Eclipsys Corporation Q2 10Q 2006

10-Q 1 eclpq22006_10q.htm ECLIPSYS CORPORATION Q2 10Q 2006 Eclipsys Corporation Q2 10Q 2006

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

________________

FORM 10-Q

________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

COMMISSION FILE NUMBER: 000-24539

ECLIPSYS CORPORATION

(Exact name of registrant as specified in its charter)

DELAWARE	65-0632092
(State of Incorporation)	(IRS Employer Identification Number)

1750 Clint Moore Road

Boca Raton, Florida

33487

(Address of principal executive offices)

561-322-4321

(Telephone number of registrant)

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

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

Large accelerated filer [ ] Accelerated filer [ ü ] Non-accelerated filer [ ]

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

Yes [ ] No [ü]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Class	Shares outstanding as of July 31, 2006
Common Stock, $.01 par value	52,199,066

Table of Contents

Part I.	Financial Information

Item 1.	Financial Statements - Unaudited

	Condensed Consolidated Balance Sheets (unaudited) - As of June 30, 2006
	and December 31, 2005	3

	Condensed Consolidated Statements of Operations (unaudited) - For the Three and
	and Six Months ended June 30, 2006 and 2005	4

	Condensed Consolidated Statements of Cash Flows (unaudited) - For the Six	5
	Months ended June 30, 2006 and 2005

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management's Discussion and Analysis of Financial Condition and Results
	of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4.	Controls and Procedures	21

Part II.	Other Information

Item 1.	Legal Proceedings	22

Item 1A.	Risk Factors	22

Item 4.	Submission of Matters to a Vote of Security Holders	30

Item 6.	Exhibits	30

Signatures

ECLIPSYS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands)

		June 30,		December 31,
		2006		2005
Assets
Current assets:
Cash and cash equivalents	$	28,588	$	76,693
Marketable securities		92,375		37,455
Accounts receivable, net of allowance for doubtful accounts of $4,503 and
$5,676, respectively		75,573		80,833
Inventory		1,611		2,289
Prepaid expenses		23,235		17,909
Other current assets		906		2,184
Total current assets		222,288		217,363

Property and equipment, net		42,390		40,500
Capitalized software development costs, net		31,303		35,690
Acquired technology, net		432		584
Intangible assets, net		2,515		2,940
Deferred tax asset		4,812		4,124
Goodwill		6,669		6,624
Other assets		17,985		20,964
Total assets	$	328,394	$	328,789

Liabilities and Stockholders’ Equity
Current liabilities:
Deferred revenue	$	97,562	$	107,960
Accounts payable		13,653		26,103
Accrued compensation costs		10,017		15,974
Deferred tax liability		4,812		4,124
Other current liabilities		18,970		10,413
Total current liabilities		145,014		164,574

Deferred revenue		14,057		16,772
Other long-term liabilities		156		1,252
Total liabilities		159,227		182,598

Stockholders’ equity:
Total stockholders’ equity		169,167		146,191
Total liabilities and stockholders’ equity	$	328,394	$	328,789

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

Table of Contents

ECLIPSYS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005

Revenues:
Systems and services	$	97,754		$	91,557		$	193,977		$	174,685
Hardware		4,576			4,308			9,137			5,615
Total revenues		102,330			95,865			203,114			180,300

Costs and expenses:
Cost of systems and services		59,097			55,248			115,555			107,513
Cost of hardware		3,851			3,557			7,502			4,658
Sales and marketing		14,473			16,196			30,742			34,372
Research and development		14,296			13,974			31,258			26,550
General and administrative		5,559			6,511			11,199			10,867
Depreciation and amortization		3,894			3,583			7,696			7,266
Restructuring charge		1,349			-			8,547			-
Total costs and expenses		102,519			99,069			212,499			191,226

Loss from operations		(189	)		(3,204	)		(9,385	)		(10,926	)
Interest income, net		1,335			719			2,484			1,280
Income (loss) before taxes		1,146			(2,485	)		(6,901	)		(9,646	)
Provision for income taxes		-			-			-			-
Net income (loss)	$	1,146		$	(2,485	)	$	(6,901	)	$	(9,646	)

Net income (loss) per common share:
Basic net income (loss) per common share	$	0.02		$	(0.05	)	$	(0.14	)	$	(0.20	)
Diluted net income (loss) per common share	$	0.02		$	(0.05	)	$	(0.14	)	$	(0.20	)

Weighted average common shares outstanding
Basic		51,598			47,629			51,109			47,444
Diluted		53,100			47,629			51,109			47,444

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

Table of Contents

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

	Six Months Ended June 30,

	2006			2005
Operating activities:
Net loss	$	(6,901	)	$	(9,646	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		18,371			16,106
Provision for bad debts		818			1,050
Stock compensation expense		7,383			1,150
Changes in operating assets and liabilities:
Decrease / (Increase) in accounts receivable		4,418			(1,135	)
Increase in prepaid expenses and other current assets		(3,242	)		(2,337	)
Decrease / (Increase) in inventory		676			(28	)
Increase/(Decrease) in other assets		1,449			(9,920	)
Decrease in deferred revenue		(12,881	)		(1,755	)
(Decrease) / Increase in accrued compensation		(5,979	)		3,763
Decrease in accounts payable and other current liabilities		(4,454	)		(3,745	)
(Decrease) / Increase in other long-term liabilities		(1,095	)		1,143
Total adjustments		5,464			4,292
Net cash used in operating activities		(1,437	)		(5,354	)
Investing activities:
Purchases of property and equipment		(9,167	)		(6,316	)
Purchase of marketable securities		(512,324	)		(159,866	)
Proceeds from sale of marketable securities		457,403			122,712
Capitalized software development costs		(4,626	)		(9,634	)
Cash advances and cash paid for acquisitions		(800	)		(20	)
Net cash used in investing activities		(69,514	)		(53,124	)
Financing activities:
Proceeds from stock options exercised		22,449			7,623
Proceeds from issuance of common stock in
employee stock purchase plan		223			-
Net cash provided by financing activities		22,672			7,623
Effect of exchange rates on cash and cash equivalents		174			89
Net decrease in cash and cash equivalents		(48,105	)		(50,766	)
Cash and cash equivalents — beginning of period		76,693			122,031
Cash and cash equivalents — end of period	$	28,588		$	71,265

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

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Eclipsys Corporation, or the Company, and the notes thereto have been prepared in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and Exchange Commission, or SEC. The year-end condensed balance sheet data included in these unaudited condensed consolidated financial statements was derived from audited financial statements. These 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 and six months ended June 30, 2006 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, 2005 that was filed with the SEC on March 7, 2006.

2. STOCK-BASED COMPENSATION

Prior to January 1, 2006, we accounted for our stock-based employee compensation arrangements under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), as allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-based Compensation (SFAS No. 123), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (SFAS No. 148). As a result, no expense was recognized for options to purchase our common stock that were granted with an exercise price equal to fair market value at the date of grant and no expense was recognized in connection with purchases under our employee stock purchase plan for the year ended December 31, 2005, nor in the six months ended June 30, 2005.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which amended SFAS No. 123. SFAS No. 123(R) required measurement of the cost of share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first annual period after June 15, 2005. Subsequent to the effective date, the pro forma disclosures previously made under SFAS No. 123 are no longer an alternative to financial statement recognition.

Effective January 1, 2006, we have adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation cost recognized during the six months ended June 30, 2006, includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 amortized over the options’ vesting period, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R) amortized on a straight-line basis over the options’ vesting period. The option vesting period ranges from three to five years and all options have a contractual life of ten years. The fair value is estimated at the date of grant using the Black - Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions such as expected term, expected volatility, and risk free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions were based on or determined from external data (for example the risk free interest rate) and other assumptions were derived from our historical experience with share-based payment arrangements (for example, volatility and expected term). The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. Pro forma results for prior periods have not been restated. As a result of the adoption of SFAS No. 123(R), we recorded an additional $2.6 million and $4.8 million in stock option expense which is included in our net income of $1.1 million and net loss of $6.9 million for the three and six months ended June 30, 2006, respectively. The adoption of SFAS No. 123(R) reduced earnings per diluted common share by $0.05 and $0.09 for the three and six months ended June 30, 2006, respectively. The adoption of SFAS No. 123(R) had no impact on cash flows from operations or financing activities.

Table of Contents

ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The following table illustrates the effect on net loss and net loss per share had we applied the fair value recognition provisions of SFAS No. 123 to account for our employee stock option plan for the three and six months ended June 30, 2005 because stock-based employee compensation was not accounted for using the fair value recognition method during that period. For purposes of pro forma disclosures, the estimated fair value of the stock awards, as prescribed by SFAS No. 123, is amortized to expense over the vesting period of such awards (in thousands, except per share data):

	Three Months Ended June 30, 2005			Six Months Ended June 30, 2005


Net loss:
As reported	$	(2,485	)	$	(9,646	)
Add: Stock-based employee compensation expense included
in reported net loss, net of related tax effects		734			1,150
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of related tax effects		(3,395	)		(5,811	)
Pro forma net loss	$	(5,146	)	$	(14,307	)
Basic net loss per common share:
As reported	$	(0.05	)	$	(0.20	)
Pro forma	$	(0.11	)	$	(0.30	)
Diluted net loss per common share:
As reported	$	(0.05	)	$	(0.20	)
Pro forma	$	(0.11	)	$	(0.30	)

The historical pro forma impact of applying the fair value method prescribed by SFAS No. 123 is not representative of the impact that may be expected in the future due to changes resulting from additional grants in future years and changes in assumptions such as volatility, interest rates and expected life used to estimate fair value of the grants in future years.

There was no stock-based employee compensation cost capitalized or tax benefit recognized during the three and six months ended June 30, 2006. The following table shows total stock-based employee compensation expense included in the condensed consolidated statement of operations (in thousands):

	Three Months Ended June 30, 2006		Six Months Ended June 30, 2006

Costs and expenses:
Cost of systems & services	$	1,438	$	2,363
Sales and marketing		708		1,565
Research and development		565		922
General and administrative		631		1,371
Restructuring charge		267		1,162

Total stock-based compensation expense	$	3,609	$	7,383

Table of Contents

ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Compensation expense for restricted common stock issued at discounted prices is recognized over the vesting period for the difference between the purchase price and the fair market value on the measurement date. Compensation expense recorded for stock-based awards of restricted stock was $639,000 and $1.3 million for the three and six months ended June 30, 2006. In the three and six months ended June 30, 2005, recorded stock-based compensation for restricted stock was $730,000 and $1.1 million.

Effective May 10, 2006, we implemented a deferred stock unit plan to provide for equity compensation for our non-employee directors in the form of deferred stock units ("DSUs") granted under the Company’s 2005 Stock Incentive Plan ("2005"). As of the date of each annual meeting of the Company's stockholders, each continuing non-employee director receives a number of DSUs determined by dividing $75,000 by the fair market value of a share of the Company’s common stock on the grant date. These DSUs vest quarterly over the course of the ensuing year. After cessation of board service, the Company will pay the DSUs by issuing to the former director a number of shares of the Company’s common stock equal to the number of accumulated deferred stock units. In addition, a non-employee director may elect to receive DSUs in lieu of all or a portion of his or her cash fees. All DSUs issued for deferred cash compensation shall be fully vested from date of issuance.

We granted 23,460 deferred stock units during the second quarter of 2006 at a market value of $19.18. The value of these deferred stock units is amortized to compensation expense ratably over the vesting period and totaled $116,000 for the six months ended June 30, 2006. The provisions of SFAS No. 123R do not change the accounting for deferred stock units.

3. EMPLOYEE BENEFIT PLANS

2005 Stock Incentive Plan

At our Annual Meeting of Stockholders held June 29, 2005, our shareholders approved the 2005 Plan. Under the 2005 Plan, no further awards will be granted under our prior Stock Incentive Plans which include our 1996, 1998, 1999 and 2000 plans. Awards may be made under the 2005 Plan for a number of shares (subject to adjustment in the event of stock splits and other similar events) equal to the sum of (1) 2,000,000 shares of our Voting Common Stock, (2) any shares reserved for issuance under the Amended and Restated 2000 Stock Incentive Plan that remain available for issuance as of the date the 2005 Plan is approved by our stockholders and (3) any shares subject to outstanding awards under our 1996 Stock Plan, the Amended and Restated 1998 Stock Incentive Plan, the Amended and Restated 1999 Stock Incentive Plan and the Amended and Restated 2000 Stock Incentive Plan that expire or are terminated, surrendered or canceled without having been fully exercised, are repurchased or forfeited in whole or part or result in any shares subject to such award not being issued. As of June 30, 2006, there were 2,148,938 shares available for future issuance under the 2005 Plan.

We issued 400,000 stock options and 100,000 shares of restricted stock in the six months ended June 30, 2006 as an inducement grant made without shareholder approval and outside the 2005 Stock Incentive Plan pursuant to Section 4350(i)(1)(A)(iv) of the NASD Marketplace Rules. The grant date fair value of the restricted stock was $21.15.

A summary of stock option transactions is as follows:


	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value (in thousands)
Outstanding at January 1, 2006		7,605,609		$	12.80
Options granted		1,072,000		$	21.37
Options exercised		(2,200,670	)	$	10.19			$	26,997
Options canceled		(449,639	)	$	14.96

Outstanding at June 30, 2006		6,027,300		$	15.11		6.62	$	25,321
Vested and expected to vest at June 30, 2006		5,620,987		$	14.91		0.75	$	24,627
Exercisable at June 30, 2006		3,199,243		$	13.34		4.70	$	18,725

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Non-vested stock award activity including inducement grants made under NASD Marketplace Rules for the six months ended June 30, 2006 is summarized as follows:

	Non-vested Number of Shares			Weighted Average Grant-Date Fair Value

Non-vested balance at January 1, 2006		623,994		$	16.89
Granted		100,000		$	21.14
Vested		(152,585	)	$	16.76
Forfeited		(52,500	)	$	18.91
Non-vested balance at June 30, 2006		518,909		$	17.33

As of June 30, 2006, $26.6 million of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted average period of 2.6 years. As of June 30, 2006, $8.1 million of total unrecognized compensation costs related to nonvested awards is expected to be recognized over a weighted average period of 3.72 years. The total fair value of shares vested during the six months ended June 30, 2006 was $3.8 million.

The weighted average estimated fair value of our employee stock options granted at grant date market prices was $16.70 per share during six months ended June 30, 2006. There were 15,853 shares granted under our stock purchase plan as a result of employee participation during the six months ended June 30, 2006.

The weighted average fair value of outstanding stock options has been estimated at the date of grant using a Black-Scholes option pricing model. The following are significant weighted average assumptions used for estimating the fair value of the activity under our stock option plans:


	Six Months Ended June 30,
	2006			2005
Expected term (in years)		6.46			6.01
Risk free interest rate		5.08	%		4.02	%
Expected volatility		77.54	%		80.26	%
Dividend yield		0	%		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.

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

4. MARKETABLE SECURITIES

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)
	June 30,		December 31,
	2006		2005
Security Type

Auction Rate Securities:

Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies	$	13,272	$	14,117
Debt securities issued by states of the United States and political subdivisions of the states		71,948		17,084
		85,220		31,201
Other Securities:

Government Bonds/Agencies		7,117		6,206
Other debt securities		38		48
Total	$	92,375	$	37,455

As of June 30, 2006, all marketable securities except for auction rate securities have a maturity of less than 2 years. Auction rate securities of $71.9 million held at June 30, 2006 have an underlying maturity of greater than ten years, but typically have an interest rate reset feature every 30 days pursuant to which we can sell or reset the interest rate on the security. At June 30, 2006, 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 transferred cash 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 was comprised of the following (in thousands):


	June 30,		December 31,
	2006		2005
Accounts Receivable:
Billed accounts receivable, net	$	62,730	$	69,772
Unbilled accounts receivable, net		12,843		11,061
Total accounts receivable, net	$	75,573	$	80,833

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 costs of systems of services revenues when they are probable and reasonably estimable. A summary of the activity in our warranty reserve was as follows (in thousands):

Balance at January 1, 2005	$	2,057
Warranty utilized		(986	)
Balance at December 31, 2005		1,071

Provision reduction		(290	)
Warranty utilized		(154	)
Balance at June 30, 2006	$	627

During the six months ended June 30, 2006, the warranty reserve was reduced by $290,000 as a result of a decrease in the estimation of expected warranty costs.

7. GOODWILL AND OTHER INTANGIBLE ASSETS

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 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 has been identified or recorded during the six months ended June 30, 2006 and fiscal year ended December 31, 2005.

The gross and net amounts for acquired technology, goodwill, and other intangible assets consist of the following (in thousands):

	June 30, 2006						December 31, 2005
	Gross Carrying		Accumulated Amortization		Net Book Value		Gross Carrying		Accumulated Amortization		Net Book Value

Intangibles subject to amortization:
Acquired technology	$	914	$	482	$	432	$	914	$	330	$	584
Ongoing customer relationships		4,335		1,820		2,515		4,335		1,395		2,940
Total	$	5,249	$	2,302	$	2,947	$	5,249	$	1,725	$	3,524
Intangibles not subject to amortization:
Goodwill	$	6,669			$	6,669	$	6,624			$	6,624

Estimated aggregate amortization expense (in thousands):
		For the remainder of
		2006		2007		2008		2009		2010		Total

Acquired technology	$	153	$	279	$	-	$	-	$	-	$	432
Ongoing customer relationships		426		851		851		340		47		2,515
Total amortization expense	$	579	$	1,130	$	851	$	340	$	47	$	2,947

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

8. OTHER COMPREHENSIVE INCOME (LOSS)

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

	Three Months Ended June 30,					Six Months Ended June 30,
	2006		2005			2006			2005

Net income (loss)	$	1,146	$	(2,485	)	$	(6,901	)	$	(9,646	)
Foreign currency translation adjustment		193		8			528			89
Total comprehensive income (loss)	$	1,339	$	(2,477	)	$	(6,373	)	$	(9,557	)

9. BASIC AND DILUTED INCOME (LOSS) PER COMMON SHARE

For all periods presented, basic and diluted income (loss) per common share is presented in accordance with SFAS 128, “Earnings per Share,” which provides for the accounting principles used in the calculation of income (loss) per share. Basic income (loss) per common share excludes dilution and is calculated by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per common share reflects the potential dilution from assumed conversion of all dilutive securities such as stock options and unvested restricted stock using the treasury stock method. When the effect of the outstanding stock options are anti-dilutive, they are not included in the calculation of diluted income (loss) per common share.

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



	Three Months Ended June 30,
	2006								2005

	Net Income			Shares		Per Share Amount			Net Loss			Shares		Per Share Amount

Basic EPS	$	1,146			51,598	$	0.02		$	(2,485	)		47,629	$	(0.05	)

Effect of dilutive securities:
Stock options and other dilutive securities		-			1,453					-			-
Shares issuable pursuant to earn-out agreement		-			49					-			-
Diluted EPS	$	1,146			53,100	$	0.02		$	(2,485	)		47,629	$	(0.05	)

	Six Months Ended June 30,
		2006								2005

		Net Income			Shares		Per Share Amount			Net Loss			Shares		Per Share Amount

Basic EPS	$	(6,901	)		51,109	$	(0.14	)	$	(9,646	)		47,444	$	(0.20	)

Effect of dilutive securities:
Stock options and other dilutive securities		-			-					-			-
Shares issuable pursuant to earn-out agreement		-			-					-			-
Diluted EPS	$	(6,901	)		51,109	$	(0.14	)	$	(9,646	)		47,444	$	(0.20	)

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ECLIPSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

10. RESTRUCTURING

In January 2006, we effected 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. We completed the restructuring during the second quarter of 2006. This resulted in restructuring charges of approximately $1.3 million and $8.5 million in the three and six months ended June 30, 2006, respectively, which have been recorded in our statements of operations as “restructuring charge.” At June 30, 2006, the remaining unpaid severance liability was $3.8 million which we expect to pay out during 2006 and 2007. A summary of the restructuring activity was as follows (in thousands):


Balance at January 1, 2006	$	-
Restructuring charge		7,198
Non-cash charges related to stock option modifications		(894	)
Payments		(2,413	)
Balance at March 31, 2006		3,891

Restructuring charge		1,349
Non-cash charges related to stock option modifications		(267	)
Payments		(1,165	)
Balance at June 30, 2006	$	3,808

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.

12. SUBSEQUENT EVENT

On June 11, 2006, we entered into an agreement to acquire the assets of Sysware Health Care Systems, Inc. (“Sysware”) and the stock of Sysware’s sister company Mosum Technology (India) Private Limited ("Mosum"). Mosum acts as Sysware’s software development organization in India. In July 2006, we closed the acquisition of the assets of Sysware. The closing of the acquisition of the stock of Mosum is pending certain Indian regulatory approvals which we expect to receive during the third quarter of 2006. As we await those approvals, we are operating Mosum under a management agreement. The acquisition will enable us to market Sysware’s laboratory information solution as a core module of Eclipsys’ Sunrise Clinical Manager™ suite of enterprise-wide advanced clinical solutions, and also provide us with the foundation for a development and support organization in India.

The aggregate purchase consideration includes closing payments for a total of $3.7 million in cash, as well as earnout consideration of up to approximately $3.9 million payable in a combination of cash and shares over a two-year period, based on the attainment of conditions defined in the acquisition agreement.

13. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 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 Statement of Financial Accounting Standard (SFAS) No. 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. This Interpretation is effective for the Company beginning January 1, 2007. We are currently evaluating the impact FIN 48 will have on our financial statements.

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

RESULTS OF OPERATIONS

This report contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about our company and our industry. When used in this report, the words “may”, “will”, “should”, “predict”, “continue”, “plans”, “expects”, “anticipates”, “estimates”, “intends”, “believe”, “could”, and similar expressions are intended to identify forward-looking statements. These statements may include, but are not limited to, statements concerning our anticipated performance, including revenue, margin, cash flow, balance sheet and profit expectations; development and implementation of our software; duration, size, scope and revenue expectations associated with client contracts; benefits provided by Eclipsys software, outsourcing and consulting services; business mix; sales and growth in our client base; market opportunities; industry conditions; and our accounting, including its effects and potential changes in accounting.

Actual results might differ materially from the results projected due to a number of risks and uncertainties. Software development may take longer and cost more than expected, and incorporation of anticipated features and functionality may be delayed, due to various factors including programming and integration challenges and resource constraints. We may change our product strategy in response to client requirements, market factors, resource availability, and other factors. Implementation of some of our software is complex and time consuming. Clients’ circumstances vary and may include unforeseen issues that make it more difficult or costly than anticipated to implement or derive benefit from software, outsourcing or consulting services. The success and timeliness of our services often depend, at least, in part upon client involvement, which can be difficult to control. We are required to meet standard performance specifications, and contracts can be terminated or their scope reduced under certain circumstances. Competition is vigorous, and competitors may develop more compelling offerings or offer more aggressive pricing. New business is not assured and existing clients may migrate to competing offerings. Financial performance targets might not be achieved due to various risks, including slower-than-expected business development or new account implementation, or higher-than-expected costs to develop products, meet service commitments or sign new contracts. Our cash consumption may exceed expected levels if profitability does not meet expectations or strategic opportunities require cash investments. These and other risks and uncertainties that could cause our actual results to differ materially from our forward-looking statements are described in this report under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results in Operations” and in our other filings made from time to time with the Securities and Exchange Commission. The cautionary statements made in this report should be read as being applicable to all related forward-looking statements wherever they appear. These statements are only predictions. We cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us or any persons acting on our behalf are expressly qualified in their entirety by the risk factors referenced above. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. We nonetheless reserve the right to make such updates from time to time without the need for specific reference to this report. No such update shall be deemed to indicate that other statements not addressed by such updates remain correct or create an obligation to provide any other updates.

Executive Overview

The following should be read in conjunction with our condensed consolidated financial statements, including the notes thereto, which are included elsewhere in this document

Eclipsys is a healthcare information technology (HIT) company and a leading provider of advanced clinical, financial and management information software and service solutions. We develop and license proprietary software and content that is designed for use in connection with many of the key clinical, administrative and financial functions that hospitals and other healthcare organizations require. Among other things, our software enables physicians, nurses and other clinicians to order tests, treatment and medications and record, access and share information about patients. Our software also facilitates many administrative and financial functions, including patient admissions, scheduling, records maintenance, invoicing, inventory control, cost accounting, and assessment of the profitability of specific medical procedures and personnel. Our content, which is integrated with our

software, provides practice guidelines in context at the point of care for use by physicians, nurses and other clinicians. We also provide services related to our software. These services include software and hardware maintenance, outsourcing, remote hosting of our software as well as third-party HIT applications, network services, and training and consulting.

We believe that one of the key differentiators of our software is its open, flexible and modular architecture. This allows our software to be installed one application at a time or all at once, and to integrate easily with software developed by other vendors or the client. This enables our clients to install our software without the disruption and expense of replacing their existing software systems to gain additional functionality.

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We market our software to small, stand-alone hospitals, large multi-entity healthcare systems, academic medical centers and community hospitals. We have one or more of our software applications installed in, or licensed to be installed at approximately 1,500 facilities. All 16 of the top-ranked U.S. hospitals named to the Honor Roll of “America’s Best Hospitals” in the July 18, 2005 issue of U.S. News & World Report use one or more of our solutions.

Software Development

In the first quarter of 2005, we released Sunrise Clinical Manager Release 4.0 XA™, which contained new features and enhancements in several key areas including incremental functionality related to ambulatory, emergency department, critical care, medication management and nursing. In September 2005, we released Remote Access Services (RAS) 4.0 XA^TM and Pocket Sunrise^TM 4.0 XA, which enhanced users’ ability to access our applications from remote locations. In the fourth quarter of 2005, we announced the release of Sunrise Radiology Information System ™(RIS), which automates radiology workflow.

In January 2006, we released Sunrise Clinical Manager Release 4.5 XA™ (SCM 4.5 XA). This release contained approximately 1,500 incremental functions which continued to enhance the capabilities of our offering in all major clinical areas including ambulatory, emergency department, critical care and nursing. Additionally, this release included integrated end-to-end medication management capabilities and builds upon recent enhancements to our Sunrise Patient Financial Manager and Sunrise Decision Support Manager solutions.

Competitive Environment and Other Challenges for 2006

Our releases of SCM 4.0 XA in March 2005 and SCM 4.5 XA in January 2006 included significant new functionality, and we are implementing this new software with a significant number of clients. In the event our new software does not continue to achieve market acceptance or we experience any significant delays in implementing these new releases, our results of operations could be negatively affected, including a delay or loss in closing future new sales transactions. Our software sales in the first half of 2006 did not meet our internal targets, and we must accelerate software sales in the second half of 2006 in order to achieve our projections for 2006 revenue and earnings and to provide a solid foundation for growth in 2007.

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THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005

(In thousands, except per share amounts)

				% of Total						% of Total
	2006			Revenues			2005			Revenues			Change $			Change %

Revenues
Systems and services	$	97,754			95.5	%	$	91,557			95.5	%	$	6,197			6.8	%
Hardware		4,576			4.5	%		4,308			4.5	%		268			6.2	%
Total revenues		102,330			100.0	%		95,865			100.0	%		6,465			6.7	%

Costs and expenses
Cost of systems and services		59,097			57.8	%		55,248			57.6	%		3,849			7.0	%
Cost of hardware		3,851			3.8	%		3,557			3.7	%		294			8.3	%
Sales and marketing		14,473			14.1	%		16,196			16.9	%		(1,723	)		-10.6	%
Research and development		14,296			14.0	%		13,974			14.6	%		322			2.3	%
General and administrative		5,559			5.4	%		6,511			6.8	%		(952	)		-14.6	%
Depreciation and amortization		3,894			3.8	%		3,583			3.7	%		311			8.7	%
Restructuring charge		1,349			1.3	%		-			0.0	%		1,349			n/a
Total costs and expenses		102,519			100.2	%		99,069			103.3	%		3,450			3.5	%
Loss from operations		(189	)		-0.2	%		(3,204	)		-3.3	%		3,015			94.1	%
Interest income, net		1,335			1.3	%		719			0.8	%		616			85.7	%
Income (loss) before taxes		1,146			1.1	%		(2,485	)		-2.6	%		3,631			146.1	%
Provision for income taxes		-			0.0	%		-			0.0	%		-			0.0	%

Net income (loss)	$	1,146			1.1	%	$	(2,485	)		-2.6	%	$	3,631			146.1	%
Basic net income (loss) per share	$	0.02					$	(0.05	)				$	0.07
Diluted net income (loss) per share	$	0.02					$	(0.05	)				$	0.07

RESULTS OF OPERATIONS

Total revenues increased $6.5 million, or 6.7%, to $102.3 million for the quarter ended June 30, 2006, compared with $95.9 million for the second quarter of 2005.

Systems and services revenues increased $6.2 million, or 6.8%, to $97.8 million for the quarter ended June 30, 2006, compared with $91.6 million for the second quarter of 2005. The increase in systems and services revenues was primarily a result of an increase in revenues associated with revenues recognized on a subscription basis including software, maintenance, outsourcing and remote hosting which increased $ 5.1 million from $63.0 million to $68.1 million or 8.1% over the prior year. Professional services revenues, which include implementation and consulting related services, were $23.5 million, an increase of $2.3 million or 10.8% over the prior year. Revenues related to third party software and networking services were $4.8 million, a decrease of $920,000 or 15.8% over the prior year.

The increase in revenues from software, maintenance, outsourcing and remote hosting was primarily related to higher sales bookings in the second half of 2005 and the achievement of software implementation milestones for various clients. The increase in professional services was related to heightened activity with customer implementations of our software solutions. These implementation activities are expected to remain at higher levels in 2006 as nearly 100 customers are in the process of upgrading their software applications. Additionally, we have experienced a trend of a higher volume of professional services being purchased by our customers as they implement our applications. The decrease in software and networking services was primarily due to a lower volume of these transactions in 2006.

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Hardware revenues increased $268,000, or 6.2%, to $4.6 million for the quarter ended June 30, 2006, compared with $4.3 million for the second quarter of 2005. We expect hardware and networking services revenue to continue to fluctuate on a quarterly basis. During the next few quarters, we expect to enhance our marketing effort around remote hosting to expand this portion of our business to increase our service offerings to our customers. In the event we are successful, hardware volumes may be negatively impacted.

The adoption of SFAS No. 123(R) on January 1, 2006, which resulted in the expensing of stock based compensation, impacted costs and expenses as indicated in the table below (in thousands):

	Three Months Ended June 30, 2006

Cost of systems & services	$	1,438
Sales and marketing		708
Research and development		565
General and administrative		631
Total stock-based compensation expense	$	3,342

Cost of systems and services increased $3.8 million, or 7.0%, to $59.1 million, for the quarter ended June 30, 2006, compared to $55.3 million for the second quarter of 2005. The increase in cost of systems and services was a result of higher volumes of outsourcing, remote hosting and the hiring of professional service employees to increase our capacity and improve our support services. They are expected to be deployed on customer implementations in the second half of the year. The impact of adopting SFAS No. 123(R), as well as, an increase in amortization of capitalized software development costs, also resulted in an increase in the cost of systems and services.

Cost of hardware increased $294,000, or 8.3%, to $3.9 million for the quarter ended June 30, 2006, compared to $3.6 million for the second quarter of 2005. The increase in the cost of hardware was attributable to the increase in hardware revenues discussed above.

Sales and marketing expenses decreased $1.7 million, or 10.6%, to $14.5 million for the quarter ended June 30, 2006, compared to $16.2 million for the second quarter of 2005. The decrease in sales and marketing expenses was primarily related to lower expenditures in the quarter related to trade shows and other marketing events. The 2006 restructuring also reduced expenditures during the current quarter as a result of lower headcount.

Research and development expenses increased $322,000, or 2.3%, to $14.3 million, for the quarter ended June 30, 2006, compared to $14.0 million for the second quarter of 2005. The increase in research and development expense was primarily related to a decrease in capitalized software development costs of $200,000 from $3.2 million in the quarter ended June 30, 2005, to $3.0 million for the quarter ended June 30, 2006. Gross research and development costs were $17.3 million in the quarter, compared to $17.2 million in the second quarter of 2005. The decrease in capitalized software development expense was due to a lower level of capitalization associated with coding and development following the release of SunriseXA 4.5 in January 2006, and preceding coding and development on the next Sunrise XA release. Amortization of capitalized software development costs, which is included as a component of cost of systems and services, increased by approximately $600,000, to $4.5 million for the three months ended June 30, 2006, compared to $3.9 million for the second quarter of 2005. We expect capitalized software development costs to continue increasing during the remainder of 2006 as a result of increased focus on new development initiatives.

General and administrative expenses decreased $1.0 million, or 14.6%, to $5.6 million, for the quarter ended June 30, 2006, compared to $6.5 million for the second quarter of 2005. The decrease is attributable to transition costs associated with our prior CEO reflected in the second quarter of 2005, offset by an increase in expense in the current year related to stock based compensation cost of $631,000 as a result of the adoption of SFAS No. 123(R) as described previously.

Depreciation and amortization increased $311,000, or 8.7%, to $3.9 million for the quarter ended June 30, 2006, compared to $3.6 million, for the second quarter of 2005. The increase was primarily the result of higher depreciation associated with the May 2006 activation of our Enterprise Resource Planning (“ERP”) solution.

During the second quarter of 2006, we completed our sales and marketing function restructuring, and we recorded additional restructuring charges of $1.3 million. This was undertaken to better align our organization, reduce costs and to re-invest some of the cost savings into client-related activities including client support and professional services. At June 30, 2006, the remaining unpaid liability was $3.8 million which we expect to pay out during 2006 and 2007.

Interest income increased $616,000, or 85.7%, to $1.3 million for the quarter ended June 30, 2006, compared to $719,000 for the second quarter of 2005. The increase was due to an improvement in yields on higher cash balances.

As a result of these factors, we had a net income of $1.1 million for the quarter ended June 30, 2006, compared to a net loss of $2.5 million for the second quarter in 2005.

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SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30, 2005

(In thousands, except in per share amounts)

				% of Total						% of Total
	2006			Revenues			2005			Revenues			Change $			Change %

Revenues
Systems and services	$	193,977			95.5	%	$	174,685			96.9	%	$	19,292			11.0	%
Hardware		9,137			4.5	%		5,615			3.1	%		3,522			62.7	%
Total revenues		203,114			100.0	%		180,300			100.0	%		22,814			12.7	%

Costs and expenses
Cost of systems and services		115,555			56.9	%		107,513			59.6	%		8,042			7.5	%
Cost of hardware		7,502			3.7	%		4,658			2.6	%		2,844			61.1	%
Sales and marketing		30,742			15.1	%		34,372			19.1	%		(3,630	)		-10.6	%
Research and development		31,258			15.4	%		26,550			14.7	%		4,708			17.7	%
General and administrative		11,199			5.5	%		10,867			6.0	%		332			3.1	%
Depreciation and amortization		7,696			3.8	%		7,266			4.0	%		430			5.9	%
Restructuring charge		8,547			4.2	%		-			0.0	%		8,547			n/a
Total costs and expenses		212,499			104.6	%		191,226			106.1	%		21,273			11.1	%
Loss from operations		(9,385	)		-4.6	%		(10,926	)		-6.1	%		1,541			14.1	%
Interest income, net		2,484			1.2	%		1,280			0.7	%		1,204			94.1	%
Loss before taxes		(6,901	)		-3.4	%		(9,646	)		-5.3	%		2,745			28.5	%
Provision for income taxes		-			0.0	%		-			0.0	%		-			0.0	%

Net loss	$	(6,901	)		-3.4	%	$	(9,646	)		-5.3	%	$	2,745			28.5	%
Basic net loss per share	$	(0.14	)				$	(0.20	)				$	0.06
Diluted net loss per share	$	(0.14	)				$	(0.20	)				$	0.06

RESULTS OF OPERATIONS

Total revenues increased $22.8 million, or 12.7%, to $203.1 million for the six months ended June 30, 2006, compared with $180.3 million for the same period in 2005.

Systems and services revenues increased $19.3 million, or 11%, to $194.0 million for the six months ended June 30, 2006, compared with $174.7 million for the same period in 2005. The increase in systems and services revenues was primarily a result of an increase in revenues associated with revenues recognized on a subscription basis including software, maintenance, outsourcing and remote hosting which increased $ 12.6 million from $122.6 million to $135.2 million, or 10.3% over the prior year. Additionally, professional services revenues, which include implementation and consulting related services were, $47.1 million, an increase of $9.7 million or 26.0% over the prior year. Revenues related to software and networking services were $8.0 million, a decrease of $2.9 million, or 26.7% over the prior year.

The increase in revenues from software, maintenance, outsourcing and remote hosting was primarily related to higher sales bookings in the second half of 2005. The higher sales bookings were associated with successful sales of our advanced clinical systems as well as outsourcing and remote hosting related services which is the result of an ongoing industry-wide trend in the adoption of such systems. The increase in professional services was related to higher volume of customer implementations of our software solutions. These activities are expected to remain at higher levels in 2006 as nearly 100 customers are in the process of upgrading their software applications. Additionally, we have experienced a trend of a higher volume of professional services being purchased by our customers as they implement our applications as a result of the expansion of our product offering with the release of SunriseXA 4.5. The decrease in software and networking services was primarily due to a lower volume of these transactions in 2006.

Hardware revenues increased $3.5 million, or 62.7%, to $9.1 million for the six months ended June 30, 2006, compared with $5.6 million for the same period in 2005. We expect hardware and networking services revenue to continue to fluctuate on a quarterly basis. During the next few quarters, we expect to enhance our marketing effort around remote hosting to expand this portion of our business to increase our service offerings to our customers. In the event we are successful, hardware volumes may be negatively impacted.

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The adoption of SFAS No. 123(R) on January 1, 2006, which resulted in the expensing of stock based compensation, impacted costs and expenses as indicated in the table below (in thousands):

	Six Months Ended June 30, 2006

Cost of systems & services	$	2,363
Sales and marketing		1,565
Research and development		922
General and administrative		1,371
Total stock-based compensation expense	$	6,221

Cost of systems and services increased $8.0 million, or 7.5%, to $115.6 million, for the six months ended June 30, 2006, compared to $107.5 million for the same period in 2005. The increase in cost of systems and services was a result of the increase in higher volumes of outsourcing, remote hosting and the delivery of professional services, the impact of adopting SFAS No. 123(R), as well as the hiring of approximately 70 professional service employees to increase our capacity and improve our support services. They are expected to be deployed on customer implementations in the second half of the year.

Cost of hardware increased $2.8 million, or 61.1% to $7.5 million for the six months ended June 30, 2006, compared to $4.7 million for the same period in 2005.

Sales and marketing expenses decreased $3.6 million, or 10.6%, to $30.7 million for the six months ended June 30, 2006, compared to $34.4 million for the same period in 2005. The decrease in sales and marketing expenses was primarily related to lower expenditures in the period related to trade shows and other marketing events. The 2006 restructuring also reduced expenditures during the current period as a result of lower headcount.

Research and development expenses increased $4.7 million, or 17.7%, to $31.3 million, for the six months ended June 30, 2006, compared to $26.6 million for the same period in 2005. The increase in research and development expense was primarily related to a decrease in capitalized software development costs of $5.0 million from $9.6 million in the six months ended June 30, 2005, to $4.6 million for the six months ended June 30, 2006. Gross research and development costs were $35.9 million for the six months ended June 30, 2006, compared to $36.2 million in the same period in 2005. The decrease in capitalized software was due to a lower level of capitalization associated with coding and development as a result of the release of SunriseXA 4.5 in January 2006. Additionally, in the first quarter of 2006, we made a concentrated effort to dedicate research and development resources on reducing our backlog of open customer support cases as part of our focus on customer service resulting in lower capitalization activity in the first quarter. Amortization of capitalized software development costs, which is included as a component of cost of systems and services, increased by approximately $1.9 million, to $9.0 million for the six months ended June 30, 2006, compared to $7.1 million for the same period in 2005. We expect capitalized software development costs to continue increasing during the remainder of 2006 as we begin to focus more heavily on new development initiatives.

General and administrative expenses increased $332,000, or 3.1%, to $11.2 million, for the six months ended June 30, 2006, compared to $10.9 million for the same period in 2005. The increase in expenses was related to stock based compensation costs of $1.4 million as a result of the adoption of SFAS No. 123(R) as described previously, as well as costs associated with the ERP implementation. The company recorded a one time cost of $2.2 million during the six months ended June 30, 2005, associated with the transition of our prior CEO.

Depreciation and amortization increased $430,000, or 5.9%, to $7.7 million for the six months ended June 30, 2006, compared to $7.3 million, for the same period in 2005. The increase was primarily the result of higher depreciation associated with the May 2006 activation of our ERP solution.

In the six months ended June 30, 2006, we completed a restructuring of the company's operations which resulted in a reduction of headcount. We recorded a charge of $8.5 million in connection with the restructuring. The restructuring was implemented to re-invest some of the cost savings into client-related activities, including client support and professional services. At June 30, 2006, the remaining unpaid liability was $3.8 million which we expect to pay out during 2006 and 2007.

Interest income increased $1.2 million, or 94.1%, to $2.5 million for the six months ended June 30, 2006, compared to $1.3 million for the same period in 2005. The increase was due to an improvement in yields on higher cash balances.

As a result of these factors, we had a net loss of $6.9 million for the six months ended June 30, 2006, compared to a net loss of $9.6 million for the same period in 2005.

LIQUIDITY AND CAPITAL RESOURCES

During the six months ended June 30, 2006, cash used in operating activities was $1.4 million, primarily related to a decrease in deferred revenue, accrued compensation and accounts payable balances, as well as costs associated with the restructuring initiative. Investing activities used $69.5 million of cash, consisting of a net $54.9 million for the purchase of marketable securities, $9.2 million for the purchase of property and equipment, and $4.6 million for the funding of capitalized software development costs. The purchase of property and equipment was related to our continued investment in the infrastructure of our Technology Solutions Center to expand our remote hosting services as well as our ERP implementation. Financing activities provided $22.4 million of cash from the exercise of stock options. Stock option exercises were higher than usual during the six months ended June 30, 2006 as a result of exercises of options from option holders whose employment was terminated in connection with our restructuring.

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At June 30, 2006, our principal source of liquidity was our combined cash and cash equivalents and marketable securities balance of $121.0 million. Our future liquidity requirements will depend on a number of factors including, among other things, the timing and level of our new sales volumes, the cost of our development efforts, the success and market acceptance of our future product releases, and other related items. We believe that our current cash and cash equivalents and marketable securities balances, combined with our anticipated cash collections from customers will be adequate to meet our liquidity requirements through 2006.

The remaining $3.8 million unpaid liability related to the restructuring will be paid out in 2006 and 2007.

These amounts are expected to be funded from current cash and cash equivalent balances.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any significant off-balance sheet arrangements.

CRITICAL ACCOUNTING POLICIES

We believe there are several accounting policies that are critical to understanding our historical and future performance as these policies affect the reported amount of revenue and other significant areas involving management’s judgments and estimates. On an ongoing basis, management evaluates and adjusts its estimates and judgments, if necessary. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingencies. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be materially different from those estimates. There were no changes to our Critical Accounting Policies as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the SEC on March 7, 2006, except as noted below.

Stock - Based Compensation

Prior to January 1, 2006, we accounted for our stock-based employee compensation arrangements under the intrinsic value method prescribed by APB No. 25, as allowed by SFAS No. 123, as amended by SFAS No. 148. As a result, no expense was recognized for options to purchase our common stock that were granted with an exercise price equal to fair market value at the date of grant and no expense was recognized in connection with purchases under our employee stock purchase plan for the year ended December 31, 2005, nor in the six months ended June 30, 2005.

In December 2004, FASB issued SFAS No. 123(R), which amended SFAS No. 123. SFAS No. 123(R) required measurement of the cost of share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first annual period after June 15, 2005. Subsequent to the effective date, the pro forma disclosures previously made under SFAS No. 123 are no longer an alternative to financial statement recognition.

Effective January 1, 2006, we have adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation cost recognized during the six months ended June 30, 2006, includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 amortized over the options’ vesting period, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R) amortized on a straight-line basis over the options’ vesting period. The fair value is estimated at the date of grant using the Black - Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model input assumptions such as expected term, expected volatility, and risk-free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions were based on or determined from external data (for example the risk free interest rate) and other assumptions were derived from our historical experience with share-based payment arrangements (for example, volatility and expected term). The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. Pro forma results for prior periods have not been restated. Implementation of SFAS No. 123(R) resulted in $2.6 million and $4.8 million in stock option expense during the three and six months ended June 30 2006, respectively. The adoption of SFAS No. 123(R) had no impact on cash flows from operations or financing activities.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not currently use derivative financial instruments. We do not currently enter into foreign currency hedge transactions. Foreign currency fluctuations, through June 30, 2006, have not had a material impact on our financial position or results of operations.

We generally invest in high quality debt instruments with relatively short maturities. Based upon the nature of our investments, we do not expect any material loss from our investments. Nevertheless, investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates.

The following table illustrates potential fluctuation in annualized interest income based upon hypothetical values for blended interest rates for marketable securities balances.

Hypothetical		Marketable securities balances (in thousands)
Interest Rate	$	100,000	$	110,000	$	120,000
1.5%		1,500		1,650		1,800
2.0%		2,000		2,200		2,400
2.5%		2,500		2,750		3,000
3.0%		3,000		3,300		3,600
3.5%		3,500		3,850		4,200
4.0%		4,000		4,400		4,800

We estimate that a one-percentage point decrease in interest rates for our marketable securities portfolio as of June 30, 2006 would have resulted in a decrease in interest income of $920,000 for a twelve month period. This sensitivity analysis, contains certain simplifying assumptions (for example, it does not consider the impact of changes in the portfolio as a result of our business needs or as a response to changes in the market). Therefore, although it gives an indication of our exposure to changes in interest rates, it is not intended to predict future results and our actual results will likely vary.

We account for cash equivalents and marketable securities in accordance with SFAS No. 115. “Accounting for Certain Investments in Debt and Equity Securities.” Cash equivalents are short-term highly liquid investments with original maturity dates of three months or less. Cash equivalents are carried at cost, which approximates fair market value.

ITEM 4. CONTROLS AND PROCEDURES

During the second quarter of fiscal 2006, the Company implemented an ERP system. As a result of the implementation, there have been changes in our internal controls over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934 (the “Exchange Act”). The general design of the Company’s internal controls has not changed, but various processes and reports that are enabled through the ERP system and that implement and support the internal controls have replaced analogous process and report features of the Company’s predecessor systems. We believe we have taken the necessary steps to monitor and maintain appropriate internal controls during this period of change.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act as of June 30, 2006. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives of ensuring that information we are required to disclose in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures, and is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. There is no assurance that our disclosure controls and procedures will operate effectively under all circumstances. Based upon the evaluation described above our chief executive officer and chief financial officer concluded that, as of June 30, 2006, our disclosure controls and procedures were effective at the reasonable assurance level.

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PART II.

ITEM 1. LEGAL PROCEEDINGS

ITEM 1A. RISK FACTORS

Many risks affect our business. We believe the following risks have emerged recently due to changes in our business and the environment in which we operate, and should be considered in addition to risk factors we have previously disclosed, which are set forth below.

Additional investment will be required to realize the potential of our Sysware acquisition.

We must make significant investments of money and management time in software development and infrastructure in order to realize the potential of our acquisition of the business of Sysware and Mosum, as described elsewhere in this report, to (i) have a fully integrated and leverageable laboratory information system to sell to our diversified client base, and (ii) build Mosum’s India operations into an integrated development and support organization that can cost-effectively augment our onshore resources.

Our performance depends upon improved software sales.

Our software sales in the first half of 2006 did not meet our internal targets, and we must accelerate software sales in the second half of 2006 and beyond in order to achieve our projections for 2006 revenue and earnings and to provide a solid foundation for future growth. Our ability to improve sales depends upon many factors, including completion of implementation and successful use of our new software releases, particularly our pharmacy and ambulatory solutions, in live environments for referenceable clients.

Other risks include, but are not limited to, those described below, each of which may be relevant to decisions regarding ownership of our stock. We have attempted to organize the description of these risks into logical groupings to enhance readability, but many of the risks interrelate or could be grouped in other ways, so no special significance should be attributed to these groupings. Any of these risks could have a significant adverse effect on our business, financial condition or results of operations.

Risks relating to development and operation of our software

Since October 2003, we have worked to overcome the effects of technical issues we experienced at that time, and the success of our recent software releases, particularly Sunrise Clinical Manager 4.5 XA, is critical.

In October 2003, we announced the existence of response time issues within some components of the version of our next-generation core clinical software that we were developing at that time. We concluded that this was attributable to the technical design of the software, which did not adequately support the throughput required in the highly interactive patient care environment. These issues harmed our reputation in the marketplace and set back our software development plans. In addition, they resulted in significant expense associated with re-development and warranty claims. Our 2003 operating results include a $1.2 million write-down of capitalized software development costs for some of our software components, and to date we have recorded provisions related to warranty costs of $4.6 million. We still have warranty and related issues with clients associated with the October 2003 problem. Our sales bookings, market position, and financial performance have suffered as a result.

We took steps to address these issues, and our subsequent releases of Sunrise Clinical Manager 3.5 XA (3.5) in June 2004 and Sunrise Clinical Manager 4.0 XA (4.0) in March 2005 to date have not manifested these same throughput shortcomings. Combined, these versions have been installed in approximately 60 locations; we believe they have performed well and achieved market acceptance. However, they are still relatively recent releases and issues may appear in the future. Due to our recent history, the marketplace can be expected to be particularly sensitive to any future technical issues we may encounter with our software, so any serious issues associated with 3.5 or 4.0 that may emerge could seriously impair our reputation, sales, client relationships and results of operations.

We believe that Sunrise Clinical Manager 4.5 XA (4.5), which we released in January 2006, largely completes the development objectives that we had envisioned before October 2003. Many clients, investors and market observers have anticipated the 4.5 release as an important milestone in the evolution of our software offering and our market position. However, 4.5 has not yet been widely implemented in clinical environments, so it is too early to assess its operational performance. It is an ambitious software release that incorporates a large number of new features and functions and was completed relatively quickly. As is typical with new software releases in general, 4.5 may require additional work to add functionality and to address issues that may be discovered as the software comes into use in our client base. If these issues are significant, our reputation, sales, client relationships and results of operations could be significantly impaired.

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Our software may not operate properly, which could damage our reputation and impair our sales.

Software development is time consuming, expensive and complex. Unforeseen difficulties can arise. We may encounter technical obstacles, and it is possible that we could discover additional problems that prevent our software from operating properly. If our software contains errors or does not function consistent with product specifications or client expectations, clients could assert liability claims against us and/or attempt to cancel their contracts with us. It is also possible that future releases of our software, which would typically include additional features for our software, may be delayed. This could damage our reputation and impair our sales.

Our software development efforts may not meet the needs of our clients, which could adversely affect our results of operations.

We continuously strive to develop new software, and improve our existing software to add new features and functionality. We schedule and prioritize these development efforts according to a variety of factors, including our perceptions of market trends, client requirements, and resource availability. Our software is complex and requires a significant investment of time and resources to develop, test and introduce into use. Sometimes this takes longer than we expect. Sometimes we encounter unanticipated difficulties that require us to re-direct or scale-back our efforts. Sometimes we change our plans in response to changes in client requirements, market demands, resource availability, regulatory requirements, or other factors. All of this can result in acceleration of some initiatives and delay of others. If we make the wrong choices or do not manage our development efforts well, we may fail to produce software that responds appropriately to our clients’ needs or fails to meet client expectations regarding new or enhanced features and functionality. If we fail to deliver software within the timeframes and with the features and functionality as described in our product specifications, we could be subject to significant contractual damages.

Market changes or mistaken development decisions could decrease the demand for our software, which could harm our business and decrease our revenues.

The healthcare information technology market is characterized by rapidly changing technologies, evolving industry standards and new software introductions and enhancements that may render existing software obsolete or less competitive. Our position in the market could erode rapidly due to the development of regulatory or industry standards that our software may not fully meet, or due to changes in the features and functions of competing software, as well as the pricing models for such software. Our future success will depend in part upon our ability to enhance our existing software and services, and to develop and introduce competing new software and services that are appropriately priced to meet changing client and market requirements. The process of developing software and services such as those we offer is extremely complex and is expected to become more complex and expensive in the future as new technologies are introduced. As we evolve our offering in an attempt to anticipate and meet market demand, clients and potential clients may find our software and services less appealing. If software development for the healthcare information technology market becomes significantly more expensive due to changes in regulatory requirements or healthcare industry practices, or other factors, we may find ourselves at a disadvantage to larger competitors with more financial resources to devote to development. If we are unable to enhance our existing software or develop new software to meet changing client requirements, demand for our software could suffer.

Our software strategy is dependent on the continued development and support by Microsoft of its .NET Framework and other technologies.

Our software strategy is substantially dependent upon Microsoft’s .NET Framework and other Microsoft technologies. The .NET Framework, in particular, is a relatively new and evolving technology. If Microsoft were to cease actively supporting .NET or other technologies, fail to update and enhance them to keep pace with changing industry standards, encounter technical difficulties in the continuing development of these technologies or make them unavailable to us, we could be required to invest significant resources in re-engineering our software. This could lead to lost or delayed sales, client costs associated with platform changes, unanticipated development expenses and harm to our reputation, and would cause our financial results and business to suffer.

Any failure by us to protect our intellectual property, or any misappropriation of it, could enable our competitors to market software with similar features, which could reduce demand for our software.

We are dependent upon our proprietary information and technology. Our means of protecting our proprietary rights may not be adequate to prevent misappropriation. The laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the United States. Also, despite the steps we have taken to protect our proprietary rights, it may be possible for unauthorized third parties to copy aspects of our software, reverse engineer our software or otherwise obtain and use information that we regard as proprietary. In some limited instances, clients can access source-code versions of our software, subject to contractual limitations on the permitted use of the source code. Furthermore, it may be possible for our competitors to copy or gain access to our content. Although our license agreements with clients attempt to prevent misuse of the source code or trade secrets, the possession of our source code or trade secrets by third parties increases the ease and likelihood of potential misappropriation of our software. Furthermore, others could independently develop technologies similar or superior to our technology or design around our proprietary rights.

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Failure of security features of our software could expose us to significant expense and reputational harm.

Clients use our systems to store and transmit highly confidential patient health information. Because of the sensitivity of this information, security features of our software are very important. If, notwithstanding our efforts, our software security features do not function properly, or client systems using our software are compromised, we could face damages for contract breach, penalties for violation of applicable laws or regulations, significant costs for remediation and re-engineering to prevent future occurrences, and serious harm to our reputation.

Risks related to sales and implementation of our software

The length of our sales and implementation cycles may adversely affect our future operating results.

We have experienced long sales and implementation cycles. How and when to implement, replace, expand or substantially modify an information system, or modify or add business processes, are major decisions for hospitals, our target client market. Furthermore, our software generally requires significant capital expenditures by our clients. The sales cycle for our software ranges from 6 to 18 months or more from initial contact to contract execution. Our implementation cycle has generally ranged from 6 to 36 months from contract execution to completion of implementation. During the sales and implementation cycles, we will expend substantial time, effort and resources preparing contract proposals, negotiating the contract and implementing the software. We may not realize any revenues to offset these expenditures and, if we do, accounting principles may not allow us to recognize the revenues during corresponding periods. Additionally, any decision by our clients to delay purchasing or implementing our software may adversely affect our revenues.

We may experience implementation delays that could harm our reputation and violate contractual commitments.

Some of our software is complex and requires a lengthy and expensive implementation process. Each client’s situation is different, and unanticipated difficulties and delays may arise as a result of failures by us or the client to meet our respective implementation responsibilities. Because of the complexity of the implementation process, delays are sometimes difficult to attribute solely to us or the client. Implementation delays could motivate clients to delay payments or attempt to cancel their contracts with us or seek other remedies from us. Any inability or perceived inability to implement consistent with a client’s schedule may be a competitive disadvantage for us as we pursue new business. Implementation also requires our clients to make a substantial commitment of their own time and resources and to make significant organizational and process changes, and if our clients are unable to fulfill their implementation responsibilities in a timely fashion our projects may be delayed or become less profitable.

Implementation costs may exceed expectations, which can negatively affect our operating results.

Each client’s circumstances may include unforeseen issues that make it more difficult or costly than anticipated to implement our software. We may fail to project, price or manage our implementation services correctly. If we do not have sufficient qualified personnel to fulfill our implementation commitments in a timely fashion, related revenue may be delayed, and if we must supplement our capabilities with expensive third-party consultants, our costs will increase.

Risks related to our outsourcing services

Various risks could interrupt clients’ access to their data residing in our service center, exposing us to significant costs.

We provide remote hosting services that involve running our software and third- party vendor’s software for clients in our Technology Solutions Center (TSC). The ability to access the systems and the data the TSC hosts and supports on demand is critical to our clients. Our operations and facilities are vulnerable to interruption and/or damage from a number of sources, many of which are beyond our control, including, without limitation: (i) power loss and telecommunications failures; (ii) fire, flood, hurricane and other natural disasters; (iii) software and hardware errors, failures or crashes, and (iv) computer viruses, hacking and similar disruptive problems. We attempt to mitigate these risks through various means including redundant infrastructure, disaster recovery plans, separate test systems and change control and system security measures, but our precautions may not protect against all problems. If clients’ access is interrupted because of problems in the operation of our facilities, we could be exposed to significant claims by clients or their patients, particularly if the access interruption is associated with problems in the timely delivery of medical care. We must maintain disaster recovery and business continuity plans that rely upon third-party providers of related services, and if those vendors fail us at a time that our center is not operating correctly, we could incur a loss of revenue and liability for failure to fulfill our contractual service commitments. Any significant instances of system downtime could negatively affect our reputation and ability to sell our remote hosting services.

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Any breach of confidentiality of client or patient data in our service center could expose us to significant expense and reputational harm.

We must maintain facility and systems security measures to preserve the confidentiality of data belonging to our clients and their patients that resides on computer equipment in our TSC. Notwithstanding the efforts we undertake to protect data, our measures can be vulnerable to infiltration as well as unintentional lapse, and if confidential information is compromised we could face damages for contract breach, penalties for violation of applicable laws or regulations, significant costs for remediation and re-engineering to prevent future occurrences, and serious harm to our reputation.

Recruiting challenges and higher than anticipated costs in outsourcing our client’s IT operations may adversely affect our profitability.

We provide outsourcing services that involve operating clients’ IT departments using our employees. At the initiation of these relationships, clients often require us to hire, at substantially the same compensation, the entire IT staff that had been performing the services we take on. In these circumstances our costs may be higher than we target unless and until we are able to transition the workforce, methods and systems to a more scalable model. Various factors can make this difficult, including geographic dispersion of client facilities and variation in client needs, IT environments, and system configurations. Also, under some circumstances we may incur unanticipated costs as a successor employer by inheriting unforeseen liabilities that the client had to these employees. Further, facilities management contracts require us to provide the IT services specified by contract, and in some places it can be difficult to recruit qualified IT personnel. Changes in circumstances or failure to assess the client’s environment and scope our services accurately can mean we must hire more staff than we anticipated in order to meet our responsibilities. If we have to increase salaries or relocate personnel, or hire more people than we anticipated, our costs may increase under fixed fee contracts.

Inability to obtain consents needed from third parties could impair our ability to provide remote outsourcing services.

We and our clients need consent from some third-party software providers as a condition to running their software in our data center, or to allowing our employees who work in client locations under facilities management arrangements to have access to their software. Vendors’ refusal to give such consents, or insistence upon unreasonable conditions to such consents, could reduce our revenue opportunities and make our outsourcing services less viable for some clients.

Risks related to the healthcare IT industry and market

We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do.

We face intense competition in the marketplace. We are confronted by rapidly changing technology, evolving user needs and the frequent introduction of new software to meet the needs of our current and future clients. Our principal competitors in our software business include Cerner Corporation, Epic Systems Corporation, Meditech, GE Medical Systems (which recently acquired IDX Systems Corporation, formerly a separate competitor), McKesson Corporation, QuadraMed Corporation and Siemens AG. Other software competitors include providers of practice management, general decision support and database systems, as well as segment-specific applications and healthcare technology consultants. Our services business competes with large consulting firms such as Deloitte & Touche and Cap Gemini, as well as independent providers of technology implementation and other services. Our outsourcing business competes with large national providers of technology solutions such as International Business Machines Corporation (IBM), Computer Sciences Corp. (CSC), Perot Systems Corporation, as well as smaller firms. Several of our existing and potential competitors are better established, benefit from greater name recognition and have significantly more financial, technical and marketing resources than we do. Some competitors, particularly those with a more diversified revenue base or that are privately held, may have greater flexibility than we do to compete aggressively on the basis of price. We expect that competition will continue to increase, which could lead to a loss of market share or pressure on our prices and could make it more difficult to grow our business profitably.

The principal factors that affect competition within our market include software functionality, performance, flexibility and features, use of open industry standards, speed and quality of implementation and client service and support, company reputation, price and total cost of ownership. We anticipate that competition will increase as a result of continued consolidation in both the information technology and healthcare industries. We expect large integrated technology companies to become more active in our markets, both through acquisition and internal investment. There is a finite number of hospitals and other healthcare providers in our target market. As costs fall, technology improves, and market factors continue to compel investment by healthcare organizations in software and services like ours, market saturation may change the competitive landscape in favor of larger competitors with greater scale.

Clients that use our legacy software are vulnerable to competition.

A significant part of our revenue comes from relatively high-margin legacy software that was installed by our clients many years ago. We attempt to convert these clients to our newer generation software, but such conversions require significant investments of time and resources by clients. This reduces our advantage as the incumbent vendor and has allowed our competitors to target these clients, with some success. If we are not successful in retaining a large portion of these clients by continuing to support legacy software - which is increasingly expensive to maintain - or by converting them to our newer software, our results of operations will be negatively affected.

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The healthcare industry faces financial constraints that could adversely affect the demand for our software and services.

The healthcare industry faces significant financial constraints. For example, the shift to managed healthcare in the 1990’s put pressure on healthcare organizations to reduce costs, and the Balanced Budget Act of 1997 dramatically reduced Medicare reimbursement to healthcare organizations. Our software often involves a significant financial commitment by our clients. Our ability to grow our business is largely dependent on our clients’ information technology budgets. If healthcare information technology spending declines or increases more slowly than we anticipate, demand for our software could be adversely affected.

Healthcare industry consolidation could impose pressure on our software prices, reduce our potential client base and reduce demand for our software.

Many hospitals have consolidated to create larger healthcare enterprises with greater market power. If this consolidation trend continues, it could reduce the size of our target market and give the resulting enterprises greater bargaining power, which may lead to erosion of the prices for our software. In addition, when hospitals combine they often consolidate infrastructure including IT systems, and acquisition of our clients could erode our revenue base.

Potential changes in standards applicable to our software could require us to incur substantial additional development costs.

Integration and interoperability of the software and systems provided by various vendors are important issues in the healthcare industry. Market forces or regulatory authorities could cause emergence of software standards applicable to us, and if our software is not consistent with those standards we could be forced to incur substantial additional development costs to conform. If our software is not consistent with emerging standards, our market position and sales could be impaired.

Risks related to our operating results, accounting controls and finances

We have a history of operating losses and we cannot predict future profitability.

During the first half of 2006, we had a net loss of $6.9 million. We also had a net loss or operating loss for each of the five preceding years. We may incur losses in the future, and it is not certain that we will achieve sustained or increasing profitability.

Our operating results may fluctuate significantly and may cause our stock price to decline.

We have experienced significant variations in revenues and operating results from quarter to quarter. Our operating results may continue to fluctuate due to a number of factors, including:

·	the performance of our software and our ability to promptly and efficiently address software performance shortcomings or warranty issues;

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

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

·	overall demand for healthcare information technology;

·	the financial condition of our clients and potential clients;

·	market acceptance of our new services, software and software enhancements by us or our competitors;

·	client decisions regarding renewal or termination of their contracts;

·	software and price competition;

·	personnel changes;

·	significant judgments and estimates made by management in the application of generally accepted accounting principles;

·	healthcare reform measures and healthcare regulation in general; and

·	fluctuations in general economic and financial market conditions; including interest rates.

It is difficult to predict the timing of revenues that we receive from software sales, because the sales cycle can vary depending upon several factors. These include the size and terms of the transaction, the changing business plans of the client, the effectiveness of the client’s management, general economic conditions and the regulatory environment. In addition, the timing of our revenue recognition could vary considerably depending upon whether our clients license our software under our subscription model or our traditional licensing arrangements. Because a significant percentage of our expenses are relatively fixed, a variation in the timing of sales and implementations could cause significant variations in operating results from quarter to quarter. We believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful. Investors should not rely on these comparisons as indicators of future performance.

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Early termination of client contracts or contract penalties could adversely affect results of operations.

Client contracts can change or terminate early for a variety of reasons. Change of control, financial issues, or other changes in client circumstances may cause us or the client to seek to modify or terminate a contract. Further, either we or the client may generally terminate a contract for material uncured breach by the other. If we breach a contract or fail to perform in accordance with contractual service levels, we may be required to refund money previously paid to us by the client, or to pay penalties or other damages. Even if we have not breached, we may deal with various situations from time to time for the reasons described above which may result in the amendment of a contract. These steps can result in significant current period charges and/or reductions in current or future revenue.

Because in many cases we recognize revenues for our software monthly over the term of a client contract, downturns or upturns in sales will not be fully reflected in our operating results until future periods.

We recognize a significant portion of our revenues from clients monthly over the terms of their agreements, which are typically 5-7 years and can be up to 10 years. As a result, much of the revenue that we report each quarter is attributable to agreements executed during prior quarters. Consequently, a decline in sales, client renewals, or market acceptance of our software in one quarter will not necessarily be reflected in lower revenues in that quarter, and may negatively affect our revenues and profitability in future quarters. In addition, we may be unable to adjust our cost structure to compensate for these reduced revenues. This monthly revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as a significant portion of revenues from new clients must generally be recognized over the applicable agreement term.

Payment defaults by large customers could have significant negative impact on our liquidity and overall financial condition.

During the fiscal year ended December 31, 2005, approximately 40.2 % of our revenues were attributable to our 20 largest clients. In addition, approximately 51.7% of our accounts receivable as of December 31, 2005 were attributable to 20 clients. Significant payment defaults by these clients could have a significant negative impact on our liquidity and overall financial condition.

Impairment of intangible assets could increase our expenses.

A significant portion of our assets consists of intangible assets, including capitalized development costs, goodwill and other intangibles acquired in connection with acquisitions. Current accounting standards require us to evaluate goodwill on an annual basis and other intangibles if certain triggering events occur, and adjust the carrying value of these assets to net realizable value when such testing reveals impairment of the assets. Various factors, including regulatory or competitive changes, could affect the value of our intangible assets. If we are required to write-down the value of our intangible assets due to impairment, our reported expenses will increase, resulting in a corresponding decrease in our reported profit.

Failure to maintain effective internal controls could adversely affect our operating results and the market price of our common stock.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we maintain internal control over financial reporting that meets applicable standards. If we fail to maintain effective internal controls and procedures in accordance with the requirements of Section 404, as such standards may be modified, supplemented or amended, we may be required to disclose our deficiencies. If we are unable, or are perceived as unable, to produce reliable financial reports due to internal controls deficiencies, investors could lose confidence in our reported financial information and our operating results which could result in a negative market reaction.

Inability to obtain additional financing could limit our ability to conduct necessary development activities and make strategic investments.

While our available cash and cash equivalents and the cash we anticipate generating from operations appear at this time to be adequate to meet our foreseeable needs, we could incur significant expenses as a result of unanticipated events in our business or competitive, regulatory, or other changes in our market. As a result, we may in the future need to obtain additional financing. If additional financing is not available on acceptable terms, we may not be able to respond adequately to these changes, which could adversely affect our operating results and the market price of our common stock.

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Risk of liability to third parties

Our software and content are used to assist clinical decision-making and provide information about patient medical histories and treatment plans. If our software fails to provide accurate and timely information or is associated with faulty clinical decisions or treatment, clients, clinicians or their patients could assert claims against us that could result in substantial cost to us, harm our reputation in the industry and cause demand for our software to decline.

We provide software and content that provides practice guidelines and potential treatment methodologies, and other information and tools for use in clinical decision-making, provides access to patient medical histories and assists in creating patient treatment plans. If our software fails to provide accurate and timely information, or if our content or any other element of our software is associated with faulty clinical decisions or treatment, we could have liability to clients, clinicians or patients. The assertion of such claims, whether or not valid and ensuing litigation, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations and decrease market acceptance of our software. We attempt to limit by contract our liability for damages and to require that our clients assume responsibility for medical care and approve all system rules and protocols. Despite these precautions, the allocations of responsibility and limitations of liability set forth in our contracts may not be enforceable, may not be binding upon patients, or may not otherwise protect us from liability for damages. We maintain general liability and errors and omissions insurance coverage, but this coverage may not continue to be available on acceptable terms or may not be available in sufficient amounts to cover one or more large claims against us. In addition, the insurer might disclaim coverage as to any future claim. One or more large claims could exceed our available insurance coverage.

Complex software such as ours may contain errors or failures that are not detected until after the software is introduced or updates and new versions are released. It is challenging for us to envision and test our software for all potential problems because it is difficult to simulate the wide variety of computing environments or treatment methodologies that our clients may deploy or rely upon. Despite extensive testing by us and clients, from time to time we have discovered defects or errors in our software, and such defects or errors can be expected to appear in the future. Defects and errors that are not timely detected and remedied could expose us to risk of liability to clients, clinicians and patients and cause delays in software introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or client satisfaction with our software.

Our software and our vendors’ software that we include in our offering could infringe third-party intellectual property rights, exposing us to costs that could be significant.

Infringement or invalidity claims or claims for indemnification resulting from infringement claims could be asserted or prosecuted against us based upon design or use of software we provide to clients, including software we develop as well as software provided to us by vendors. Regardless of the validity of any claims, defending against these claims could result in significant costs and diversion of our resources, and vendor indemnity might not be available. The assertion of infringement claims could result in injunctions preventing us from distributing our software, or require us to obtain a license to the disputed intellectual property rights, which might not be available on reasonable terms or at all. We might also be required to indemnify our clients at significant expense.

Risks related to our strategic relationships and initiatives

We depend on licenses from third parties for rights to some technology we use, and if we are unable to continue these relationships and maintain our rights to this technology, our business could suffer.

We depend upon licenses for some of the technology used in our software from a number of third-party vendors. Most of these licenses expire within one to five years, can be renewed only by mutual consent and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. We may not be able to continue using the technology made available to us under these licenses on commercially reasonable terms or at all. As a result, we may have to discontinue, delay or reduce software shipments until we obtain equivalent technology, which could hurt our business. Most of our third-party licenses are non-exclusive. Our competitors may obtain the right to use any of the technology covered by these licenses and use the technology to compete directly with us. In addition, if our vendors choose to discontinue support of the licensed technology in the future or are unsuccessful in their continued research and development efforts, particularly with regard to Microsoft, we may not be able to modify or adapt our own software.

Our offering often includes software modules provided by third parties, and if these third parties do not meet their commitments, our relationships with our clients could be impaired.

Some of the software modules we offer to clients are provided by third parties. We often rely upon these third parties to produce software that meets clients’ needs and to implement and maintain that software. If these third parties fail to fulfill their responsibilities, our relationships with affected clients could be impaired, and we could be responsible to clients for the failures. We might not be able to recover from these third parties for all of the costs we incur as a result of their failures.

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If we undertake additional acquisitions, they may be disruptive to our business and could have an adverse effect on our future operations and the market price of our common stock.

An important element of our business strategy has been expansion through acquisitions. Since 1997, we have completed ten acquisitions. While there is no assurance that we will complete any future acquisitions, any future acquisitions would involve a number of risks, including the following:

·	The anticipated benefits from any acquisition may not be achieved. The integration of acquired businesses requires substantial attention from management. The diversion of management’s attention and any difficulties encountered in the transition process could hurt our business.

·	In future acquisitions, we could issue additional shares of our capital stock, incur additional indebtedness or pay consideration in excess of book value, which could have dilutive effect on future net income, if any, per share.

·	New business acquisitions must be accounted for under the purchase method of accounting. These acquisitions may generate significant intangible assets and result in substantial related amortization charges to us.

Risks related to industry regulation

Potential regulation by the U.S. Food and Drug Administration of our software and content as medical devices could impose increased costs, delay the introduction of new software and hurt our business.

The U.S. Food and Drug Administration, or FDA, is likely to become increasingly active in regulating computer software or content intended for use in the healthcare setting. The FDA has increasingly focused on the regulation of computer software and computer-assisted products as medical devices under the Food, Drug, and Cosmetic Act, or the FDC Act. If the FDA chooses to regulate any of our software, or third party software that we resell, as medical devices, it could impose extensive requirements upon us, including the following:

·	requiring us to seek FDA clearance of pre-market notification submission demonstrating substantial equivalence to a device already legally marketed, or to obtain FDA approval of a pre-market approval application establishing the safety and effectiveness of the software;

·	requiring us to comply with rigorous regulations governing the pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and

·	requiring us to comply with the FDC Act regarding general controls including establishment registration, device listing, compliance with good manufacturing practices, reporting of specified device malfunctions and adverse device events.

If we fail to comply with applicable requirements, the FDA could respond by imposing fines, injunctions or civil penalties, requiring recalls or software corrections, suspending production, refusing to grant pre-market clearance or approval of software, withdrawing clearances and approvals, and initiating criminal prosecution. Any FDA policy governing computer products or content, may increase the cost and time to market of new or existing software or may prevent us from marketing our software.

Changes in federal and state regulations relating to patient data could depress the demand for our software and impose significant software redesign costs on us.

Clients use our systems to store and transmit highly confidential patient health information and data. State and federal laws and regulations and their foreign equivalents govern the collection, use, transmission and other disclosures of health information. These laws and regulations may change rapidly and may be unclear or difficult to apply.

Federal regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, impose national health data standards on healthcare providers that conduct electronic health transactions, healthcare clearinghouses that convert health data between HIPAA-compliant and non-compliant formats and health plans. Collectively, these groups are known as covered entities. The HIPAA standards prescribe transaction formats and code sets for electronic health transactions; protect individual privacy by limiting the uses and disclosures of individually identifiable health information; and require covered entities to implement administrative, physical and technological safeguards to ensure the confidentiality, integrity, availability and security of individually identifiable health information in electronic form. Though we are not a covered entity, most of our clients are and require that our software and services adhere to HIPAA standards. Any failure or perception of failure of our software or services to meet HIPAA standards could adversely affect demand for our software and services and force us to expend significant capital, research and development and other resources to modify our software or services to address the privacy and security requirements of our clients.

States and foreign jurisdictions in which we or our clients operate have adopted, or may adopt, privacy standards that are similar to or more stringent than the federal HIPAA privacy standards. This may lead to different restrictions for handling individually identifiable health information. As a result, our clients may demand information technology solutions and services that are adaptable to reflect different and changing regulatory requirements which could increase our development costs. In the future, federal or state governmental authorities may impose new data security standards or additional restrictions on the collection, use, transmission and other disclosures of health information. We cannot predict the potential impact that these future rules, may have on our business. However, the demand for our software and services may decrease if we are not able to develop and offer software and services that can address the regulatory challenges and compliance obligations facing our clients.

If we fail to attract, motivate and retain highly qualified technical, marketing, sales and management personnel, our ability to execute our business strategy could be impaired.

Our success depends, in significant part, upon the continued services of our key technical, marketing, sales and management personnel, and on our ability to continue to attract, motivate and retain highly qualified employees. Competition for these employees is intense and we maintain at-will employment terms with our employees, meaning that they are free to leave at any time. Further, while we do utilize non-compete agreements with some employees, such agreements may not be enforceable, or we may choose for various reasons not to attempt to enforce them. In addition, the process of recruiting personnel with the combination of skills and attributes required to execute our business strategy can be difficult, time-consuming and expensive. We believe that our ability to implement our strategic goals depends to a considerable degree on our senior management team. The loss of any member of that team could hurt our business.

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Risks related to our personnel and organization

Recent changes in our executive team could distract management and cause uncertainty that could result in delayed or lost sales.

From April until November 2005, our Chairman, Eugene V. Fife, served as our President and Chief Executive Officer on an interim basis, pending a search for a new, long-term Chief Executive Officer. In November 2005, R. Andrew Eckert replaced Mr. Fife as CEO and President. Including Mr. Eckert, five of our executive officers have joined the Company or assumed their current roles within the past year. In January, 2006, we announced a headcount reduction of approximately 100 persons, including seven senior executives, and reorganization of our management structure. These changes may disrupt continuity in our organization, disrupt established relationships with clients, prospects and vendors, divert our management’s time and attention from the operation of our business, delay important operational initiatives, and cause some level of uncertainty among our clients and potential clients that could lead to delays in closing new business or ultimately in lost sales.

Provisions of our charter documents and Delaware law may inhibit potential acquisition bids that a stockholder may believe is desirable, and the market price of our common stock may be lower as a result.

Our board of directors has the authority to issue up to 4,900,000 shares of preferred stock. The board of directors can fix the price, rights, preferences, privileges and restrictions of the preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may discourage, delay or prevent a merger or acquisition of our company. The issuance of preferred stock may result in the loss of voting control to other stockholders. We have no current plans to issue any shares of preferred stock. In August 2000, our board of directors adopted a shareholder rights plan under which we issued preferred stock purchase rights that would adversely affect the economic and voting interests of a person or group that seeks to acquire us or a 15% or more interest in our common stock without negotiations with our board of directors.

Our charter documents contain additional anti-takeover devices including:

·	only one of the three classes of directors is elected each year;

·	the ability of our stockholders to remove directors without cause is limited;

·	the right of stockholders to act by written consent has been eliminated;

·	the right of stockholders to call a special meeting of stockholders has been eliminated; and

·	advance notice must be given to nominate directors or submit proposals for consideration at stockholders meetings.

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

(a) The Annual Meeting of Stockholders was held on May 10, 2006.

(b) Two Class II directors - Steven A. Denning and Jay B. Pieper - were elected to serve for a term of three years ending at the 2009 annual meeting of stockholders. Continuing directors included Class I directors R. Andrew Eckert, Eugene V. Fife, and Braden L. Kelly, and Class III directors Dan L. Crippen and Edward A. Kangas.

Matter

Votes For

Votes Against or Withheld

Abstain

Broker

Non-votes

Election of Directors

Steven A. Denning

45,638,003

1,909,740

Jay B. Pieper

45,876,199

1,671,574

Ratification of the selection of PricewaterhouseCoopers

LLP as the Company's independent registered public

accounting firm for the fiscal year ending December 31.2206

47,332,371

203,443

11,959

ITEM 6. EXHIBITS

See Index to exhibits.

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SIGNATURES

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

Date: August 9, 2006

/s/ Robert J. Colletti

Robert J. Colletti

Senior Vice President, Chief Financial Officer and Chief Accounting Officer

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ECLIPSYS CORPORATION

EXHIBIT INDEX

Exhibit Number	Description
3.1 (1)	Third Amended and Restated Certificate of Incorporation of Eclipsys Corporation
3.2 (3)	Certificate of Designation of Series A Junior Participating Preferred
3.3 (2)	Amended and Restated Bylaws of Eclipsys Corporation
4.1 (3)	Rights Agreement dated July 26, 2000 by and between Eclipsys Corporation and Fleet National Bank, as Rights Agent, which includes as Exhibit A, the Form of Certificate of Designation, as Exhibit B, the form of Rights Certificate, and as Exhibit C, the Summary of Rights to Purchase Preferred Stock.
31.1	Rule 13a-14(a) Certification of R. Andrew Eckert
31.2	Rule 13a-14(a) Certification of Robert J. Colletti
32.1	Rule 13a-14(b) Certification of R. Andrew Eckert (pursuant to 18 U.S.C. Section 1350)
32.2	Rule 13a-14(b) Certification of Robert J. Colletti (pursuant to 18 U.S.C. Section 1350)

(1) Previously filed with the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 000-24539 and incorporated herein by reference.

(2) Previously filed with the Registrant’s Registration Statement on Form S-1, as amended (Registration No. 333-50781) and incorporated herein by reference.

(3) Previously filed with the Company’s Current Report on Form 8-K filed August 8, 2000 and incorporated herein by reference.