or projection of future stock price.
(2)
Represents the fair market value, based upon an independent appraisal of the value of our common stock.
 
Aggregate Option Exercises in 2005 and Option Values

The following table sets forth information concerning the number and value of unexercised options held by each of our named executive officers on December 31, 2005. The value of “in-the-money” options to purchase our common stock represents the positive spread between the exercise price of options to purchase our common stock and the assumed initial public offering price of $12.50 per share, the midpoint of the range on the front cover of this prospectus.