Notes to condensed consolidated financial statements

(Unaudited)

1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of Eclipsys Corporation, (“Eclipsys” or the “Company”), and the notes thereto have been prepared in accordance with the instructions for Form 10-Q of the Securities and Exchange Commission, or SEC. The December 31, 2006 condensed balance sheet data was derived from audited financial statements. These condensed statements do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America but do reflect all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of results for the interim periods presented.

 

The results of operations for the three months ended March 31, 2007 are not necessarily indicative of annual results. The Company manages its business as one reportable segment.

The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and the notes thereto that are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006 that was filed with the SEC on May 23, 2007.

A summary of stock option transactions is as follows:

		Number of Shares			Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (in years)			Aggregate Intrinsic Value (in thousands)
Outstanding at January 1, 2007			5,631,584		$	15.40			6.32		$	32,480
Options exercised			(242,538	)	$	17.02
Options canceled			(101,743	)	$	19.79
Outstanding at March 31, 2007			5,287,303		$	15.24			6.08		$	26,091
Vested and expected to vest at March 31, 2007			5,071,565		$	15.11			0.58		$	25,652
Exercisable at March 31, 2007			3,149,266		$	13.67			4.50		$	20,391

 

As of March 31, 2007, $29.5 million of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted average period of 3.6 years.

The weighted average fair value of outstanding stock options is estimated at the date of grant using a Black-Scholes option pricing model. We did not issue any stock options during the three months ended March 31, 2007. The following are significant weighted average assumptions used for estimating the fair value of the activity for the quarter ended March 31, 2006 under our stock option plans:

		Quarter Ended
		March 31,
		2006
Expected term (in years)			6.5
Risk free interest rate			5.1	%
Expected volatility			78	%
Dividend yield			0	%

 

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

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

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

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

 

Non-vested Stock Awards

Non-vested stock award activity for the three months ended March 31, 2007 is summarized as follows:

 

		Non-vested Number of Shares			Weighted Average Grant-Date Fair Value
Nonvested balance at January 1, 2007			366,128		$	17.29
Awarded			100,000			19.88
Vested			(12,500	)		13.50
Forfeited			(3,616	)		15.11
Nonvested balance at March 31, 2007			450,012		$	17.99

As of March 31, 2007, $7.0 million of total unrecognized compensation costs related to non-vested stock awards is expected to be recognized over a weighted average period of 3.7 years.  All non-vested stock awards vest semiannually, in June and December of each year.

 

Deferred Stock Units

We did not grant any deferred stock units in the first quarter of 2007. As of March 31, 2007, 26,459 DSUs were outstanding at the weighted average grant-date fair value of $18.91. The value of these DSUs is amortized to compensation expense and director fees ratably over the vesting period. During the quarter ended March 31, 2007 we recorded expense for DSUs of $0.1 million.

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

 

		(in thousands)
		March 31,			December 31,
		2007			2006
Security Type
Auction Rate Securities:
Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies		$	52,681		$	45,139
Debt securities issued by states of the United States and political subdivisions of the states			24,873			21,187
			77,554			66,326
Other Securities:
Government Bonds/Agencies			10,248			11,259
Other debt securities			9,431			11,964
Total		$	97,233		$	89,549

As of March 31, 2007, most of our marketable securities have a maturity of more than 1 year. Auction rate securities of $24.9 million, held at March 31, 2007, typically have an interest rate reset feature every 30 days pursuant to which we can sell or reset the interest rate on the security. Eclipsys’ policy for all securities in the portfolio is to hold them less than one year, and therefore, we believe that these investments are part of our working capital and are appropriately classified as current assets.

 

In an effort to maximize the yield of our excess cash, we periodically transfer excess cash not needed for operations from money market investments to marketable securities, which include auction rates securities and government bonds. These funds remain highly liquid.

5. ACCOUNTS RECEIVABLE

 

Accounts receivable, net of allowances for doubtful accounts, is comprised of the following (in thousands):

 

		March 31,			December 31,
		2007			2006
Accounts Receivable:
Billed accounts receivable, net		$	74,504		$	77,570
Unbilled accounts receivable, net			15,171			16,251
Total accounts receivable, net		$	89,675		$	93,821

 

6. WARRANTY RESERVE

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

 

		March 31,
		2007
Beginning Balance		$	438
Provision reduction			-
Warranty utilized			(108	)
Ending Balance		$	330

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Acquired technology and other intangible assets are amortized over their estimated useful lives on a straight-line basis. The carrying values of acquired technology and other intangible assets are reviewed if the facts and circumstances suggest that they may be impaired, and goodwill is reviewed annually in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” Testing is performed on a more frequent basis if impairment triggering events arise. The impairment test is based upon a number of factors, including operating results, business plans and projected future cash flows. No impairment charge has been recorded in the quarter ended March 31, 2007 and the year ended December 31, 2006.

The changes in the carrying amount of goodwill for the three months ended March 31, 2007, is as follows (in thousands):

		March 31,
		2007
Beginning Balance		$	12,281
Earnout related to past acquisitions			522
Ending Balance		$	12,803

 

The gross and net amounts for acquired technology, ongoing customer relationships and goodwill consist of the following (in thousands):

 

		March 31, 2007									December 31, 2006
		Gross						Net			Gross						Net
		Carrying			Accumulated			Book			Carrying			Accumulated			Book			Estimated
		Amount			Amortization			Value			Amount			Amortization			Value			Life
Intangibles subject to amortization
Acquired Technology		$	1,967		$	(907	)	$	1,060		$	1,967		$	(743	)	$	1,224			3-5 years
Ongoing customer relationships			5,644			(2,615	)		3,029			5,644			(2,337	)		3,307			5-7 years
Total		$	7,611		$	(3,522	)	$	4,089		$	7,611		$	(3,080	)	$	4,531
Intangibles not subject to amortization:
Goodwill								$	12,803								$	12,281

 

Estimated aggregate amortization expense (in thousands):
		For the remainder of
		2007			2008			2009			2010			2011			Thereafter			Total
Total amortization expense		$	1,301		$	1,463		$	845		$	303		$	177		$	-		$	4,089

8. OTHER COMPREHENSIVE INCOME (LOSS)

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

 

		Three Months Ended March 31,
		2007			2006
					As restated
Net income (loss)		$	2,401		$	(7,912	)
Foreign currency translation adjustment			59			335
Unrealized loss on investments			(23	)		-
Total comprehensive income (loss)		$	2,437		$	(7,577	)

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The computation of basic and diluted income (loss) per common share was as follows (in thousands, except per share data):

		Three Months Ended March 31,
		2007									2006
		Net Income			Shares			Per Share Amount			Net Loss			Shares			Per Share Amount
											As restated						As restated
Basic EPS		$	2,401			52,328		$	0.05		$	(7,912	)		50,581		$	(0.16	)
Effect of dilutive securities:
Stock options and other dilutive securities			-			1,149						-			-
Shares issuable pursuant to earn-out agreement			-			67						-			-
Diluted EPS		$	2,401			53,544		$	0.04		$	(7,912	)		50,581		$	(0.16	)

 

10. RESTRUCTURING

In January 2006, we affected a restructuring of our operations which included a reduction in headcount of approximately 100 individuals, and the reorganization of our Company. This was undertaken to better align our organization, reduce costs, and re-invest some of the cost savings into client-related activities including client support and professional services.  During the quarter ended March 31, 2006, we recorded severance related charges of $7.2 million, of which $0.9 million related to non-cash stock-based compensation expense.

In December 2006 we realigned certain management resources and closed three of our facilities to eliminate excess office space.

We did not incur any restructuring charges during the quarter ended March 31, 2007. As of March 31, 2007, the remaining unpaid restructuring liability of $4.2 million relates to severance and future lease payments which we expect to pay out through 2009. 

A summary of the restructuring charges, along with the activity for the three months ended March 31, 2007 are as follows (in thousands):

		Restructuring												Restructuring
		Liability at			2007 Activity									Liability at
		January 1,			Restructuring			Reductions						March 31,
		2007			Charge			Cash			Non-Cash			2007
Severance		$	3,174		$	-		$	1,002		$	-		$	2,172
Facility closures			2,486			-			441			-			2,045
		$	5,660		$	-		$	1,443		$	-		$	4,217

 

11. CONTINGENCIES

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

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In June 2006, the FASB issued Financial Interpretation 48, "Accounting for Uncertainty in Income Taxes" (FIN 48) which clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with SFAS 109, "Accounting for Income Taxes." This Interpretation prescribes a recognition threshold and measurement attribute of tax positions taken or expected to be taken on a tax return. We adopted this Interpretation effective January 1, 2007.

 

We did not have any material unrecognized tax benefits and there was no effect on our financial condition or results of operations as a result of implementing FIN 48.

The Company records income tax penalties, if any, in general and administrative expense. The Company has not recorded any interest or penalties related to FIN 48, in the current quarter or on a cumulative basis.

We file income tax returns in the U.S. federal jurisdiction, numerous states and Canada. All federal, state and international jurisdictions are open to examination due to net operating loss carryforwards. The Company has not been audited by the Internal Revenue Service. We do not believe there will be any material change in our unrecognized tax benefits over the next twelve months.

In June 2006, EITF 06-3, “How Sales Taxes Collected from Clients and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross Versus Net Presentation)” (“EITF 06-3”) was issued. EITF 06-3 requires disclosure of the presentation of taxes on either a gross (included in revenues and costs) or a net (excluded from revenue) basis as an accounting policy decision. The provisions of this standard are effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF 06-3 did not have a material impact on our consolidated financial statements.

13.  SUBSEQUENT EVENT

In April 2007, we entered into a letter of credit agreement in the amount of $1.9 million with Wachovia Bank to secure our obligation under a new lease agreement for our Atlanta location. The letter of credit is collateralized by the Company’s cash of $2.0 million. The letter of credit expires in October 2008, but is automatically extended for one year periods, not beyond December 2017.

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