MEDE Medecision (MM)

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

         The following discussion of our financial condition and results of operations should be read in conjunction with the "Selected Financial Data" and our consolidated financial statements and the notes to those statements appearing elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this report, particularly under the caption "Risk Factors."

Overview

        We are a leading provider of collaborative health care management solutions, including integrated software, services and clinical content to health care payers. Our solutions provide a logical way to manage members and member populations and improve health outcomes.

        Before we simplified our product offerings in December 2007, our Collaborative Health Care Management suite consisted of four related product modules—(i) Data Gathering and Analytics; (ii) Clinical Rules and Processes; (iii) Advanced Medical Management; and (iv) Collaborative Data Exchange. We currently have combined our Case Management, Disease Management, Utilization Management functions and supporting applications (which were primarily features and functions incorporated into the previous Data Gathering and Analytics, Clinical Rules and Processes, and Advanced Medical Management module) into Alineo and our collaborative health information exchange services (previously certain features and functions of Collaborative Data Exchange) into Nexalign.

        Our collaborative health care management solutions include—(i) Alineo, a platform addressing case management, disease management and utilization management within a payer organization; and (ii) Nexalign, a collaborative health information exchange service. The Alineo solution provides a simplified and smart process for analyzing, applying, and automating payer-driven best practices. It provides intuitive predictive modeling tools to identify patients who can immediately benefit from case and disease management programs, delivers turnkey clinical knowledge and pathways based on embedded clinical content and allows payers to automatically and intelligently administer and evaluate member and population-wide health care programs including approvals, referrals, and extensions. The Nexalign solution provides a simplified and smart way for health care payers, patients, physicians, and other health care providers to securely access and exchange health information to foster better clinical decisions. It is designed around Clinical Summaries, clinically validated payer-based electronic health records.

        Since 1999, we have focused on broadening our solutions to respond to the evolving needs of our customers. In 1999, we began offering a Data Gathering and Analytics module; in 2001, we began offering a Collaborative Data Exchange module; in 2003, we began offering OptiCareCert; in 2004, we began offering OptiCarePath; in 2005, we began offering our customers the ability to electronically transmit Clinical Summaries via our Collaborative Data Exchange module; and, in December 2007, we reengineered and simplified our product offering into two solutions: Alineo, focusing on the information and workflow requirements inside a payer's organization, and Nexalign, focusing on the exchange of clinical information from multiple sources to the point of care.

        We operate in a relatively small market, where we have 56 of approximately 350 potential customers. This presents our management with the challenge of expanding our revenue within a limited potential customer base, and the attendant risk of our inability to grow revenue if we are unable to do so. Our strategy is to develop new customers, sell additional solutions to existing customers, and introduce new products such as Alineo and Nexalign. However, not every potential customer is in the market for software at all times. Because of the cost, time and effort involved in implementing a

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software solution like the products we sell, once a potential customer chooses a solution from a competitor over the collaborative health care management solutions that we offer, these potential customers may not be in the market to buy a complete software solution for a number of years, although there may be opportunities to provide them with specific modules to address particular needs that they may have.

        We license our solutions primarily to large regional health care insurance companies. As of December 31, 2007, our customers included approximately 56 regional and national managed care organizations, including the largest organizations in more than 28 regional markets. Our revenue has increased at a compound annual growth rate of 21.5% since 2003, to $44.8 million for the year ended December 31, 2007. Our overall increase in revenue is attributable to increased emphasis by our customers on active management of their total insured population and the expansion of our solutions to meet their evolving needs.

        In the past, our non-recurring revenue, which primarily consists of term license fees for our software products and professional service fees associated with implementation of these software products, has constituted a significant portion of our revenue. This non-recurring revenue is generally paid in lump sums, thereby decreasing the predictability of our revenue. As a result of these risks and challenges, we have focused, and anticipate that we will continue to focus, on the growth of our business, expanding existing customer relationships, developing innovative new solutions, expanding our customer base within our market and continuing to build recurring and predictable revenue through new products like our Clinical Summary.

        Prior to 2006, we experienced our fastest growth in term licenses and professional services revenue, thereby increasing those items as a percentage of our revenue. Consequently we realized a decreasing percentage of subscription, maintenance and transaction fee revenue even though that revenue grew as well. For the year ended December 31, 2007, subscription, maintenance and transaction fee revenue increased as a percentage of total revenue due to increased sales of our Data Gathering and Analytics and Collaborative Data Exchange modules, which are currently a part of our Alineo solution. In the future, we anticipate the market will have an increased focus on Electronic Health Records and what we refer to as our Clinical Summary. For these solutions, our customers pay an annual subscription fee and pay a transaction fee each time they utilize the solution. In addition, once adopted by a customer, there are less sales and administrative efforts required to increase the transaction volume with a customer as compared to the efforts required to sell a new term license for one of our other solutions. We anticipate that the growth of this portion of our business will continue to outpace our traditional software licenses and, as a result, subscription and transaction revenue will become a larger portion of our overall revenue. We anticipate that this strategy will continue to lead to more recurring and predictable overall revenue. In addition, given the lower administrative and sales costs associated with this revenue, we anticipate that this will increase our margins, especially as transaction volume with a given customer increases.

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

Background

        We began operations in 1988 by licensing an automated medical management solution to large regional health care insurance companies. This solution was the predecessor to the Advanced Medical

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Management module. In 1999, we acquired the assets of an analytical software company that became the basis of the Data Gathering and Analytics module. In 2000, we expended a significant amount of capital to begin the development of the Collaborative Data Exchange module, completing the initial development of the module in the third quarter of 2001. In December 2002, we acquired assets that were the foundation for clinical decision support content, which enabled us to create the Clinical Rules and Processes module. In 2005, we began to offer our customers the ability to electronically transmit Clinical Summaries to providers at the point of care. These modules were licensed to customers individually or as an integrated collaborative health care management solution. In December 2007, we combined our Case Management, Disease Management, Utilization Management functions and supporting applications (which were primarily features and functions incorporated into the previous Data Gathering and Analytics, Clinical Rules and Processes, and Advanced Medical Management module) into Alineo and our collaborative health information exchange services (previously certain features and functions of Collaborative Data Exchange) into Nexalign. Alineo focuses on the information and workflow requirements inside a payer's organization, and Nexalign, focusing on the exchange of clinical information from multiple sources to the point of care.

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

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

        On December 18, 2006, we raised approximately $26.4 million from our initial public offering, net of fees and expenses. In connection with the closing of our initial public offering, all of our outstanding shares of Series A preferred stock, Series B preferred stock and Series C preferred stock were converted into common stock under the terms of each of the respective preferred stock designations. All dividends on the Series A preferred stock that were accrued but unpaid as of the date of the offering were converted into common stock pursuant to an election of each holder of such shares as provided under the terms of the Series A preferred stock designation. All dividends on the Series B preferred stock and Series C preferred stock that were accrued but unpaid as of the date of the offering (approximately $9.5 million) were paid in cash from the proceeds of the offering. We currently have no shares of preferred stock outstanding.

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Sources of Revenue

        We derive revenue from the following sources: (i) subscription, maintenance and transaction fees; (ii) term license fees for our solutions; and (iii) fees for discrete professional services. These revenue streams are derived from the licensing of our collaborative health care management solutions that include—(i) Alineo, a platform addressing case management, disease management, and utilization management within a payer organization; and (ii) Nexalign, a collaborative health information exchange service. Alineo is a collaborative health care management platform that addresses case, disease, and utilization management within the walls of the payer and consists of: Alineo Care Management Analytics, that enables a payer to process, summarize, and evaluate information from both internal and external sources; Alineo Clinical Intelligence, that identifies specific condition treatment opportunities as well as health and wellness interventions; Alineo Clinical Summaries, that are clinically validated payer-based health records compiled from claims and care management data files and created for our customer's members; Alineo Clinical Programs, that consists of clinical pathways for case and disease management that automatically populate questionnaires, goal templates, and other correspondence to members and providers; Alineo Clinical Criteria, that allows our customers to determine the medical appropriateness of a requested health care service or treatment; Alineo Automated Approvals, that support the use of customer defined business rules to automatically evaluate care requests to determine medical appropriateness and whether the request should be approved or pended for further review by our customer's medical staff; Alineo Reporting, that is a standard set of report templates; Alineo Correspondence , that supports documentation management and letter generation; and Workflow Management, that allows care management staff to automatically and intelligently administer, manage and evaluate both individual and population-wide health care programs. Our Nexalign solution is a collaborative health care information exchange service that provides a way for payers, patients, physicians, and other health care providers to securely access and exchange health information to foster better clinical decisions. Nexalign is designed around Clinical Summaries, which are payer-based electronic health records that have been clinically validated.

Subscription, Maintenance and Transaction Fees

        Our customers pay annual subscription fees to license clinical pathways for case and disease management through Alineo Clinical Programs, to process data through MEDecision's service bureau and access reports using Alineo Care Management Analytics and Alineo Clinical Intelligence and to transmit clinical data and decisions through our Nexalign solution. Customers also pay a fee for each transaction transmitted over our network. We recognize these subscription fees ratably over the term of the subscription agreement and include this in the subscription, maintenance and transaction fee revenue on our consolidated statements of operations. We also offer our customers a hosted solution and receive monthly fees for those services. We recognize hosting revenue ratably over the term of the related agreement, which is typically five years in duration. Hosting revenue is included in subscription, maintenance and transaction fee revenue on our consolidated statements of operations.

        Our customers pay an annual maintenance and support fee equal to approximately 22% of the Workflow Management and Alineo Automated Approvals initial license fees, which entitles our customers to unspecified software updates and upgrades and basic product support. For Alineo Clinical Programs contracted for under a term license model, our customers pay approximately 35% of the initial license fee for unspecified software updates and upgrades, including content updates, and basic product support. We recognize maintenance and support fees ratably over the term of the maintenance and support agreement.

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

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Term License Fee

        Our customers pay a term license fee to utilize Workflow Management and Alineo Automated Approvals and Clinical Rules and Processes modules, typically for five years. We recognize revenue for term license fees upon delivery of the software assuming all other revenue recognition criteria have been met.

Professional Services

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

        Each of our license models provides us with a recurring revenue stream. Historically, a substantial portion of our clients have renewed their licenses each year. During the year ended December 31, 2007, our clients renewed 89% of the contracts which were to expire during that period. The combination of recurring revenue and high renewal rates provide us with substantial annual revenue predictability. Although in general our revenue is consistent throughout the year, sales of certain modules that have an initial term license can cause revenue volatility from quarter to quarter. The sales cycle for our Alineo solution is typically eight months or longer. As a result, it is difficult for us to predict the quarter in which a particular sale may occur. In addition, in a small portion of our sales, the license fee is material relative to our total revenue during the quarter. Accordingly, our revenue may vary significantly from quarter to quarter depending on the quarter during which a large sale occurs.

Strategy for Growth

        Our strategy for revenue growth is to (1) increase recurring and transaction-based revenue streams as a percentage of total revenue, primarily through Clinical Summary transactions; (2) expand our customer base into additional managed care organizations in the United States that could benefit from our entire collaborative health care management solutions, including Alineo and Nexalign; (3) expand relationships with our existing customers; and (4) develop the next generation of our solutions.

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

        Prior to 2003, we licensed our software module separately to payer organizations. Beginning in 2003, we began marketing and licensing our modules as an integrated solution, providing the payer an ability to license the entire Collaborative Care Management suite, or certain components initially, based upon the payer's business needs at that time. In December 2007, we reengineered and simplified our

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product offering into two solutions: Alineo, focusing on the information and workflow requirements inside a payer's organization, and Nexalign, focusing on the exchange of clinical information from multiple sources to the point of care. We intend to market and license Alineo and Nexalign as an integrated Collaborative Health Care Management Solution. In addition we intend to allow new customers to license components based upon their business needs at the time of licensing and to allow existing customers to increase their utilization of integrated solutions as their business needs changes. We believe there are at least 350 additional managed care organizations in the United States, self-insured companies and Medicare and Medicaid organizations that could benefit from licensing and deploying our entire collaborative health care management solutions, or selected modules-within Alineo and Nexalign. We license our solutions to new customers through our direct sales force, and our marketing initiatives generally have included conferences, trade shows, health care industry events and direct mail campaigns. We will continue to invest in additional sales personnel and marketing programs to increase awareness of our integrated solution, but not at the same rate of our revenue growth.

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

Trends in Sales of our Solutions

        Prior to 2007, our Collaborative Care Management suite consisted of four related product modules: (i) Data Gathering and Analytics; (ii) Clinical Rules and Processes; (iii) Advanced Medical Management; and (iv) Collaborative Data Exchange. Prior to 2003, we marketed and sold these modules individually rather than as a suite of products. From 2003 to December 2007, we marketed these modules as the Collaborative Care Management suite, although we continued to license the modules individually in order to offer our customers an individualized solution. Prior to 2004, our customers generally initiated their relationships with us by licensing just Advanced Medical Management as the core of their business. However, since 2004, we believe that our customers have focused more on implementing integrated multi-functional systems and have looked for products that offer more than a claims management system.

        A significant number of our new customers have licensed one or two modules in addition to the Workflow Management component of Alineo. We anticipate that this will remain the case for the foreseeable future. In December 2007, we simplified our product offering into two solutions, Alineo and Nexalign. By doing so, we now focus on implementing integrated multi-functional systems and will attempt to license several of our modules to new customers with a view to integrating them as one platform. Both new and existing customers will be able to license individual components of Alineo based upon their business requirements at the time of licensing.

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

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Cost of Revenue

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

        Our cost of subscription, maintenance and transaction fees primarily consists of:

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amortization of internally developed and purchased capitalized software;



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compensation and related employee benefits of our product support, product maintenance and product hosting staff;



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third-party maintenance fees associated with the third-party software incorporated into our software solutions;



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solution hosting costs associated with a third-party secured facility;



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royalties related to software subscriptions; and



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communication costs associated with our hosting network.

        Our cost of term licenses primarily consists of:

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amortization of internally developed and purchased capitalized software; and



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third-party license fees for the third-party software incorporated in our software solutions.

        Our cost of professional services primarily consists of:

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compensation and related employee benefits for our professional services staff;



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costs of independent contractors that provide consulting and professional services to our customers; and



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travel, lodging and other out-of-pocket expenses for our staff and independent consultants to perform work at a customer's site for which we receive reimbursement.

        The costs associated with each of our modules, as a percentage of revenue, is different. Therefore, changes in the mix of modules and services will result in fluctuations in gross margin. We expect the percentage of our revenue derived from our software licenses and subscriptions to increase in the future. As a result, we expect our gross margins to increase in the future.

Operating Expenses

        We classify our operating expenses as follows:

Sales and Marketing

        Sales and marketing expenses primarily consist of:

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



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travel related expenses to meet with existing and potential customers, and for other sales and marketing related purposes;



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costs associated with trade shows and industry conventions;



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fees and other expenses related to public relations consultants; and



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costs associated with our annual user conference and other marketing related activities.

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

Research and Development

        Research and development expenses consist primarily of:

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personnel and related costs, including salaries and employee benefits for software engineers, software quality assurance engineers and clinical systems engineers;



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consulting fees paid to independent consultants who provide software or quality engineering services to us; and



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costs of medical panels and research for annual clinical updates to our solutions.

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

        Historically, we have capitalized a portion of our research and development expenses related to purchased and internally developed software. Capitalized research and development expenses totaled $4.8 million, $1.4 million, and $2.4 million for the years ended December 31, 2007, 2006, and 2005, respectively. Otherwise, we expense research and development as those costs are incurred.

General and Administrative

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

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personnel and related costs for our executives, finance, human resources, corporate information technology systems, corporate quality, and administrative personnel;



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legal and accounting fees;



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professional fees relating to Sarbanes-Oxley compliance;



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facilities and related costs;



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recruiting and training costs;



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depreciation and amortization;



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travel related expenses for executives and other administrative personnel; and



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computer maintenance and support for our internal information technology system.

        We expect general and administrative expenses to increase in the future as we invest in an infrastructure to support our continued growth.

Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with

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

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

Revenue Recognition

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

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

        We enter into transactions that represent multiple-element arrangements, which may include a combination of professional services, hosting, PCS and software. In instances where certain arrangements include both software and non-software related elements, we apply the principles of SOP 97-2 to software elements. If the elements of the arrangement fall outside the scope of SOP 97-2, then we apply the principles of EITF 00-21. In accordance with EITF 00-21, multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met:

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the delivered item(s) has value to the client on a stand-alone basis;



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there is objective and reliable evidence of the fair value of the undelivered item(s); and



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if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the company.

        If these criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit's relative fair value. There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s)

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but no such evidence for the delivered item(s). In those cases, the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item(s). We apply the revenue recognition policies discussed below to each separate unit of accounting.

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

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

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persuasive evidence of an arrangement exists;



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delivery of our basic software code has occurred;



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the license fee is fixed or determinable; and



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collection of the license fee is probable.

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

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the customer cannot take possession of the software at any time during the hosting period without significant penalty;



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the customer cannot contract with another hosting provider without significant effort or expenditure; or



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the software's functionality is compromised by the termination of hosting services.

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

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

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

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returns of its products. If an arrangement allows for customer acceptance of the software or services, then we defer revenue recognition until the earlier of customer acceptance or when the acceptance rights lapse.

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

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

        While the statements of work with our customers may specify multiple elements, we believe that the service elements included in our contractual arrangements with customers are not essential to the functionality of our software, which can operate in a standalone fashion upon installation. These service elements do not include significant modification or customization of our software, but may include configuring, designing and implementing simple interfaces with other customer software, installation and configuration of third-party software, and training in the use of both our software and third-party software. The timing of payments for software is independent of the payment terms for the service elements in our contractual arrangements with customers. In multi-element arrangements involving software and consulting, training or other services that are not essential to the functionality of the software, the services revenue is accounted for separately from the software revenue. We offer package pricing for the various service elements of our contractual arrangements with customers, and recognize VSOE for service elements based on the prices of those packages, which are based on hourly rates consistent with those used in the separate sales of services.

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

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

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

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        In accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred , we account for out-of-pocket expenses billed to customers as maintenance, consulting and training revenue with related costs included in cost of revenue. For the years ended December 31, 2007, 2006, and 2005, reimbursement expenses totaled $501, $438, and $427, respectively.

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

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

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the determination that it is probable that the customer will pay for the products and services purchased is inherently judgmental;



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the allocation of proceeds to certain elements in multiple-element arrangements is complex;



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the determination of whether a service is essential to the functionality of the software is complex;



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establishing company-specific fair values of elements in multiple-element arrangements requires adjustments from time-to-time to reflect recent prices charged when each element is sold separately; and



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the determination of the stage of completion for certain consulting arrangements is complex.

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

        In prior periods, our estimates of the total cost of consulting, training and other services, which are recognized under the proportional performance method, have been reasonably accurate. As a result, there have been no significant changes in the amount of gross profit recognized relative to the revenue recognized in different periods.

        If we were to change our pricing approach in the future, this could affect our revenue recognition estimates, in particular, if bundled pricing precludes establishment of VSOE.

Accounts Receivable and Allowance for Doubtful Accounts

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

        We believe that our estimate of our allowance for doubtful accounts is critical because of the significance of our accounts receivable balance relative to total assets. If the general economy deteriorated, or factors affecting the profitability or liquidity of the industry changed significantly, then this could affect the accuracy of our allowance for doubtful accounts.

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Capitalized Software Research and Development Costs

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

        We believe that our estimate of our capitalized software costs and the period for their amortization is critical because of the significance of our balance of capitalized software costs relative to our total assets. Potential impairment is determined by comparing the balance of unamortized capitalized software costs to the sales revenue projected for a capitalized software project. If efforts to sell that software project are terminated, or if the projected sales revenue from that software project drops below a level that is less than the unamortized balance, then an impairment would be recognized.

        Factors that could change the amount of software capitalized in the future include greater use of offshore programming resources, which would reduce the amount of software capitalized, or shorter product life cycles, which would require amortization on a shorter time schedule.

Stock-Based Compensation

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

        As required by the FASB under SFAS No. 123R, Share-Based Payment , effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R which requires us to apply the provisions of SFAS No. 123R to new awards granted, and to awards modified, repurchased, or cancelled after the effective date. We began recognizing stock-based compensation expense under a calculated measurement value computation effective January 1, 2006. The fair value of stock options will be recognized as expense in our financial statements over the remaining vesting period of the stock options. The adoption of SFAS No. 123R resulted in $1,174 and $224 of expense in 2007 and 2006, respectively. In addition, the adoption of this standard will result in difficulties comparing our operating

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results for future periods to those of our prior periods, since prior periods through 2005 will not reflect stock-based compensation expense under SFAS No. 123R.

        At the time that options were granted during the years 2004, 2005 and in January and April of 2006, the fair value of the common stock for the options was estimated by the board of directors, with input from management. Given the absence of an active market for our common stock, our board of directors, the members of which we believe had extensive business and finance experience, was required to estimate the fair value of our common stock at the time of each option grant. In July 2006, we engaged an independent valuation specialist, Mufson, Howe, Hunter, & Company, LLC ("Valuation Expert") to perform a retrospective valuation of our common stock as of and for the years ended December 31, 2004 and 2005, and the six months ended June 30, 2006. As a result of this retrospective valuation, it was determined that the exercise prices for the stock options granted in the first half of 2004 and for April and July 2006 exceeded the fair value of our common stock at those dates. The exercise prices for stock option grants in the second half of 2004, all of 2005 and January 2006 were below the retrospective fair values determined for those dates. Accordingly, as required by APB Opinion 25, for the difference by which the fair value of the underlying common stock exceeded the option exercise price of the grants in 2004 and 2005, we recognized stock-based compensation expense in our consolidated statements of operations for the years ended December 31, 2007, 2006, and 2005 in the amounts of approximately $490, $397, and $256, respectively.

Significant Factors, Assumptions, and Methodologies Used in Determining Fair Value of Options Granted Prior to Our Initial Public Offering.

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

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

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asymmetrical distribution of returns; and (iii) an appropriate risk-adjusted discount rate to the present rate.

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

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

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

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

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

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

        We granted stock options with exercise prices of $0.50 during the years ended December 31, 2005 and 2004, $2.50 in January 2006 and $22.00 in April and July 2006. The Valuation Expert determined in its retrospective valuation that the fair value of our common stock was, as of each date indicated:

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

        As of June 30, 2006, the Valuation Expert determined that the fair value of our common stock was $6.34 per share. As disclosed elsewhere, the initial public offering price of our common stock was $10.00. This increase in fair value between that determined by the Valuation Expert and that determined by our underwriters is attributable to the following factors: an increase in the valuation of comparable public companies included in the Valuation Expert's report; an increase in the probability of completing our initial public offering; and, as our initial public offering became more likely, the removal of the discount related to the uncertainty associated with a shareholder liquidity event. In addition, there was also a difference in the methodology utilized by the independent Valuation Expert and our underwriters. The Valuation Expert used a broader group of health care software companies that, overall, had valuation multiples that were lower than the group included in the underwriters' valuation. In addition, the Valuation Expert included as comparable companies only those companies whose revenue base is most closely comparable to our current business model, despite the fact that we anticipate increased subscription, maintenance and transaction fee based revenues in the future from our Patient Clinical Summary product.

        We consider the estimates of expected term and volatility used in calculating the Black-Scholes fair value of future awards to be critical because of the amount of stock-based compensation to be recognized in our financial statements. Because of the short time that our stock has been publicly traded, we cannot estimate how accurate our estimates may prove to be compared to the actual market behavior of our stock price and the future exercise behavior of the participants in our equity incentive plans. As we develop historical data, these estimates may change in the future. Also, we may find that a different method to calculate fair value may be more accurate in determining the actual economic impact of stock-based compensation.

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        We do not anticipate any significant changes in the number of stock option awards granted in the future or the number of participants in our equity incentive plans.

Accounting for Preferred Shares and Derivative Shares

        As of the closing of our initial public offering on December 18, 2006, all of our preferred stock converted into common stock. We currently have no shares of preferred stock outstanding.

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

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

Accounting for Income Taxes

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

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

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        In evaluating our ability to realize deferred tax assets, we consider all available positive and negative evidence. Our positive evidence includes our projections of future taxable income, the remaining life of the net operating loss carryforwards and cumulative taxable income over the three most recent fiscal years. Our negative evidence includes operating losses generated from 2000 through 2003 and the taxable losses generated in 2006 and 2007. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business.

        Term license revenue of $1.4 million recorded during the fourth quarter of 2006 was below our expectations resulting in a net loss for the year ended December 31, 2006 and reversing the trend of two consecutive years of book and three consecutive years of taxable income. This lower term license revenue was primarily the result of the delay in the execution of certain contracts which became known to us during the last two weeks of the year. In addition, a new customer contract which the Company anticipated obtaining and closing prior to December 31, 2006 was initially lost to a competitor in January 2007 but subsequently signed as a new customer in June 2007. As a result of the delay in the closing of contracts and the lost opportunity, the Company recorded a net loss in the fourth quarter of 2006 and the full year 2006, and, reduced its revenue and net income guidance for 2007. Accordingly, the Company fully reserved the deferred tax asset at December 31, 2006. Due to the continued losses in 2007, the Company maintained this 100% reserve as of December 31, 2007.

        We operate within multiple state taxing jurisdictions and are subject to audit in each jurisdiction. Our United States federal income tax return for 2005 is currently under audit by the Internal Revenue Service ("IRS"). The final resolution of this audit is uncertain and may take several months. Our management does not believe, based upon information currently known to us that the final resolution of this audit will have a material adverse effect upon our consolidated financial position and the results of operations and cash flows. However, if upon the conclusion of this audit the ultimate determination of our taxes owed is for an amount in excess of the tax provision we have recorded or reserved for, our overall effective tax rate may be adversely impacted in the period of adjustment. In our opinion, adequate provisions for income taxes have been made for all periods. As we gain experience with tax examinations in the future, our estimates of any unrecognized tax benefits may change, which may affect the amount of net operating losses that we may be able to utilize in the future.

        We believe that our estimate of our deferred tax assets and liabilities and our estimation of future tax benefits to be realized in calculating the valuation allowance against those deferred tax assets are critical because of the significance of our net deferred tax assets relative to our total assets and because of the effect that possible realization of past net operating losses may have upon our future net income. Because of the variability of our revenue and expenses in the past and uncertainties about the future, we cannot estimate how accurate those estimates are without further operating history. As our business continues to develop and our ability to forecast future income improves, we expect to be able to become accurate in determining the amount of deferred tax assets and liabilities that we can expect to utilize.

        We adopted the Financial Accounting Standard Board's Interpretation No. 48, Accounting for Income Tax Uncertainties ("FIN 48"), on January 1, 2007. FIN 48 clarifies the accounting for uncertain income tax positions recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. As of December 31, 2007, we had $19,050 of unrecognized tax benefits which, if recognized, would favorably impact our effective tax rate. The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits and the expiration of the statute of limitations within the next 12 months. Our policy is to recognize interest and penalties on unrecognized tax benefits in provision for income taxes in the consolidated statements of operations. As

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of December 31, 2007, we have no accrued interest or penalties related to uncertain tax positions. Tax years beginning in 2003 are subject to examination by taxing authorities, although net operating loss and credit carryforwards from all years are subject to examinations and adjustments for at least three years following the year in which the attributes are used.

Recently Issued Accounting Standards

        In June 2006, the FASB reached a consensus on Emerging Issues Task Force ("EITF") Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation), ("EITF 06-03"). EITF 06-3 indicates that the income statement presentation on either a gross basis or a net basis of the taxes within the scope of the issue is an accounting policy decision that should be disclosed. EITF 06-3 is effective for interim and annual periods beginning after December 15, 2006. The adoption of EITF 06-3 did not change our policy of presenting taxes within the scope of EITF 06-3 on a net basis and had no impact on our consolidated financial statements.

        In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair values, establishes a framework for measuring fair value, and expands the disclosure requirements about fair value measurements. In February 2008, the FASB issued Staff Position No. FAS 157-2 ("FSP 157-2") that defers the effective date of applying the provisions of SFAS 157 to the fair value measurement of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. We were required to adopt the provisions of SFAS 157 that pertain to financial assets and liabilities on January 1, 2008. The adoption of SFAS 157 did not have a material impact on our consolidated financial position or results of operations. We are currently evaluating the effect FSP 157-2 will have on our consolidated financial position and results of operations.

        In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115 . Under this statement, entities will be permitted to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). By electing the fair value measurement attribute for certain assets and liabilities, entities will be able to mitigate potential "mismatches" that arise under the current mixed measurement attribute model. Entities will also be able to offset changes in the fair values of a derivative instrument and its related hedged item by selecting the fair value option for the hedged item. SFAS No. 159 will become effective for fiscal years beginning after November 15, 2007. We were required to adopt SFAS 159 on January 1, 2008. The adoption of SFAS 159 did not have a material effect on our consolidated financial position or results of operations.

        In December 2007, the FASB issued SFAS No. 141 (revised), "Business Combinations" ("SFAS 141(R)"). SFAS 141(R) changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer's income tax valuation allowance. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for certain tax adjustments for prior business combinations. Accordingly, we will adopt this statement on January 1, 2009. We are evaluating the effect SFAS 141(R) will have on our consolidated financial position and results of operations.

        In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160"). SFAS 160 changes the accounting

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for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders' equity, and the elimination of "minority interest" accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, SFAS 160 revises the accounting for both increases and decreases in a parent's controlling ownership interest. SFAS 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. Accordingly, we will adopt this statement on January 1, 2009. We do not expect the adoption of SFAS 160 to have a material impact on our consolidated financial position or results of operations.

        In December 2007, the FASB Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 07-1, Accounting for Collaborative Arrangements. The EITF concluded on the definition of a collaborative arrangement and that revenues and costs incurred with third parties in connection with collaborative arrangements would be presented gross or net based on the criteria in EITF 99-19 and other accounting literature. Based on the nature of the arrangement, payments to or from collaborators would be evaluated and its terms, the nature of the entity's business, and whether those payments are within the scope of other accounting literature would be presented. Companies are also required to disclose the nature and purpose of collaborative arrangements along with the accounting policies and the classification and amounts of significant financial-statement amounts related to the arrangements. Activities in the arrangement conducted in a separate legal entity should be accounted for under other accounting literature; however required disclosure under EITF 07-1 applies to the entire collaborative agreement. EITF 07-1 will be effective for us January 1, 2009 and is to be applied retrospectively to all periods presented for all collaborative arrangements existing as of the effective date. We are currently evaluating the effect that the adoption of this consensus opinion will have on our consolidated financial statements.

Significant Customer Contracts

        Two of our customers, Health Care Service Corporation ("HCSC") and Blue Cross Blue Shield of Minnesota ("Minnesota") accounted for 26% and 12%, respectively, of our revenue for the year ended December 31, 2007. HCSC and Horizon Blue Cross Blue Shield ("Horizon") accounted for 27% and 20%, respectively, of our revenue for 2006. HCSC accounted for 25% of our revenue for 2005. Each of these contracts contains a term license component and an annual subscription and maintenance fee component. As is the case generally with all of our term license arrangements, a significant amount of the revenue of the contract is recognized in the initial year of the contract, with the remaining year revenue composed predominantly of annual subscription and maintenance fees and services relating primarily to implementation. See the discussion of "Sources of Revenue" contained under Item 7 of this Annual Report on Form 10-K. As a result, while these two contracts represent a material portion of our revenue for the year ended December 31, 2007, we can not determine at this time whether these contracts will represent a material portion of our revenue in the future.

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