Eclipsys 10-K 2006
Documents found in this filing:
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”, and “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; capabilites of or 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 depends at least in part upon client involvement, which can be difficult to control. We are required to meet specified performance standards, 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 software, 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 are described in this report under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of 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. 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.
Item 1. Business
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.
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.
Our Web site address is www.eclipsys.com. We make available free of charge, on or through our Web site, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.
In October 2005, we named R. Andrew Eckert president and chief executive officer. He assumed these roles on November 14, 2005 from our chairman, Eugene V. Fife, who had served in an interim capacity for the previous six months.
In March 2005, we announced the release of Sunrise Clinical Manager 4.0XA, which contained numerous new features and enhancements, particularly in the ambulatory, emergency department, and medications management parts of our software, extending the usability, depth and reach of Eclipsys clinical solutions. SCM 4.0XA was installed at 38 client sites in 2005, and approximately 18 additional client sites are expected to begin using SCM 4.0XA in 2006.
Following the launch of SCM 4.0XA, we released Sunrise Clinical Manager 4.5XA in January 2006. The Sunrise 4.5 XA advanced clinical suite builds upon our previous releases and adds significant new or expanded capabilities, including the fully integrated capabilities of our Sunrise Ambulatory Care Manager™,Sunrise ED Manager™ and Sunrise Medication Management solutions. Sunrise 4.5 XA also builds upon recent enhancements to our Sunrise Patient Financial Manager and Sunrise Decision Support Manager solutions. These industry-leading business process solutions help save healthcare enterprises significant time and costs by streamlining workflows and optimizing best practices across the organization. Sunrise Clinical Manager 4.5XA is already being installed at initial client sites.
Client input has played an important role in the development of the software we released this year. Our solutions utilize the same architecture and share the same Health Data Repository (HDR), while being customized for the workflows of different environments. This enables Eclipsys clients to tie together their workflows, operations and the entire continuum of care. Further, our software is built upon an open architecture that supports the secure exchange of data between systems, as well as the ability to embed evidence-based content.
In February 2005, we introduced Remote Access Services (RAS) 4.0 XA™ and Pocket Sunrise™ 4.0 XA, at the Annual Healthcare Information and Management Systems Society Conference and Exhibition (HIMSS) in Dallas.
In March 2005, we were recognized as a leading provider of computerized physician order entry (CPOE) solutions based on physician usage in the KLAS CPOE Digest 2005. Eclipsys CPOE solutions include its award-winning Sunrise™ Clinical Manager and Eclipsys 7000 offerings. The survey found that when software functionality is the key decision-making criteria, healthcare organizations selected Eclipsys more often than any other vendor.
In April 2005, we released Sunrise Access Manager/Patient Financial Manager 11.5, the latest major milestone in our proven revenue cycle management solution. The new release added new and enhanced capabilities for maximizing revenue capture, improving cash flow, decreasing administrative costs, and enhancing patient satisfaction.
In November 2005, we announced the latest release of Sunrise RIS, the Eclipsys advanced radiology information system. Sunrise RIS supports a paperless workflow, including document generation, document management, scanner support, and the ability to markup diagrams and capture key images. All components, including speech recognition, are Web-based, simplifying deployment and providing today's increasingly mobile radiology personnel the flexibility to work from virtually any location.
Also in November 2005, our Sunrise Pocket XA wireless solution was recognized as among the most innovative uses of enterprise technology in healthcare in this year's InfoWorld 100. The annual awards honor Information Technology (IT) products that demonstrate the most creative use of cutting-edge technologies. Pocket XA is a wireless companion to our advanced clinical solutions. Running on a pocket personal computer, it provides wireless access to clinical information. As a result, physicians can place orders for medications and additional lab work, access patient records including current lab and other diagnostic results, make positive patient identification using barcode technology and perform other functions directly from the device, both at the point of care and at wireless locations inside and outside the hospital or clinic.
In the second quarter of 2005, we contracted for Oracle’s Enterprise Resource Planning (ERP) system, Oracle’s E-Business Suite 11i, which will provide Eclipsys with a web-based, integrated set of business applications. This is a significant infrastructure investment that should facilitate better communication and increased efficiency and productivity across our organization.
Healthcare Industry Factors
Hospitals are under increased pressure to reduce medical errors and increase operational efficiencies. Our software and services are designed to help clients achieve these objectives. Legislation is also requiring changes within the healthcare industry. We believe that these changes may increase demand for HIT software and services like ours.
The Decade of Health Information Technology. On April 27, 2004, President George W. Bush issued an executive order that established the position of National Health Information Technology Coordinator within the Department of Health & Human Services, or HHS. The post, filled by David J. Brailer, MD, PhD, was created to provide leadership for the development and nationwide implementation of an interoperable health information technology infrastructure to improve the quality and efficiency of healthcare in the United States. The vision of this infrastructure is to:
On July 21, 2004, the Secretary of Health and Human Services released the first outline of a 10-year plan to build the national electronic health information infrastructure. The report entitled, “The Decade of Health Information Technology: Delivering Consumer-centric and Information-rich Health Care,” concluded that federal leadership can facilitate efforts to be carried out by the private sector and laid out the broad steps needed to achieve widespread electronic health records or EHRs for Americans. This report was a response to the call by President Bush in 2004 to achieve EHRs for most Americans within a decade.
CCHIT. The HHS inititatives have, among other things, led to the creation of the private-sector Certification Commission for Health Information Technology, or CCHIT, which consists of 15 commissioners from across the healthcare industry. CCHIT intends to develop a set of private sector determined criteria for EHR functionality, interoperability, reliability and security, and will inspect EHR software to determine its performance against these criteria.
Institute of Medicine. In 1999, the Institute of Medicine, or IOM, issued a report titled, “To Err Is Human: Building a Safer Health System” calling for the expanded use of information technology to reduce avoidable medical errors by 50 percent in the U.S. over the ensuing five-year period. According to that report, between 44,000 and 98,000 people died each year as a result of medical errors. The IOM concluded that more people were injured from preventable mistakes than from many other common illnesses or accidents. The IOM report identified medication and pharmacy errors as significant causes of deaths and adverse events. In 2003, the IOM released a separate report stating that medical errors may be reduced through widespread adoption of information technology, such as electronic medical records that can be connected through a national system linking all healthcare organizations.
The Leapfrog Group. Following the release of the initial IOM report, the Leapfrog Group was formed. The Leapfrog Group is a consortium of more than 170 companies including large private and public healthcare purchasers representing more than 34 million healthcare consumers within the United States. Leapfrog Group members and their employees spend billions of dollars on healthcare annually. The Leapfrog Group is urging its members and their employees to base their healthcare purchases on principles that encourage hospitals to utilize stringent patient-safety measures such as computerized physician order entry systems, or CPOE. The adoption of CPOE is a leading Leapfrog Group recommendation for reducing medical errors.
The IOM and The Leapfrog Group are leveraging their influence to encourage hospitals to use advanced clinical software to reduce adverse drug events and medical errors. Their influence, coupled with consumer demands, are spurring new legislation.
Health Insurance Portability and Accountability Act. The federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, seeks to impose national health data standards on covered entities. Under HIPAA, a covered entity includes (i) healthcare providers that conduct electronic health transactions; (ii) healthcare clearinghouses that convert health data between HIPAA-compliant and non-compliant formats; and (iii) health plans. The HIPAA standards prescribe, among other things, transaction formats and code sets for electronic health transactions, in order to protect individual privacy by limiting the uses and disclosure of individually identifiable health information. HIPAA also requires 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.
Under HIPAA, covered entities are required to utilize HIPAA-compliant products, software and services. We believe that the need for HIPAA-compliant products will continue to create demand for software and services like ours. We are not a covered entity under HIPAA, but many of our clients are. Accordingly, we have developed our software to facilitate HIPAA compliance.
Joint Commission on Accreditation of Healthcare Organizations. The Joint Commission on the Accreditation of Healthcare Organizations, or JCAHO, is an independent non-profit organization that provides voluntary evaluation and accreditation for more than 15,000 healthcare organizations in the United States. JCAHO periodically introduces new process improvement initiatives, standards and performance measurements that are used to assess hospitals. JCAHO has also established patient safety standards that require hospitals to initiate specific efforts to prevent medical errors and inform patients when they have been unknowingly harmed during treatment. Additionally, each year since 2002, JCAHO has approved annual National Patient Safety Goals that include specific recommendations for improving patient safety. Most of our clients seek to comply with JCAHO standards. We believe that our software and services aid our clients in meeting JCAHO standards.
The Internet. We believe the Internet will enable consumers to be more involved in their healthcare choices, and will provide increased availability of medical information to physicians, clinicians and healthcare workers. As consumers and physicians adopt Web-centric lifestyles, we believe that software and services like ours will become more appealing to a wider customer base.
We provide the following:
Our offering is described below:
Eclipsys software provides comprehensive functionality that helps hospitals and care providers address many of their key clinical, financial and administrative needs. Among other things, our software is designed to:
For several years we have been committed to building our new software on, and re-engineering and migrating existing software to, an architecture based on the Microsoft .NET Framework and other industry-standard technologies. We believe this approach allows our software to be more open and extensible, making it easier to integrate with a client’s legacy and ancillary systems. We believe this architecture enables hospitals to continue to derive value from their existing technology investments, and to add other software as functional needs and resources dictate.
SunriseXA is built upon a single database model known as a Health Data Repository or HDR. The HDR can be used by all components within SunriseXA regardless of where in the hospital a physician, nurse or employee resides. SunriseXA is designed to prevent the isolation of information and duplication of functionality that can occur with other information technology, or IT, systems. We believe that this approach will enable a faster, more cost-effective implementation of our software, simplify software maintenance and provide a lower total cost of ownership.
The following summarizes our principal software offerings:
Sunrise Clinical Manager is a computerized patient record system that provides patient information to clinicians at the point of decision-making. SCM allows a physician to enter orders quickly and efficiently, and provides evidence-based clinical decision support at the time of order entry. SCM’s core capabilities and related modules are designed for use in the ambulatory, acute care and Emergency Department settings, and include the following features among others:
Sunrise Access Manager enables healthcare providers to identify the patient at any time within a hospital and to collect and maintain patient information on an
Sunrise Patient Financial Manager provides centralized enterprise-wide business office capabilities.
Sunrise Decision Support Manager integrates data from throughout the enterprise to create a clinical and financial data repository that can be used as an analytical tool.
Sunrise Discovery builds upon Sunrise Decision Support Manager by using a data warehouse, data-extraction techniques, including natural language processing, and business intelligence tools to collect useful clinical and financial data and distribute it across the enterprise using portal technology.
Sunrise Record Manager provides comprehensive clinical data management and enterprise-wide document and image-management functions.
Knowledge-Based Charting provides nurses with evidence-based practice guidelines and patient charting tools.
eLink provides tools to enable the integration of clinical and financial data from disparate existing systems within an integrated health network.
Eclipsys Diagnostic Imaging Solutions comprise a comprehensive radiology information system, or RIS, and
a picture archiving and communications system, or PACS image-enabled clinical information system, that delivers imaging data as an integrated part of the overall patient record that is accessible to clinicians at the point of care on any Sunrise-enabled device.
Professional Services. Implementation of some of our software is complex. We offer our clients professional assistance in the implementation of our software, the conversion and integration of their historical data into our software and systems, and ongoing training and support in the use of our software. We also provide regular maintenance releases and software updates.
Consulting Services. We also offer consulting services to help clients to improve their operations.
IT Outsourcing. We provide IT outsourcing services to our clients. This means that we assume responsibility for a healthcare organization’s IT operations using our employees. These services include facilities management, by which we assume responsibility for all aspects of client internal IT operations, as well as network outsourcing, which relieves our clients of the need to secure and maintain an expensive IT infrastructure in a rapidly changing technological environment, and transition management, which offers our clients a solution for migrating their IT to new processes, technologies or platforms without interfering with healthcare delivery.
Remote Hosting. We also provide remote hosting services to our clients. This means that we assume processing of selected applications for our clients using equipment and personnel at our facilities. This frees an organization from the capital investment, operating expense, and management challenges of maintaining the environment, equipment and technical staff required to support their IT operations.
Hardware and Networks. As part of our commitment to being a comprehensive software and services provider, we sell a variety of desktop, network and platform solutions including hardware, middleware and related services. We also offer several network services. Our professionals assess changes in network utilization and function, forecast necessary upgrades to accommodate a client’s growth, and design the changes required to provide our clients with the network performance and functionality.
Sales and Marketing
Our sales and marketing teams target academic medical centers, larger multi-entity healthcare systems, community hospitals and small, stand-alone hospitals and other healthcare facilities. We sell our software and services primarily in North America exclusively through our direct sales force, which works closely with our client services and software specialists and experts with extensive experience with each of our specific software applications to design client solutions.
Our marketing group develops targeted campaigns designed to increase demand for our software and services, as well as increase corporate awareness and brand identity for our company. In addition to advertising, direct mail, public relations and Internet marketing, our marketing group produces a wide range of collateral and sales support training and materials.
Research and Development
We believe that our future success depends on our ability to maintain and enhance our existing software and develop new software. We seek to maintain technological competitiveness and respond to market trends and our clients’ evolving needs. We are currently developing our software based on Microsoft’s .NET Framework and other industry standards. We are also creating new functionality for our existing software. Since the announcement of our SunriseXA response time issues in October 2003, we have enhanced our staff and our processes within our research and development function. Among other things, we have decreased our reliance on outside vendors that have historically aided our internal personnel in software development. We use Microsoft’s Solutions Framework development methodology to gauge the quality and performance of our software development efforts. As part of these new processes, we have also involved clients in our software design process, enabling them in some cases to have direct and regular access to the development staff, including its senior leadership.
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.
Executive Officers of the Registrant
Certain biographical information concerning the Company’s executive officers is presented below.
R. Andrew Eckert joined Eclipsys Corporation in October 2005 and became President and Chief Executive Officer and joined the Board of Directors on November 14, 2005. From March 2004 to October 2005, Mr. Eckert was CEO of SumTotal Systems, Inc., a provider of learning and business performance technologies and services. From 2002 to March 2004, he was CEO of Docent, Inc., until it merged with Click2learn to form SumTotal Systems. Previously, Mr. Eckert spent 11 years with ADAC Laboratories, , a publicly traded provider of healthcare enterprise radiology and cardiology information systems and integrated imaging solutions, where he served as CEO (1997 to 2001), Chairman (1999 until its sale to Philips Medical Systems in December 2000), and President (1994 to 1997). Prior to ADAC, he worked in the consulting and finance industries with Goldman Sachs, Summit Partners and Marakon Associates. Mr. Eckert serves on the Boards of Directors of Connetics Corporation, a specialty pharmaceuticals company, and Varian Medical Systems, Inc., a manufacturer of integrated cancer therapy systems. He is a Fellow of the College of Nuclear Medicine and co-chairman of the Pacific Vascular Research Foundation, a vascular disease research and public awareness organization.
John A. Adams joined Eclipsys as our Executive Vice President and Chief Administrative Officer in December 2004 and became Executive Vice President Business Solutions in January 2006. Prior to joining us, Mr. Adams was chief financial officer of Exult, Inc., a publicly traded provider of human resources and related business process outsourcing services from June 2003 until its acquisition by Hewitt Associates late in 2004. From November 2000 to June 2003, Mr. Adams was vice president and chief financial officer of AT&T’s Business Services division. Previously he served in a variety of managerial positions with EDS Corporation over 15 years.
John Gomez has served as our Executive Vice President and Chief Technology Strategy Officer since December 2004. He held the title of Senior Vice President and Chief Technology Officer from August 2003, when he first joined our Company, to December 2004. From October 2002 to January 2003, Mr. Gomez was a senior vice president and chief technology officer at WebMD Corporation. Prior to that, from February 2001 to October 2002 Mr. Gomez served as chief technology officer and senior vice president of strategic business development at Brill Media Holdings, an e-commerce and media publication company. From April 1998 through January 2001 Mr. Gomez was employed by Microsoft Corporation.
John E. Deady, joined Eclipsys in January 2006 as our Executive Vice President of Customer Solutions. Prior to joining Eclipsys, from April 2004 until January 2006, Mr. Deady served as vice president, marketing & sales support, at McKesson Corporation, a publicly traded provider of healthcare information technology. While at McKesson, Mr. Deady also served as national vice president, new business, from October 2002 to April 2004 and national vice president, Clinical Sales Group, from August 2001 to October 2002. From October 2000 to August 2001, Mr. Deady served as senior vice president, global sales, at TrueSpectra, a provider of dynamic imaging solutions for the retail, manufacturing, and entertainment & media industries. Prior to that, from August 1997 to September 2000, Mr. Deady held executive sales and marketing positions at ADAC Laboratories, a publicly traded provider of healthcare enterprise radiology and cardiology information systems and integrated imaging solutions. Prior to joining ADAC, from June 1992 to July 1997, Mr. Deady held sales management positions with Cerner Corporation, a publicly traded provider of enterprise healthcare software and services. From October 1989 to May 1992, Mr. Deady was Technical Sales Representative at E.I. du Pont de Nemours and Company, a manufacturer of medical imaging consumables and capital equipment.
Robert J. Colletti has served as our Senior Vice President, Chief Financial Officer and Chief Accounting Officer since August 2001. From June to August 2001, Mr. Colletti served as Senior Vice President Finance and Chief Accounting Officer. From January 1997 to June 2001, Mr. Colletti served as our vice president of finance. Mr. Colletti joined Eclipsys in January 1997 as part of our acquisition of ALLTEL Healthcare Information Services, Inc.
Frank E. Stearns, Jr., has served as our Senior Vice President Professional Services since November 2005, which includes responsibility for all professional services including implementation, integration and consulting services. Previously, Mr. Stearns led the Eclipsys Consulting Group from January 2003. Prior to Eclipsys, from August 1999 to January 2003, Mr. Stearns served as a Vice President and Partner for Cerner Corporation, a publicly traded provider of enterprise healthcare software and services. From October 1993 to August 1999, Mr. Stearns served as Vice President of Decision Technologies at Computer Sciences Corporation (CSC), a worldwide provider of technology products and services focusing in the healthcare sector. Previously, Mr. Stearns served as a Partner with APM Management Consultants in the information resources and clinical effectiveness consulting practice, and in a leadership role at MediQual Systems, Inc., a leading supplier of severity of illness and outcomes measurement tools.
Brian W. Copple joind Eclipsys as our Chief Legal Office, General Counsel and Secretary in May 2005. Before joining Eclipsys, Mr. Copple served as Executive Vice President, General Counsel and Secretary of Exult, Inc., a publicly traded provider of human resources and related business process outsourcing services, from February 2000 until its acquisition by Hewitt Associates late in 2004. Previously, Mr. Copple practiced corporate and securities law as a partner with the law firm of Gibson, Dunn & Crutcher LLP.
As of December 31, 2005, we had 2020 employees. Our success depends on our continued ability to attract and retain highly skilled and qualified personnel. Competition for such personnel is intense in our industry, particularly for software developers, implementation and service consultants and sales and marketing personnel. We cannot be assured that we will continue to attract and retain qualified personnel. Our employees are not represented by any labor unions. We consider our relations with our employees to be good.
Financial Information About Geographic Areas
Revenues from U.S. operations totaled $359.3 million in 2005, $293.1 million in 2004 and $244.3 million in 2003. Revenues from outside the United States totaled $24.0 million in 2005, $16.0 million in 2004 and $10.4 million in 2003. Long-lived assets totaled $108.5 million in the United States in 2005, $89.8 million in 2004 and $73.6 million in 2003. Long-lived assets totaled $2.9 million in other countries in 2005, $2.1 million in 2004 and $100,000 in 2003.
Item 1A. Risk Factors
Many risks affect our business. These 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 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.
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, 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.
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 risk 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.
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.
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.
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.
We had a profit of $485,000 in 2005 although we had a loss from operations of $2.6 million. We had a net loss of $32.6 million for the year ended December 31, 2004. We also had net losses of $56.0 million in 2003, $29.8 million in 2002, $34.0 million in 2000, $9.4 million in 1999, and $35.3 million in 1998. In 2001, we had net income of $4.4 million, although we had a loss from operations of $1.6 million. It is not certain that we will remain profitable, or that our profitability will increase. We may incur net losses in the future.
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:
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.
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, we may be required to refund money previously paid to us by the client, or to pay 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 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.
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 and the market price of our common stock could be adversely affected.
Adoption of FAS 123R will increase our expenses and have a significant effect on our reported profit.
In 2006 and beyond, recorded expenses will increase as a result of our adoption of FAS 123R, which requires us to record expense associated with stock options based upon their fair value at the date of grant. If we had adopted this methodology we would have recorded stock option related expense of $10.7 million, $9.6 million and $16.2 million in 2005, 2004 and 2003, respectively, using the Black-Scholes valuation model. Actual amounts recorded in the future will vary depending upon the number of options actually granted, the fair market value at the date of grant, and other variables affecting the calculation.
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.
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 methodolgies, 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.
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:
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:
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.
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.
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.
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:
Item 1B. Unresolved Staff Comments
Item 2. Properties
Our corporate offices are located in Boca Raton, Florida under a lease that expires in February 2008. In addition, we maintain leased office space in Phoenix, Arizona; Newport Beach, California; San Jose, California; Santa Rosa, California; Atlanta, Georgia; Westchester, Illinois; Overland Park, Kansas; Rockville, Maryland; Boston, Massachusetts; Grand Rapids, Michigan; Mountain Lakes, New Jersey; Malvern, Pennsylvania; San Antonio, Texas; Montreal, Canada, Toronto, Canada and Richmond, Canada. These leases expire at various times through September 2013.
Item 3. Legal Proceedings
We and our subsidiaries are from time to time parties to legal proceedings, lawsuits and other claims incident to our 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 has been terminated. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, we are 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.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our stockholders during the fourth quarter of 2005.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock has been publicly traded on the NASDAQ National Market under the symbol “ECLP” since our initial public offering on August 6, 1998. The following table sets forth, for the quarters indicated, the high and low sales prices of our common stock as reported by the NASDAQ National Market.
Holders of Record
On February 15, 2006, the last reported sale price of our common stock on the NASDAQ National Market was $21.15 per share. Also as of February 15, 2006, we had approximately 192 stockholders of record.
We have never paid or declared any cash dividends on our common stock or other securities and do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain all future earnings, if any, for use in the operation of our business.
Shares Available Under Equity Compensation Plans
Information regarding securities authorized for issuance under equity compensation plans is provided under Item 12 — Security Ownership of Certain Beneficial Owners and Management elsewhere in this document.
Item 6. Selected Financial Data
You should read the following selected financial data in conjunction with our consolidated financial statements and the related notes thereto, along with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, that is included elsewhere in this document. Our statement of operations data for the years ended December 31, 2005, 2004 and 2003 and the balance sheet data at December 31, 2005 and 2004 are derived from, and are qualified by reference to, our audited consolidated financial statements, which appear elsewhere in this document. Our statement of operations data for the years ended December 31, 2002 and 2001 and the balance sheet data at December 31, 2003, 2002 and 2001 set forth below, are derived from, and are qualified by reference to, our audited consolidated financial statements which are not included in this document. Historical results are not necessarily indicative of any future results.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with our consolidated financial statements, including the notes thereto, which are included elsewhere in this document.
Eclipsys is a healthcare information technology company. We develop and license our proprietary software and content to hospitals. Our software allows hospitals to automate many of the key clinical, administrative and financial functions that they require. Our software is designed to enable our clients to improve patient care and patient satisfaction, and allow them to reduce their operating costs and enhance their revenues. Our content provides practice guidelines for use in clinical environments.
We were founded in December 1995 to commercialize an integrated clinical and financial information software system for use by hospitals. Historically, hospitals kept records in paper form. This has been associated with patient safety concerns, including avoidable medical errors, duplicative and unnecessary procedures, inefficient use of limited resources, and a limited ability to track, bill and collect for services rendered. Our software is designed to address these issues by turning data into information that can be easily used, accessed by or provided to the right person, at the right time, in the right place. This enables hospital employees to redesign business processes, deliver higher quality care at lower cost, and receive expedited payment for services rendered. Our software also helps to improve collaboration among physicians, nurses and other healthcare workers across all venues of care.
In June 1999, we began re-expressing the intellectual property we had acquired through acquisitions on a common platform to provide integrated software to our clients. In 1999, we announced the general availability of SCM, the first version of our SunriseTM suite of software. SCM provides advanced knowledge-based clinical decision-support capabilities including computerized physician order entry.
In 2001, we announced our SunriseXATM strategy. This strategy was to migrate our Sunrise suite of software to an open architecture and platform. SunriseXA’s architecture is built on Microsoft’s .NET Framework, Microsoft SQL Server and the Microsoft Windows family of operating systems. In 2002 and 2003, we announced the general availability of certain components of our SunriseXA software offerings.
In October 2003, we identified and announced certain response time issues within components of the version of our next-generation clinical software that we were developing at that time. Although some of our software components had been implemented in and were working at some client sites, we determined that the software did not produce acceptable response times for complex, high-volume hospital environments. To address the issue, we implemented a strategy that was designed to allow SunriseXA clients to continue their deployment of SunriseXA, and at the same time allow us to continue the development of advanced SunriseXA solutions. This strategy was to replace the affected SunriseXA components with certain components from our SCM software, which is our prior generation, core clinical software. The response time issue resulted in a software delivery delay for some of our advanced SunriseXA functionality. The announcement of these issues also impacted the implementation schedules for a number of our clients. This announcement adversely affected our sales in 2004 and 2005.
In connection with this issue, we recorded a $1.2 million write-down of capitalized software development costs to net realizable value for some SunriseXA components in the third quarter of 2003. The write-down was included in the costs of systems and services revenues. Also, we believe that the correction of the response time issue and related issues is covered by the warranties that we provide to our clients. We intend to continue to remediate the problem for our clients. Accordingly, we recorded provisions related to warranty costs of $4.6 million to date. These provisions reflect our estimate of warranty-related costs that includes among other things, implementation and third-party costs for affected clients. Warranty costs are charged to costs of systems and services revenues when they are probable and reasonably estimable. Through December 31, 2005, we had expended approximately $3.5 million in warranty costs related to remediation of the response time issue and related issues. As of December 31, 2005 the warranty reserve balance was $1.1 million. Professional services revenues have been, and we believe will continue to be negatively affected as we utilize resources to fulfill these obligations.
On June 30, 2004, we introduced Sunrise Clinical Manager Release 3.5 XA. This new release contained significant additional functionality for core clinical, ambulatory and emergency department settings, as well as enhancements to patient management functions. Additionally, the new release extended support for physicians through the inclusion of advanced functionality for clinical decision support, structured notes, medical necessity checking, prescription writing and medical management configuration.
In November 2004, we announced the general availability of Sunrise ED Manager 3.6 XA and Sunrise Ambulatory Care Manager 3.6 XA. In the first quarter of 2005, we released Sunrise Clinical Manager Release 4.0XA, which contained new features and enhancements in several key areas including incremental functionality related to ambulatory, emergency department, critical care, medication management and nursing. Additionally, we released Remote Access Services (RAS) 4.0 XATM and Pocket SunriseTM 4.0 XA, which enhanced users’ ability to access our applications from remote locations. Furthermore, in November 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. 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.
The general availability of these releases fulfilled key deliverables expected by our clients in connection with the 2003 response time issue. These releases were consistent with our strategy and contained enhanced functionality as planned.
During 2001, our management made two strategic decisions that significantly impacted our operating results. First, we substantially increased our gross research and development spending, which includes research and development expenses and capitalized software development costs. This decision was made to enable us to bring components of our SunriseXA software line to market more rapidly. Second, we invested heavily in sales and marketing to enhance market awareness surrounding Eclipsys and its software and services. We did this to capitalize on perceived market demand for our software and services. Additionally, in 2002, we moved aggressively to change our contracting model, offering our clients payment terms which are more evenly distributed over the term of the contract compared to our historical licensing model, in which software license fees were paid in advance. We did this to meet the needs of our clients, by matching the timing of their payments to the value that we deliver to them. We believe that this new contracting model makes purchase decisions easier for our clients.
The change in our contracting model has had a material affect on our revenues, gross margins, and cash flows. Because the payments from our clients for software license fees are more evenly distributed over the term of the contract, our revenues are recognized over a longer period of time compared to our historical licensing model, while a significant portion of our operating expenses remain relatively fixed, resulting in lower margins early in the contract term. We believe that this contracting model will provide for more predictable revenues on a year over year basis, and that over time, our margins will trend back towards historical levels as revenue from contracts later in their contract term help to compensate for lower margins earned in connection with new contracts.
During the fourth quarter of 2004 and much of 2005, we experienced a slow-down in closing new sales transactions related to increasing competition, issues associated with our previously discussed software delay and our CEO transition. Additionally, we hired a new CEO during the fourth quarter of 2005 and implemented a restructuring of senior management and our operations during January 2006. Also, we continue to release significant new functionality in our software suite including a major new release in January 2006. In connection with these releases, we continue to implement a significant number of clients on this new software. In the event our new software does not continue to achieve market acceptance, we experience any significant delays in implementing these new releases or experience disruptions in our operations as a result of the restructuring activities, our results of operations could be negatively affected, including a delay or loss in closing future new sales transactions.
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. These significant accounting policies relate to revenue recognition, allowance for doubtful accounts, capitalized software development costs and our warranty reserve. Please refer to Note 2 of the audited consolidated financial statements for further discussion of our accounting policies.
We generally contract under multiple element arrangements, which include software license fees, hardware and services including consulting, implementation, and software maintenance, for periods of 3 to 10 years. We evaluate revenue recognition on a contract-by-contract basis as the terms of each arrangement vary. The evaluation of our contractual arrangements often requires judgments and estimates that affect the timing of revenue recognized in our statements of operations. Specifically, we may be required to make judgments about:
We recognize revenues in accordance with the provisions of Statement of Position, or SOP, No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-9, Staff Accounting Bulletin, or SAB, 104, “Revenue Recognition” and Emerging Issues Task Force, or EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” SOP 97-2 and SAB 104, as amended, require among other matters, that there be a signed contract evidencing an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable.
Many of our contracts with our clients are multiple element arrangements which may provide for multiple software modules including the rights to future versions and releases we may offer within the software suites the client purchases or rights to software versions that support different hardware or operating platforms, and that do not qualify as exchange rights. We refer to these arrangements as subscription contracts. Additionally, we sometimes enter into multiple element arrangements that do not include these rights to future software or platform protection rights. We refer to these arrangements as traditional software contracts. Finally, we offer much of our software and services on a stand-alone bases. Revenue under each of these arrangements is recognized as follows:
Our subscription contracts typically include the following deliverables:
Software license fees are recognized ratably over the term of the contract, commencing upon the delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. The value of the software is determined using the residual method pursuant to Statement of Position or SOP 98-9, “Modification of SOP 97-2, With Respect to Certain Transactions” or SOP 98-9. These contracts contain the rights to unspecified future software within the suite purchased and/or unspecified platform transfer rights that do not qualify for exchange accounting. Accordingly, these arrangements are accounted for pursuant to paragraphs 48 and 49 of SOP 97-2 “Software Revenue Recognition” or SOP 97-2. Under certain arrangements, we capitalize related direct costs consisting of third party software costs and direct software implementation costs. These costs are amortized over the term of the arrangement.
In the case of maintenance revenues, vendor-specific objective evidence, or VSOE of fair value is based on substantive renewal prices, and the revenues are recognized ratably over the maintenance period.
In the case of professional services revenues, VSOE is based on prices from stand-alone sale transactions, and the revenues are recognized as services are performed pursuant to paragraph 65 of SOP 97-2.
Third party hardware revenues are recognized upon delivery, pursuant to SAB 104.
In the case of remote hosting services, VSOE is based upon consistent pricing charged to clients based on volumes and performance requirements on a stand-alone basis and substantive renewal terms, and the revenues are recognized ratably over the contract term as the services are performed. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the client at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly the related set-up fees are recognized ratably over the term of the contract.
We consider the applicability of EITF 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored On Another Entity’s Hardware,” to our remote hosting services arrangements on a contract-by-contract basis. If we determine that the client has the contractual right to take possession of our software at any time during the hosting period without significant penalty, and can feasibly run the software on its own hardware or enter into another arrangement with a third party to host the software, a software element covered by SOP 97-2 exists. When a software element exists in a remote hosting services arrangement, we recognize the license, professional services and remote hosting services revenues pursuant to SOP 97-2, whereby the fair value of the remote hosting service is recognized as revenue ratably over the term of the remote hosting contract. If we determine that a software element covered by SOP 97-2 is not present in a remote hosting services arrangement; we recognize revenue for the remote hosting services arrangement, ratably over the term of the remote hosting contract pursuant to SAB 104.
We enter into traditional multiple-element arrangements that include the following elements:
Revenue for each of the elements is recognized as follows:
Software license fees are recognized upon delivery of the software provided that (1) there is evidence of an arrangement, (2) the fee is fixed or determinable and (3) collection of our fee is considered probable. For those arrangements in which the fee is not considered fixed or determinable, the software license revenue is recognized as the payments become due. For arrangements where VSOE only exists for the undelivered elements, we account for the delivered elements (software license revenue) using the residual method in accordance with SOP 98-9.
In addition to the software license fees, these contracts may also contain maintenance, professional services and hardware or remote hosting services. VSOE and revenue recognition for these elements is determined using the same methodology as noted above for subscription contracts.
We enter into certain multiple element arrangements containing milestone provisions in which the professional services are considered essential to the functionality of the software. Under these arrangements, software license fees and professional service revenues are recognized using the percentage-of-completion method over the implementation period which generally ranges from 12 to 24 months. Under the percentage-of-completion method, revenue and profit are recognized throughout the term of the implementation based upon estimates of total labor hours incurred and revenues to be generated over the term of the implementation. Changes in estimates of total labor hours and the related effect on the timing of revenues and profits are recognized in the period in which they are determinable. Accordingly, changes in these estimates could occur and have a material effect on our operating results in the period of change.
Stand-Alone Software and Service
We also market certain software and services on a stand-alone basis, including the following:
Revenues related to such software and services are recognized as follows:
Software license fees and maintenance are marketed on a stand-alone basis may be licensed either under traditional contracts or under subscription arrangements. Software license fees under traditional contracts are recognized pursuant to SOP 97-2 upon delivery of the software, persuasive evidence of an arrangement exists, the fee is fixed or determinable and collectibility is probable. Under subscription agreements for stand-alone software, license fees are recognized ratably over the term of the contract. With respect to maintenance, VSOE is determined based on substantive renewal prices contained in the contracts. Maintenance is recognized ratably over the term of the contract.
Professional services represent incremental services marketed to clients including implementation and consulting services. Professional services revenues, where VSOE is based on prices from stand-alone transactions are recognized as services are performed.
Hardware is recognized upon delivery pursuant to SAB 104.
Network service arrangements include the assessment, assembly and delivery of a wireless network which may include wireless carts or other wireless equipment to the client. Our network services arrangements are sold to a client for a fixed fee. All services are performed prior to the delivery of the equipment. These contracts are typically 60 to 90 days in length and are recognized pursuant to SAB 104, upon the delivery of the network to the client.
Remote hosting contracts that are sold on a stand alone basis are recognized ratably over the contract term pursuant to SAB 104. Our remote hosting arrangements generally require us to perform one-time set-up activities and include a one-time set-up fee. This one-time set-up fee is generally paid by the client at contract execution. We have determined that these set-up activities do not constitute a separate unit of accounting, and accordingly we recognize the related set-up fees ratably over the term of the contract.
We provide outsourcing services to our clients. Under these arrangements we assume all responsibilities for a healthcare organization’s IT operations using our employees. Our outsourcing services include facilities management, network outsourcing and transition management. These arrangements typically range from five to ten years in duration. Revenues from these arrangements are recognized when services are performed.
We record reimbursable out-of-pocket expenses in both systems and services revenues and as a direct cost of systems and services revenues in accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred (“EITF 01-14”). EITF 01-14 requires reimbursable out-of-pocket expenses incurred to be characterized as revenue in the statement of operations. For 2005, 2004, and 2003 reimbursable out-of-pocket expenses were $9.2 million, $5.7 million, and $4.5 million, respectively.
In accordance with EITF Issue No. 00-10, Accounting for Shipping and Handling Fees, we have classified the re-imbursement by clients of shipping and handling costs as revenue and the associated cost as cost of revenue.
If other judgments or assumptions were used in the evaluation of our revenue arrangements, the timing and amounts of revenue recognized may have been significantly different.
In evaluating the collectibility of our accounts receivable, we assess a number of factors, including a specific client’s ability to meet its financial obligations to us, as well as general factors such as the length of time the receivables are past due and historical collection experience. Based on these assessments, we record a reserve for specific account balances as well as a reserve based on our historical experience for bad debt to reduce the related receivables to the amount we ultimately expect to collect from clients. If circumstances related to specific clients change, or economic conditions deteriorate such that our past collection experience is no longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in the consolidated financial statements.
Capitalized Software Development Costs
We capitalize software development costs in accordance with FASB Statement No. 86 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” We capitalize software development costs incurred subsequent to establishing technological feasibility of the software being developed. These costs include salaries, benefits, consulting and other directly related costs incurred in connection with coding and testing software. Capitalization ceases when the software is generally released for sale to clients, at which time amortization of the capitalized costs begins. At each balance sheet date, we perform a detailed assessment of our capitalized software development costs which includes a review of, among other factors, projected revenues, client demand requirements, software lifecycle, changes in software and hardware technologies, and software development plans. Based on this analysis we record adjustments, when appropriate, to reflect the net realizable value of our capitalized software development costs. The estimates of expected future revenues generated by the software, the remaining economic life of the software, or both, could change, materially affecting the carrying value of capitalized software development costs, as well as our consolidated operating results in the period of change.
On October 20, 2003, we announced response time issues with some components of the version of our next-generation core clinical software that we were developing at that time. To address the issue, we implemented a strategy that was designed to allow SunriseXA clients to continue their deployment of SunriseXA, and at the same time allow us to continue the development of our advanced SunriseXA solutions. Our strategy was to replace the affected SunriseXA components with certain components from our SCM software. As a result, in 2003 we recorded a $1.2 million write-down of capitalized software development costs for certain SunriseXA components to net realizable value. The write-down is included in the costs of systems and services revenues.
The agreements that we use to license our software include a limited warranty providing that our software, in its unaltered form, will perform substantially in accordance with the related documentation. Through September 30, 2003, we did not incur any material warranty costs related to our software. Due to the response time issues that we identified in October 2003, we recorded provisions related to warranty costs of $4.6 million to date and expended $3.5 million against the provision through December 31, 2005. Warranty costs are charged to costs of systems and services revenues when they are probable and reasonably estimable. In determining this warranty reserve, we used significant judgments and estimates for the additional professional service hours and third party costs that will be necessary to remedy this issue on a client-by-client basis. The timing and amount of our warranty reserve could have been different if we had used other judgments or assumptions in our evaluation. We expect to substantially complete this work by December 31, 2006.
Results of Operations
We derive revenues from licensing our software and the delivery of services including software and hardware maintenance; professional services (including implementation, integration, training and consulting); remote hosting services; outsourcing services; network services; and the sale of computer hardware. Our software and services are generally sold to clients under contracts that range in duration from 3 to 10 years.
Costs of Revenues
The principal costs of systems and services revenues are salaries, benefits and related overhead costs for implementation, maintenance, remote hosting and outsourcing personnel. Other significant costs are the amortization of capitalized software development costs and acquired technology intangible asset. Capitalized software development costs are generally amortized over three years on a straight-line basis commencing upon general release of the related software, or are based on the ratio that current revenues bear to total anticipated revenues for the applicable software. Acquired technology is amortized over three to five years based upon the estimated economic life of the underlying asset. Cost of revenues related to hardware sales includes our cost to acquire the hardware from the manufacturer.
During the third quarter of 2003, we recorded a write-down of capitalized software costs to net realizable value of certain components of our SunriseXA software in the amount of $1.2 million. This related to the SunriseXA response time issue discussed above. Additionally, to date, we have recorded a warranty provision of $4.6 million related to anticipated costs of our SunriseXA response time issue. This warranty provision reflects an estimate of implementation and third party costs for certain clients. The warranty provision was included in the costs of systems and services revenues.
Sales and marketing expenses consist primarily of salaries, benefits, commissions, and related overhead costs. Other costs include expenditures for marketing programs and events, public relations, trade shows, advertising, and related communications.
Research and Development
Research and development expenses consist primarily of salaries, benefits and related overhead, as well as consultants for the design, development and testing of new software. We capitalize certain software development costs subsequent to attaining technological feasibility. These costs are amortized as an element of the costs of systems and services revenues.
General and Administrative
General and administrative expenses consist primarily of salaries, benefits and related overhead costs for administration, executive, finance, legal, human resources, purchasing and internal systems personnel, as well as accounting and legal fees and expenses.
Depreciation and Amortization
We depreciate the costs of our tangible capital assets on a straight-line basis over the estimated economic lives of the assets, which generally range from 3 to 7 years, and may reach 10 years for outsourcing contracts. Acquisition-related intangible assets, which primarily consisted of the value of ongoing client relationships, acquired technology and goodwill, have been amortized based upon their estimated economic lives at the time of the acquisition, and vary among acquisitions. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 142, our amortization of goodwill ceased as of January 1, 2002, leaving a recorded balance of $454,000 for goodwill as of December 31, 2001. On at least an annual basis, we conduct an impairment review of our goodwill balance. As of December 31, 2005, there was no impairment of the goodwill balance.
As of December 31, 2005, we had U.S. net operating loss carryforwards for federal income tax purposes of $306.5 million. Of this amount, $6.0 million expires in 2012 with the balance expiring in varying amounts annually through 2025. Of the $306.5 million total, $63.3 million relate to stock option tax deductions which will be tax-effected and the benefit credited as additional paid-in-capital when realized. Additionally, the Company has Canadian foreign net operating loss carryovers of $19.1 million that expire in varying amounts through 2012. We did not record a benefit for the resulting net deferred tax asset for any of the periods presented, because we believe it is more likely than not that we would not realize our net deferred tax asset. Accordingly, we have recorded a valuation allowance against our total net deferred tax asset. We are required to reverse the valuation allowance and record a benefit for the net deferred tax asset if and to the extent that we conclude that it is more likely than not that we will realize the asset. This will result in a non-recurring benefit in the period that we make the determination. For all future periods, after the recognition of the non-recurring benefit, we will record income tax expense in any period in which we earn taxable income.
Year Ended December 31, 2005 compared to December 31, 2004
Total revenues for the year ended December 31, 2005 increased $74.2 million or 24.0 % to $383.3 million, from $309.1 million in 2004.
Systems and services revenues increased $88.2 million or 31.3% to $370.3 million for the year ended December 31, 2005 compared to $282.1 million in 2004. The increase in systems and services revenues was primarily a result of an increase in ratable generated revenues related to software, maintenance, outsourcing and remote hosting. These revenues increased $50.7 million or 25.6% to $248.7 million in 2005 from $198.0 million in 2004. Additionally, professional services revenues which include implementation, integration, consulting and training services increased $28.3 million or 51.0% to $83.8 million in 2005 from $55.5 million in 2004. Also, revenue related to software and networking services increased $9.2 million or 32.2% to $37.8 million in 2005 compared to $28.6 million in 2004.
Increases in ratable generated revenues were primarily driven by increases in outsourcing, remote hosting and subscription revenues which include software maintenance. The increase in outsourcing revenues was primarily the result of revenues associated with a large contract entered into in Q4 2004. Remote hosting revenues were favorably impacted by a shift in sales mix as more clients began to elect this option in-lieu of purchasing hardware as a mechanism to deliver their software applications. We expect that remote hosting will continue to expand as a delivery option in future periods. Subscription revenues increased as a result of progress made on a significant number of client implementations during the past twelve months as our clients continue to activate our clinical and financial modules. These activations resulted in higher revenues under these contracts. Additionally, new sales bookings in 2005 and 2004 favorably impacted subscription related revenues.
Revenues related to software and networking services increased $9.2 million in 2005 compared to the prior year. Networking services increased $2.0 million to $17.2 million in 2005 compared to $15.2 million in 2004. These increases were related to higher sales volume. Software related revenues increased $7.2 million to $20.6 million in 2005. This increase was primarily driven by an increase in third-party related software revenues which increased from $3.5 million in 2004 to $8.6 million in 2005. Other software related revenues, which includes revenues recognized upon delivery of our software and content sold directly by us or through third parties, increased from $10.0 million in 2004 to $12.1 million in 2005; these revenues can vary significantly from period to period and past levels are not necessarily indicative of future performance. Other software related revenues increased primarily as a result of a higher volume of revenues related to sales of our clinical practice content under a remarketing arrangement with a third-party. There is no assurance that we will generate comparable amounts under this arrangement in future periods. The increase in third party software was a result of higher software sales in 2005. In the event that we are not successful in achieving comparable levels of software related revenues in 2006, our operating results could be negatively impacted.
Professional service revenues increased as a result of major activation activities at numerous client installations during 2005. Additionally, we experienced significant growth in our consulting practice as clients have begun to acquire these services from us to improve their respective work flow and processes associated with their ongoing operations. In 2005, new sales levels associated with consulting and implementation services have significantly increased as clients have purchased higher volumes of these offerings to improve their workflows and benefits derived from using our software. We expect this trend to continue in the future.
Hardware revenues decreased approximately $14.0 million, or 51.9% to $13.0 million for the year ended December 31, 2005 compared to $27.0 million in 2004. The decrease was a result of lower software related sales in 2004 and the first half of 2005 associated with the previously discussed software issue. Additionally, we have begun to experience a change in sales mix as more clients have elected remote hosting services in-lieu of hardware purchases to operate their respective software applications. We expect hardware and network service transactions will fluctuate in future periods due a variety of factors, including competition within the hardware industry, the status of the client implementations and future sales volumes related to hardware and network services.
Revenue increases in any period are attributable, to a significant degree, to sales contracts entered into in prior-years. Because 2005 software sales bookings have fallen short of our expectations, the percentage revenue increases experienced in 2005 may not be repeated in 2006.
Cost of systems and services revenues “exclusive of depreciation shown below”, increased approximately $56.7 million or 33.7% to $225.1 million, for the year ended December 31, 2005 compared to $168.4 million in 2004. The increase in costs of systems and services revenues in 2005 was related to the following:
During 2005, we experienced a significant increase in costs associated with the use of third party consultants to augment our implementation services. In Q4 2005, we implemented an initiative to improve our professional services area which included a reorganization of these resources. Additionally, we are investing incremental resources in training related activities and improvements in our services infrastructure. We expect these initiatives to improve our results in this area over the next 12 – 24 months.
Cost of hardware revenues decreased $11.9 million to $11.1 million or 51.8% in 2005 compared to $22.9 million in 2004. The decrease in these costs was directly related to the lower hardware volumes discussed above. The gross margin percentage on hardware revenue decreased to 14.7% in 2005 compared to 14.8% in 2004.
Research and development expenses were $51.8 million in 2005 compared to $58.1 million in 2004. Gross research and development spending which consists of research and development expense plus capitalized software development costs decreased $1.4 million to $71.9 million in 2005 compared to $73.3 million in 2004. The decrease in overall spending was driven by an improvement in internal processes within the research and development organization and a shifting of resources from third party consultants to internal resources. In summary, research and development was as follows:
The increase in amortization of capitalized software development costs was a result of the release of Sunrise Clinical Manager 3.5 XA in June 2004 and Sunrise Clinical Manager 4.0 XA in March 2005. These costs are included as a component of costs of systems and services revenues. We expect capitalization of software development costs to reduce in 2006 from 2005 levels. Sunrise Clinical Manager 4.0XA and 4.5XA, which accounted for a significant part of our software development expense in 2005, have been released, and software development in 2006 is expected to focus more on enhancement and maintenance of existing software than on new software development. The anticipated reduction in software development capitalization will result in a commensurate increase in research and development expense recognized in 2006.
General and administrative expenses increased approximately $3.7 million or 23.6% to $19.2 million in 2005 compared to $15.5 million in 2004. The increase was primarily related to costs associated with the transition of our CEO resulting in incremental costs of $2.7 million. Additionally, costs increased as a result of an incremental investment in our infrastructure related to the expansion of our management team and an increase in costs associated with incentive related compensation. These increases were partially offset by lower legal costs and a reduction in insurance related expenses.
In 2006 and beyond, recorded expenses will increase as a result of our adoption of FAS 123R, which requires us to record expense associated with stock options based upon their fair value at the date of grant. If we had adopted this methodology we would have recorded stock option related expense of $10.7 million, $9.6 million and $16.2 million in 2005, 2004 and 2003, respectively using the Black-Scholes valuation model. Actual amounts recorded in the future will vary depending upon the number of options actually granted, the fair market value at the date of grant, and other variables affecting the calculation.
Depreciation and amortization increased $1.4 million or 10.4% to $14.7 million in 2005 compared to $13.3 million in 2004. The increase was a result of an on-going investment in our infrastructure in research and development area and other areas of the Company. The increase was also attributable to a full year of amortization for acquired intangible assets in the current year compared to a pro-rated period in the prior year.
Interest income increased $1.5 million to $3.1 million in 2005 compared to $1.6 million in 2004. The increase was primarily related to better yields earned on cash and cash equivalent balances in 2005.
As a result of these factors, we had a net income of $485,000 for the year ended December 31, 2005, compared to a net loss of $32.6 million for the year ended December 31, 2004.
Year Ended December 31, 2004 compared to December 31, 2003
Total revenues for the year ended December 31, 2004 increased $54.4 million or 21.4% to $309.1 million, from $254.7 million in 2003.
Systems and services revenues increased $48.2 million or 20.6% to $282.1 million for the year ended December 31, 2004 compared to $234.0 million in 2003. The increase in systems and services revenues was primarily a result of an increase in monthly generated revenues related to software, maintenance, outsourcing and remote hosting. These revenues increased $31.0 million to $198.0 million in 2004. Additionally, professional services revenues which include implementation and consulting services increased $8.4 million or 17.8% from $47.1 million in 2003 to $55.5 million in 2004. Also, revenue related to software and networking services increased $8.7 million or 43.9% to $28.6 million in 2004 compared to $19.9 million in 2003.
The increase in monthly generated revenues related to software, maintenance, outsourcing and remote hosting and professional services was primarily driven by higher sales volume in 2003 and 2004. The higher sales volume was related to an ongoing initiative in which we expanded our sales and marketing functions. The higher sales volume was related to success in the market place in connection with sales of our advanced clinical systems and combined software and outsourcing transactions. The sales of advanced clinical systems were related to ongoing industry wide initiatives to adopt and implement these systems. In connection with the higher sales volume, we began to market multiple element arrangements that are recognized on a monthly basis. This initiative which was implemented in 2002, has resulted in lower cash flows during the past two years as these contracts provide for payment terms that provide for lower cash flows during the early portion of the respective contracts. The growth in professional services was a result of significant incremental activity in 2004 tied to client implementations. Activities increased in 2004 as numerous clients went live on one or more software applications. This activity is expected to continue at these heightened levels in 2005 as numerous clients are scheduled to activate or upgrade their software applications. The increase in software license revenues and network services revenues was primarily a result of higher network services revenues which increased by $6.3 million in 2004. Network services revenues increased from $8.9 million in 2003 to $15.2 million in 2004. This increase was a result of an initiative we implemented to expand our network services offering to our client base.
As part of our future growth and continued expansion of our solutions offering, we implemented a strategy to market combined outsourcing and software contracts. We signed several large contracts in this area in 2004 and continued this program in 2005. In the event that we experience a change in revenue mix whereby a higher portion of contracts are combined outsourcing and software contracts, our overall gross margin percentage would likely decline. However, given the significantly larger size of typical combined outsourcing and software contracts, we expect the overall contribution of these contracts to our profitability would be positive.
Hardware revenues increased approximately $6.2 million, or 30.2% to $27.0 million for the year ended December 31, 2004 compared to $20.7 million in 2003. Hardware increased as a significant number of clients made purchases as they progressed on their respective installations in 2004 following our release of Sunrise Clinical Manager 3.5 XA in June 2004.
Cost of systems and services exclusive of “depreciation as shown below”, increased approximately $25.1 million or 17.5% to $168.4 million, for the year ended December 31, 2004 compared to $143.3 million in 2003. The increase in costs of systems and services revenues in 2004 was related to the following:
Cost of hardware revenues increased $5.7 million to $22.9 million or 33.0% in 2004 compared to $17.3 million in 2003. The increase in these costs was directly related to the higher hardware volumes discussed above. The gross margin percentage on hardware revenue decreased to 14.8% in 2004 compared to 16.7% in 2003. The decrease was a result of pricing pressures in 2004 in the hardware sector of our business. It is expected that fluctuations in revenue and margin will continue to occur in future periods.
Research and development expenses were $58.1 million in 2004 compared to $58.1 million in 2003. Gross research and development spending which consists of research and development expense and capitalized software development costs decreased $3.1 million to $73.3 million in 2004 compared to $76.4 million in 2003. The decrease in overall spending was driven by an improvement in internal processes within the research and development organization and a shifting of resources from third party consultants to internal resources. In summary research and development expenses were as follows:
The decrease in capitalized software development costs was primarily related to the decrease in costs associated with a shift from third party resources to internal resources in 2004. The increase in amortization of capitalized software development costs was a result of the release of Sunrise Clinical Manager 3.5 XA in June 2004. These costs are included as a component of the costs of systems and services revenues.
General and administrative expenses increased approximately $2.0 million or 14.8% to $15.5 million in 2004 compared to $13.5 million in 2003. The increase was primarily related to higher legal costs, higher accounting and professional fees associated with the implementation of Section 404 of the Sarbanes-Oxley Act and expense associated with a stock option repurchase which was executed in the fourth quarter of 2004.
Depreciation and amortization increased $2.8 million or 26.6% to $13.3 million in 2004 compared to $10.5 million in 2003. The increase was a result of on-going investment to improve our infrastructure in our research and development area and continued investments in our TechnologySolutionsCenter related to higher volumes of remote hosting services. As a result of these initiatives, we expect depreciation and amortization to continue to increase in future periods.
Interest income decreased $801,000 to $1.6 million in 2004 compared to $2.4 million in 2003. The decrease was primarily related to lower cash and cash equivalent balances in 2004.
As a result of these factors, we had a net loss of $32.6 million for the year ended December 31, 2004, compared to a net loss of $56.0 million for the year ended December 31, 2003.
Liquidity and Capital Resources
During 2005, operating activities provided $14.4 million of cash. Operating activities were favorably impacted in 2005 as a result of improvements in operations related to increased revenues and related contribution across all significant areas of our business. Investing activities used $77.2 million of cash, consisting of net purchases of marketable securities of $37.5 million, $20.1 million of capitalized software development costs and $19.3 million for the procurement of property and equipment. The property and equipment expenditures were related to activities at our TSC for the expansion of our remote hosting function and activities in our research and development area, as well as investments in our Oracle ERP solution. Financing activities provided $17.0 million from the proceeds of stock options exercised and proceeds from the issuance of common stock in the employee stock purchase plan. Cash provided by the exercise of stock options was higher in 2005 than in 2004. The timing and amount of cash provided by future stock option exercises is uncertain.
As of December 31, 2005, our principal source of liquidity was our cash and cash equivalents and marketable-securities balances of $114.1 million.
Our future capital and liquidity requirements will depend upon a number of factors, including the rate of growth of our sales and the timing and level of research and development activities. As of December 31, 2005, we have a commitment for capital expenditures related to our ERP system of $1.2 million. We believe that our available cash and cash equivalents and anticipated cash generated from our future operations will be sufficient to meet our operating requirements at least through 2006.
Contracts and Commitments
The following table provides information related to our contractual cash obligations under various financial and commercial agreements as of December 31, 2005:
The unconditional purchase obligations consist of minimum purchase commitments for telecommunication services, computer equipment, maintenance, consulting, airplane charters and other commitments. The contract for airplane charters is discussed in further detail in Note 10 to the consolidated financial statements, “Related Party Transactions” included herein.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We do not currently use derivative financial instruments. 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.
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. A hypothetical 10% increase or decrease in interest rates, however, would not have a material adverse effect on our financial condition.
The following table illustrates potential fluctuation in annualized interest income based upon hypothetical values for blended interest rates and cash and marketable securities account balances.
* This sensitivity analysis is not a forecast of future interest income.
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.
We do not currently enter into foreign currency hedge transactions. Through December 31, 2005, foreign currency fluctuations have not had a material impact on our financial position or results of operations.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Certified Accounting Firm
To the Board of Directors and Stockholders of Eclipsys Corporation:
We have completed integrated audits of Eclipsys Corporation’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Eclipsys Corporation and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedulebased on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in “Report of Management on Eclipsys Corporation’s Internal Control over Financial Reporting” appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
March 6, 2006
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.