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TriZetto Group 10-Q 2007
TriZetto Form 10-Q June 30, 2007
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                         

Commission file number 000-27501

 


The TriZetto Group, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware   33-0761159

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

 

567 San Nicolas Drive, Suite 360

Newport Beach, California

  92660
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (949) 719-2200

 


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

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

Large accelerated filer  ¨                Accelerated filer  x                Non-accelerated filer  ¨

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨    No  x

As of August 6, 2007, 45,538,277 shares, $0.001 par value per share, of the registrant’s common stock were outstanding.

 



Table of Contents

THE TRIZETTO GROUP, INC.

QUARTERLY REPORT ON

FORM 10-Q

For the Quarterly Period Ended June 30, 2007

TABLE OF CONTENTS

 

     PAGE
PART I—FINANCIAL INFORMATION   

Item 1    Financial Statements:

  

Condensed Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December 31, 2006

   1

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006

   2

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006

   3

Notes to Unaudited Condensed Consolidated Financial Statements

   4

Item 2    Management’s Discussion and Analysis of Financial Condition and Results of Operations

   13

Item 3    Quantitative and Qualitative Disclosures About Market Risk

   25

Item 4    Controls and Procedures

   26
PART II—OTHER INFORMATION   

Item 1    Legal Proceedings

   27

Item 1A Risk Factors

   27

Item 2    Unregistered Sales of Equity Securities and Use of Proceeds

   36

Item 4    Submission of Matters to a Vote of Security Holders

   36

Item 6    Exhibits

   37

SIGNATURES

   38

 

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Table of Contents

PART I — FINANCIAL INFORMATION

Item 1.     Financial Statements

The TriZetto Group, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     June 30
2007
    December 31,
2006
 
     (unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 202,062     $ 107,057  

Short-term investments

     53,065       —    

Restricted cash

     1,740       921  

Accounts receivable, less allowances of $2,633 and $3,770 at June 30, 2007 and December 31, 2006, respectively

     83,961       64,386  

Prepaid expenses and other current assets

     14,368       11,415  

Deferred tax assets

     20,313       14,100  
                

Total current assets

     375,509       197,879  

Property and equipment, net

     32,025       26,777  

Capitalized software development costs, net

     26,435       27,913  

Deferred tax assets

  

 

4,314

 

    —    

Goodwill

     187,335       90,337  

Other intangible assets, net

     80,039       27,347  

Other assets

     18,673       12,347  
                

Total assets

  

$

724,330

 

  $ 382,600  
                

Liabilities and stockholders’ equity

    

Current liabilities:

    

Current portion of notes payable and term loan

   $ 11,331     $ 115  

Current portion of capital lease obligations

     1,321       1,461  

Accounts payable

     15,300       18,091  

Accrued liabilities

     52,131       61,595  

Deferred revenue

     56,115       30,508  
                

Total current liabilities

     136,198       111,770  

Long-term convertible debt

     330,000       100,000  

Long-term revolving line of credit and term loan

     81,286       12,000  

Other long-term liabilities

     15,298       2,340  

Capital lease obligations

     1,671       2,030  

Deferred tax liabilities

  

 

—  

 

    14,100  

Deferred revenue

     8,584       6,453  
                

Total liabilities

  

 

573,037

 

    248,693  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Common stock

     46       43  

Additional paid-in capital

     384,477       376,633  

Accumulated deficit

     (233,230 )     (242,769 )
                

Total stockholders’ equity

     151,293       133,907  
                

Total liabilities and stockholders’ equity

  

$

724,330

 

  $ 382,600  
                

See accompanying notes.


Table of Contents

The TriZetto Group, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2007     2006     2007     2006  

Revenue:

        

Services and other

   $ 91,432     $ 69,793     $ 181,207     $ 135,565  

Products

     23,403       17,917       47,131       37,463  
                                

Total revenue

     114,835       87,710       228,338       173,028  
                                

Operating costs and expenses:

        

Cost of revenue—services and other

     50,888       41,980       100,989       82,327  

Cost of revenue—products (excludes amortization of acquired technology)

     4,776       3,232       9,979       7,706  

Research and development

     16,444       10,743       32,181       21,221  

Selling, general and administrative

     28,801       24,027       56,105       45,343  

Amortization of acquired technology

     1,237       940       2,947       2,155  

Amortization of acquired other intangible assets

     1,360       128       2,661       421  
                                

Total operating costs and expenses

     103,506       81,050       204,862       159,173  

Income from operations

     11,329       6,660       23,476       13,855  

Interest income

     2,803       945       3,556       1,835  

Interest expense

     (3,483 )     (835 )     (6,124 )     (1,667 )

Change in fair value of derivative liabilities

     (2,483 )     —         (2,483 )     —    

Other income

     —         —         —         180  
                                

Income before provision for income taxes

     8,166       6,770       18,425       14,203  

Provision for income taxes

     (4,523 )     (356 )     (8,886 )     (951 )
                                

Net income

   $ 3,643     $ 6,414     $ 9,539     $ 13,252  
                                

Net income for diluted EPS calculation

   $ 4,184     $ 6,414     $ 10,858     $ 13,252  
                                

Net income per share:

        

Basic

   $ 0.08     $ 0.15     $ 0.22     $ 0.31  
                                

Diluted

   $ 0.07     $ 0.14     $ 0.18     $ 0.29  
                                

Shares used in computing net income per share:

        

Basic

     44,522       42,370       44,192       42,140  
                                

Diluted

     61,876       45,394       61,777       45,548  
                                

See accompanying notes.

 

2


Table of Contents

The TriZetto Group, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended
June 30,
 
     2007     2006  

Cash flows from operating activities:

    

Net income

   $ 9,539     $ 13,252  

Adjustments to reconcile net income to net cash provided by operating activities:

    

(Net reduction in) provision for doubtful accounts and sales allowance

     (1,578 )     731  

Stock-based compensation

     5,533       3,544  

Depreciation and amortization

     12,332       11,064  

Amortization of acquired technology

     2,947       2,155  

Amortization of acquired other intangible assets

     2,661       421  

Deferred tax benefit

     —         (406 )

Change in fair value of derivative liabilities

     2,483       —    

Gain on disposal of assets

     —         (158 )

Increase in cash surrender value of life insurance policies

     (565 )     (596 )

Changes in assets and liabilities, net of acquisitions:

    

Restricted cash

     (819 )     551  

Accounts receivable

     (11,456 )     (21,067 )

Prepaid expenses and other current assets

     (2,285 )     (527 )

Other assets

     1,954       1,140  

Accounts payable

     (5,456 )     (839 )

Accrued liabilities

     (7,715 )     (5,200 )

Deferred revenue

     19,557       7,504  
                

Net cash provided by operating activities

     27,132       11,569  
                

Cash flows from investing activities:

    

Purchase of short-term investments

     (53,065 )     —    

Purchase of property and equipment and software licenses

     (9,333 )     (6,252 )

Capitalization of software development costs

     (3,829 )     (4,605 )

Acquisitions, net of cash acquired

     (143,196 )     (42,370 )
                

Net cash used in investing activities

     (209,423 )     (53,227 )
                

Cash flows from financing activities:

    

Proceeds from revolving line of credit

     104,200       19,000  

Proceeds from term loan

     75,000       —    

Proceeds from convertible debt (net of costs of convertible note hedge)

     164,128       —    

Proceeds from warrant

     25,714    

Proceeds from debt financing

     717       992  

Payments on revolving line of credit

     (99,200 )     (15,000 )

Payments on notes payable

     (1,076 )     (359 )

Payments on capital leases

     (915 )     (1,341 )

Employee exercises of stock options and purchase of common stock

     8,728       6,921  
                

Net cash provided by financing activities

     277,296       10,213  
                

Net increase (decrease) in cash and cash equivalents

     95,005       (31,445 )

Cash and cash equivalents at beginning of period

     107,057       106,940  
                

Cash and cash equivalents at end of period

   $ 202,062     $ 75,495  
                

See accompanying notes.

 

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Table of Contents

The TriZetto Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Preparation

The accompanying unaudited condensed consolidated financial statements have been prepared by The TriZetto Group, Inc. (the “Company”) in accordance with generally accepted accounting principles for interim financial information that are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, and pursuant to the instructions to Form 10-Q and Article 10 promulgated by Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes to financial statements required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2007, are not necessarily indicative of the results that may be expected for the year ending December 31, 2007, or for any future period. The financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K as filed with the SEC on March 16, 2007.

2. Computation of Earnings per Share

The computation of basic earnings per share (“EPS”) is based on the weighted average number of common shares outstanding during each period. The computation of diluted EPS is based on the weighted average number of common shares outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options and shares issuable upon vesting of restricted stock awards, calculated using the treasury stock method, and shares to be issued upon conversion of convertible debt.

Emerging Issues Task Force Issue No. 04-08, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (“EITF 04-08”), requires companies to account for contingently convertible debt using the “if converted” method set forth in Statement of Financial Accounting Standard (“SFAS”) No. 128, “Earnings per Share,” for calculating diluted EPS. Under the “if converted” method, the after-tax effect of interest expense related to the convertible securities is added back to net income and convertible debt is assumed to have been converted to equity at the beginning of the period, or at such time when the convertible debt became outstanding if issued during the period, and is added to outstanding common shares, unless the inclusion of such shares is anti-dilutive.

The following table provides a reconciliation of the computations of basic and diluted EPS information for the periods presented (in thousands, except per share data):

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2007    2006    2007    2006

Numerator:

           

Net income, as reported

   $ 3,643    $ 6,414    $ 9,539    $ 13,252

After-tax interest expense on 2.75% convertible debt

     307      —        712      —  

After-tax interest expense on 1.125% convertible debt

     234      —        607      —  
                           

Net income for diluted EPS calculation

   $ 4,184    $ 6,414    $ 10,858    $ 13,252
                           

Denominator:

           

Weighted average shares outstanding – basic

     44,522      42,370      44,192      42,140

2.75% convertible debt converted to common shares

     5,305      —        5,305      —  

1.125% convertible debt converted to common shares

     8,512      —        8,512      —  

Unvested common shares outstanding

     767      586      744      554

Unvested stock options

     2,770      2,438      3,024      2,854
                           

Weighted average shares outstanding – diluted

     61,876      45,394      61,777      45,548
                           

Basic earnings per share

   $ 0.08    $ 0.15    $ 0.22    $ 0.31
                           

Diluted earnings per share

   $ 0.07    $ 0.14    $ 0.18    $ 0.29
                           

In the second quarter of 2007, the Company recorded adjustments to the purchase price of Plan Data Management, Inc. of approximately $6.2 million. The adjustments were primarily the result of the first contingent consideration due to PDM stockholders and option holders. The contingent consideration consists of 149,664 shares of common stock with the value of $19.36 per share (which represents the closing price of TriZetto common stock on June 29, 2007) and cash payments of $2.3

 

4


Table of Contents

million. The issuance of the 149,664 shares of common stock and the $2.3 million cash payment were not completed prior to June 30, 2007. However, these amounts were accrued as of June 30, 2007. The computation of earnings per share for the three and six months ended June 30, 2007 did not include the issuance of the 149,664 shares of common stock since the impact of these amounts was not material.

3. Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment.” This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R, using the modified prospective method. Under this method, the provisions of SFAS No. 123R apply to all awards granted or modified after the date of adoption and all previously granted awards not yet vested as of the date of adoption.

The following table is a summary of the amount of stock-based compensation expense recognized in the consolidated statement of operations (in thousands):

 

    

Three Months Ended

June 30,

  

Six Months Ended

June 30,

     2007    2006    2007    2006

Cost of revenue—services and other

   $ 120    $ 441    $ 774    $ 796

Cost of revenue—products

     85      —        130      —  

Research and development

     424      213      800      399

Selling, general and administrative

     1,992      1,362      3,829      2,349
                           

Total

   $ 2,621    $ 2,016    $ 5,533    $ 3,544
                           

The Company has the following stock-based compensation plans: (i) the 1998 Long-Term Incentive Plan, which is an amendment and restatement of the 1998 Stock Option Plan, permits the Company to grant other types of awards in addition to stock options, (ii) the RIMS Stock Option Plan, a plan the Company assumed through the acquisition of Resource Information Management Systems, Inc. in late 2000, (iii) the QCSI Stock Option Plan, a plan the Company adopted in connection with the acquisition of Quality Care Solutions, Inc. in January 2007, and (iv) the Employee Stock Purchase Plan, which allows full-time employees to purchase shares of the Company’s common stock at a discount to fair market value.

The fair value of option grants was estimated using the Black-Scholes pricing model. The Company evaluates the assumptions used to value stock awards on a quarterly basis. The following weighted average assumptions were used for the periods presented:

 

    

Three Months Ended

June 30,

  

Six Months Ended

June 30,

     2007    2006    2007    2006

Expected volatility

   45%    45%    45%    45%

Risk-free interest rate

   4.82%    4.75%    4.82%    4.75%

Expected life

   6.25 years    6.25 years    6.25 years    6.25 years

Forfeiture rate

   6%    6%    6%    6%

Expected dividends

           

Weighted average fair value

   $10.08       $10.11    $8.61

 

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Table of Contents

The following is a summary of stock option activity for the six months ended June 30, 2007 (in thousands, except per share data):

 

    

Number of

Shares

   

Weighted

Average

Exercise
Price

   Weighted
Average
Remaining
Contractual
Life
   Aggregate
Intrinsic
Value

Options Outstanding at December 31, 2006

   7,720     $ 10.25      

Granted

   679       19.80      

Exercised

   (1,057 )     8.39      

Cancelled

   (166 )     14.06      
              

Options Outstanding at June 30, 2007

   7,176     $ 11.34    6.14    $ 60,902
              

Exercisable at June 30, 2007

   4,223     $ 10.61    5.04    $ 39,824

Expected volatility is based on a combination of implied volatility from traded options on the Company’s stock and historical volatility of the Company’s stock. The risk-free interest rate is the U.S. Treasury rate for the week of the grant having a term equal to the expected life of the option. The expected life of options granted represents the period of time that options granted are expected to be outstanding. The Company has determined that historical experience is not a good predictor of future exercise patterns and thus has applied the “simplified” method outlined in Staff Accounting Bulletin No. 107, “Share-Based Payment,” to calculate expected life. The forfeiture rate is the estimated percentage of options granted that are expected to be forfeited or cancelled before becoming fully vested and is based on historical experience. The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future.

The total intrinsic value of options exercised during the six months ended June 30, 2007 was $13.0 million. As of June 30, 2007, $12.4 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted average period of 1.95 years.

The following table summarizes nonvested restricted stock awards as of June 30, 2007 and changes during the six months ended June 30, 2007 (in thousands, except per share data):

 

    

Number of

Shares

   

Weighted-
Average
Grant-Date

Fair Value

Nonvested at December 31, 2006

   546     $ 12.04

Granted

   355       20.28

Vested

   (120 )     10.79

Forfeited

   (19 )     14.78
        

Nonvested at June 30, 2007

   762       16.01
        

As of June 30, 2007, there was $10.0 million of total unrecognized compensation cost related to nonvested restricted stock awards, which will be amortized over the weighted-average remaining service period of 2.19 years.

4. Supplemental Cash Flow Disclosures

The following table is a summary of supplemental cash flow disclosures as follows (in thousands):

 

    

Six Months Ended

June 30,

     2007    2006

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION

     

Cash paid for interest

   $ 4,490    $ 1,615

Cash paid for income taxes

     6,571      502

NON-CASH INVESTING AND FINANCING ACTIVITIES

     

Assets acquired through capital lease

     349      —  

Common stock issued in connection with PDM acquisition

     8,000      —  

 

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5. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 

     June 30,
2007
   December 31,
2006
     (unaudited)     

Accrued payroll and benefits

   $ 23,162    $ 29,475

Accrued professional and litigation fees and settlements

     8,307      8,609

Accrued acquisition costs

     10,384      16,500

Accrued outside services

     303      370

Accrued employee benefits

     1,186      602

Accrued income and other taxes

     2,346      2,125

Accrued interest

     2,386      752

Accrued travel

     809      415

Other

     3,248      2,747
             
   $ 52,131    $ 61,595
             

6. Debt

2.75% Convertible Senior Notes

In October 2005, the Company issued $100.0 million aggregate principal amount of 2.75% Convertible Senior Notes due 2025 (the “2025 Notes”). The 2025 Notes bear interest at a rate of 2.75%, which is payable in cash semi-annually in arrears on April 1 and October 1 of each year, commencing on April 1, 2006, to the holders of record on the preceding March 15 and September 15, respectively.

The 2025 Notes are convertible into shares of the Company’s common stock at an initial conversion price of $18.85 per share, or 53.0504 shares for each $1,000 principal amount of 2025 Notes, subject to certain adjustments pursuant to an indenture with Wells Fargo Bank, National Association, as trustee (the “2025 Indenture”). The maximum conversion rate is 68.9655 shares for each $1,000 principal amount of 2025 Notes. Upon conversion of the 2025 Notes, the Company will have the right to deliver shares of its common stock, cash or a combination of cash and shares of its common stock. The 2025 Notes are convertible (i) prior to October 1, 2020, during any fiscal quarter after the fiscal quarter ending December 31, 2005, if the closing sale price of the Company’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 120% of the conversion price in effect on the last trading day of the immediately preceding fiscal quarter, (ii) prior to October 1, 2020, during the five business day period after any five consecutive trading day period (the “Note Measurement Period”) in which the average trading price per $1,000 principal amount of 2025 Notes was equal to or less than 97% of the average conversion value of the 2025 Notes during the Note Measurement Period, (iii) upon the occurrence of specified corporate transactions, as described in the 2025 Indenture, (iv) if the Company calls the 2025 Notes for redemption, or (v) any time on or after October 1, 2020.

The 2025 Notes mature on October 1, 2025. However, on or after October 5, 2010, the Company may from time to time at its option redeem the 2025 Notes, in whole or in part, for cash, at a redemption price equal to 100% of the principal amount of the 2025 Notes the Company redeems, plus any accrued and unpaid interest to, but excluding, the redemption date. On each of October 1, 2010, October 1, 2015 and October 1, 2020, holders may require the Company to purchase all or a portion of their 2025 Notes at a purchase price in cash equal to 100% of the principal amount of the 2025 Notes to be purchased, plus any accrued and unpaid interest to, but excluding, the purchase date. In addition, holders may require the Company to repurchase all or a portion of their 2025 Notes upon a fundamental change, as described in the 2025 Indenture, at a repurchase price in cash equal to 100% of the principal amount of the 2025 Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. Additionally, the 2025 Notes may become immediately due and payable upon an Event of Default, as defined in the 2025 Indenture. Pursuant to a Registration Rights Agreement dated October 5, 2005, the Company filed with the Securities and Exchange Commission, a registration statement under the Securities Act for the purpose of registering for resale, the 2025 Notes and all of the shares of its common stock issuable upon conversion of the 2025 Notes.

1.125% Convertible Senior Notes

On April 11, 2007, the Company entered into a Purchase Agreement with Deutsche Bank Securities Inc., Goldman, Sachs & Co. and UBS Investment Bank (the “Initial Purchasers”), to sell

 

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$230.0 million aggregate principal amount of its 1.125% Convertible Senior Notes due 2012 which included $30 million to cover over-allotments (the “2012 Notes”) in a private placement in reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The 2012 Notes have been resold by the Initial Purchasers to qualified institutional buyers pursuant to Rule 144A under the Securities Act. The sale of the 2012 Notes to the Initial Purchasers was consummated on April 17, 2007.

The aggregate net proceeds received by the Company from the sale of the 2012 Notes was approximately $223 million, after deducting the Initial Purchasers’ discount and offering expenses. The 2012 Notes are the Company’s senior unsecured obligations and rank equal in right of payment with all of the Company’s other senior unsecured debt and senior to all of the Company’s future subordinated debt.

The 2012 Notes were issued pursuant to an indenture, dated April 17, 2007, by and between the Company and Wells Fargo Bank, National Association, as trustee (the “2012 Indenture”). The 2012 Notes bear interest at a rate of 1.125%, which is payable in cash semi-annually in arrears on April 15 and October 15 of each year, commencing on October 15, 2007, to the holders of record on the preceding April 1 and October 1, respectively.

The 2012 Notes are convertible into shares of the Company’s Common stock at an initial conversion price of $21.97 per share, or 45.5114 shares for each $1,000 principal amount of 2012 Notes, subject to certain adjustments set forth in the 2012 Indenture. The maximum conversion rate is 53.4759 shares for each $1,000 principal amount of 2012 Notes. Upon conversion of the 2012 Notes, the Company will have the right to deliver shares of its common stock, cash or a combination of cash and shares of its common stock. The 2012 Notes are convertible (i) prior to January 15, 2012, during any calendar quarter after the calendar quarter ending June 30, 2007, if the closing sale price of the Company’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price in effect on the last trading day of the immediately preceding fiscal quarter, (ii) prior to January 15, 2012, during the five business day period after any five consecutive trading day period (the “Note Measurement Period”) in which the average trading price per $1,000 principal amount of 2012 Notes was equal to or less than 97% of the average conversion value of the 2012 Notes during the Note Measurement Period, (iii) upon the occurrence of specified corporate transactions, as described in the 2012 Indenture, (iv) if the Company calls the 2012 Notes for redemption, or (v) any time on or after January 15, 2012.

The Company used $59.0 million of the aggregate net proceeds from the 2012 Notes to pay the net cost of a call option transaction entered into in connection with the offering. The call option covers approximately 10.4 million shares of the Company’s common stock and is intended to reduce the dilution to the Company’s common stock upon potential future conversion of the 2012 Notes. The call option has an exercise price equal to the conversion price of the 2012 Notes and will terminate on the earlier of (i) the last day any of the 2012 Notes remain outstanding or (ii) April 15, 2012. The Company also entered into a warrant transaction in connection with the offering. The Company sold warrants to acquire approximately 10.4 million shares of the Company’s common stock to affiliates of one or more of the initial purchases for $25.7 million. The warrants have an exercise price of $31.79 per share and may be settled at various dates from July 2012 through December 2012.

It was determined that upon execution of the combined agreements the Company did not have sufficient authorized and unissued shares available to settle all of its commitments that may require the issuance of stock during the maximum period those commitments could remain outstanding. As a result, warrants to purchase approximately 3.0 million shares of the Company’s common stock did not meet the definition of an equity instrument and were recorded as a derivative financial instrument liability. Such warrants were recorded at fair value upon purchase and were subsequently marked to fair value through earnings.

The initial fair value of the derivative instruments on April 17, 2007 was determined based on the price paid by the initial purchasers for the warrants. The Company recorded $7.3 million of the $25.7 million proceeds from the warrants as a non-current liability. During the three months ended June 30, 2007, the Company recorded a charge to earnings of $2.5 million to reflect the increase in the fair value of the warrant liability to $9.8 million. Since no actively traded market for the derivative instruments existed as of June 30, 2007, the fair value of the derivative instruments was determined using a Black-Scholes valuation model utilizing the following weighted average assumptions: volatility of 28%, expected life of 5.33 years to 5.44 years, risk-free interest rate of 4.86% and no expected dividends. Expected volatility was based on the observed volatility in the initial hedge transactions. On June 30, 2007, due to a change in the components of the warrant liability, approximately $400,000 was reclassified from the non-current liability into equity as additional paid-in capital, which reduced the value of the warrant liability to $9.4 million.

 

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As discussed further in Note 10, “Subsequent Events,” on July 26, 2007, the Company amended the warrant agreements which eliminated the requirement to classify the warrants as a derivative liability and the fair value of the liability at July 26, 2007 was reclassified to stockholders’ equity. Due to the decrease in the underlying fair value of the derivative instruments from July 1, 2007 to July 26, 2007, the Company recorded income during the third quarter of 2007 of approximately $2.9 million.

Wells Fargo Foothill Amended and Restated Credit Agreement

In January 2007, the Company (together with certain specified subsidiaries, the “Borrowers”) entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with Wells Fargo Foothill, Inc., as the administrative agent and lender (the “Lender”). The Credit Agreement amended and restated the Company’s $100.0 million revolving credit facility with the Lender and provided that the Lender will make available to the Company up to $150.0 million of term debt (the “Term Loan”). The Credit Agreement expires by its terms on January 5, 2011. All borrowings under the Credit Agreement bear interest at a per annum rate equal to either (i) the LIBOR rate plus an adjustable applicable margin of between 1.75% and 3.50% or (ii) Wells Fargo’s prime rate plus an adjustable applicable margin of between 0.0% and 2.0%, at the election of the Company, subject to specified restrictions.

The Company initially drew down $75.0 million from the Term Loan to partially fund its acquisition of Quality Care Solutions, Inc. (“QCSI”) in January 2007. All borrowings under the Term Loan must be repaid in quarterly installments commencing on June 30, 2007 and continuing on the first day of each calendar quarter thereafter through January 5, 2011, in amounts equal to the amount outstanding under the Term Loan on June 30, 2007 with a final balloon payment due January 5, 2011. The Company recently amended the Credit Agreement to permit additional draws on the Term Loan until October 1, 2007, in which case the amount of each quarterly payment would be recalculated. In the event Borrowers terminate the Credit Agreement prior to its expiration or make certain prepayments, the Borrowers will be required to pay the Lender a termination or prepayment fee equal to 1% of the maximum credit amount in the event of termination or 1% of the prepayment amount in the event of prepayments, subject to specified exceptions. Under the Credit Agreement, the Borrowers have granted the Lender a security interest in all of the assets of the Borrowers.

The Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type, including limitations on the Borrowers with respect to indebtedness, liens, investments, distributions, mergers and acquisitions, dispositions of assets and transactions with affiliates of the Borrowers. The Credit Agreement also includes financial covenants including minimum EBITDA, minimum liquidity, minimum recurring revenue (which includes outsourced business services and software maintenance revenue) and maximum capital expenditures.

As of June 30, 2007, the Company was in compliance with all applicable covenants and other restrictions under the Credit Agreement. As of June 30, 2007, the Company had outstanding borrowings on the revolving line of credit of $17.0 million and $75.0 million outstanding under the Term Loan.

 

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Debt consists of the following for the periods presented (in thousands):

 

     Notes Payable     Line of Credit
    

June 30,

2007

   

December 31,

2006

   

June 30,

2007

  

December 31,

2006

Long-term convertible debt, due in 2025, interest at 2.75% fixed rate, payable semi-annually in arrears

   $ 100,000     $ 100,000     $ —      $ —  

Long-term convertible debt, due in 2012, interest at 1.125% fixed rate, payable semi-annually in arrears

     230,000       —         —        —  

Term loan of $150.0 million, interest at the lending institution’s prime rate plus adjustable applicable margin between 0.00% and 2.00% (prime rate 8.25% at June30, 2007), payable monthly in arrears; or LIBOR rate plus an adjustable applicable margin of between 1.75% and 3.50%, payable upon maturity date

     75,000       —         —        —  

Revolving credit facility of $100.0 million, interest at the lending institution’s prime rate plus adjustable applicable margin between 0.00% and 2.00% (prime rate 8.25% at June 30, 2007), payable monthly in arrears; or LIBOR rate plus an adjustable applicable margin of between 1.75% and 3.50%, payable upon maturity date

     —         —         17,000      12,000

Other

     617       115       —        —  
                             

Total debt

     405,617       100,115       17,000      12,000

Less: Current portion

     (11,331 )     (115 )     —        —  
                             
   $ 394,286     $ 100,000     $ 17,000    $ 12,000
                             

As of June 30, 2007, the Company had outstanding four unused standby letters of credit in the aggregate amount of $1.7 million, which serve as security deposits for certain operating leases. The Company is required to maintain a cash balance equal to the outstanding letters of credit, which is classified as restricted cash on the balance sheet.

7. Litigation

The Company is involved in litigation from time to time relating to claims arising out of its operations in the normal course of business. As of the filing date of this quarterly report on Form 10-Q, the Company was not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on its results of operations, financial position and/or cash flows.

8. Acquisitions

Plan Data Management, Inc.

On December 22, 2006, the Company acquired all of the issued and outstanding shares of Plan Data Management, Inc. (“PDM”). The acquisition was accounted for using the purchase method of accounting. At December 31, 2006, the excess of the purchase price over the preliminary fair market value of the assets purchased and liabilities assumed was $15.0 million and was initially allocated to goodwill. In the first quarter of 2007, the Company received a preliminary report from its independent valuation firm of the fair market value of certain intangible assets acquired from PDM. As a result, the Company allocated $11.1 million from goodwill to identifiable intangible assets and recorded approximately $350,000 of related amortization expense. In June 2007, the Company received the final valuation report and identifiable intangible assets were determined to be $9.8 million. The $9.8 million allocated to identifiable intangible assets includes customer relationships of $7.3 million to be amortized over a 10-year life, core technology of $1.9 million to be amortized over a 10-year life, existing software of $400,000 to be amortized over a three-year life, and $200,000 in tradenames to be amortized over a five-year life. Based on the final valuation report, the Company has recorded approximately $550,000 of amortization expense for the six months ended June 30, 2007.

The estimated purchase price as of December 31, 2006 was approximately $19.6 million, which consisted of 491,488 shares of the Company’s common stock with a value of $16.28 per share (which represents the average closing price of TriZetto’s common stock for the 20 trading days ending October 27, 2006), cash payments of $8.0 million, assumed liabilities of $3.1 million and acquisition-related costs of $500,000. The issuance of the 491,488 shares of common stock and the cash payment of $8.0 million to PDM stockholders and option holders were completed in January 2007.

 

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In the second quarter of 2007, the Company recorded adjustments to the purchase price of approximately $6.2 million. The adjustments were primarily the result of the first contingent consideration due to PDM stockholders and option holders. The contingent consideration consists of 149,664 shares of common stock with the value of $19.36 per share (which represents the closing price of TriZetto common stock on June 29, 2007) and cash payments of $2.3 million. The issuance of the 149,664 shares of common stock and the $2.3 million cash payment were not completed prior to June 30, 2007. However, these amounts were accrued as of June 30, 2007. The computation of earnings per share for the three and six months ended June 30, 2007 did not include the issuance of the 149,664 shares of common stock since the impact of these amounts was not material.

PDM stockholders and option holders are also entitled to receive contingent consideration under each of the following circumstances: $5.0 million on or before December 31, 2008 and $8.0 million on or before December 31, 2009, each subject to reduction if certain revenue thresholds are not satisfied during the applicable measurement period. Additional contingent consideration of up to $8.0 million may be paid on June 30, 2009 if certain revenue thresholds are satisfied, provided that in no event will the aggregate consideration of all payments exceed $42.0 million. The contingent consideration, if and when it is earned, will be recorded as additional purchase price and allocated to goodwill. The merger consideration is also subject to adjustment based upon minimum cash and working capital balances or to the extent TriZetto is entitled to claims for indemnification as specified in the Merger Agreement. The contingent consideration is payable in either cash or the Company’s common stock, however, the Company expects that 50% of each payment will be made in cash and 50% will be paid in shares of the Company’s common stock.

Quality Care Solutions, Inc.

On January 10, 2007, the Company acquired privately held Quality Care Solutions, Inc. (“QCSI”). The acquisition was accounted for using the purchase method of accounting. At March 31, 2007, the excess of the purchase price over the preliminary fair market value of the assets purchased and liabilities assumed was $147.5 million. The Company received a preliminary report from its independent valuation firm of the fair market value of certain intangible assets acquired from QCSI. As a result, the Company allocated $55.9 million from goodwill to identifiable intangible assets and recorded approximately $1.4 million of related amortization expense. In June 2007, the Company received the final valuation report and identifiable intangible assets were determined to be $48.5 million. The $48.5 million allocated to identifiable intangible assets includes customer relationships of $37.5 million to be amortized over a 10-year life, core technology of $8.0 million to be amortized over a 10-year life, existing software of $2.2 million to be amortized over a five-year life, and $800,000 in tradenames to be amortized over a five-year life. Based on the final valuation report, the Company has recorded approximately $2.6 million of amortization expense for the six months ended June 30, 2007.

The estimated purchase price as of March 31, 2007 was approximately $174.0 million, which consisted of cash payments of $146.4 million, assumed liabilities of $17.4 million, a $5.0 million contingent payment (the “Holdback”), and acquisition-related costs of $5.2 million. The amount of the Holdback will be reduced if QCSI has negative working capital, as defined in the Merger Agreement, on the closing date, or to the extent TriZetto is entitled to claims for indemnification as specified in the Merger Agreement. In the second quarter of 2007, the Company recorded adjustments to the purchase price of approximately $300,000, which primarily reflects revisions to balances of certain liabilities assumed.

QCSI stockholders, warrantholders and optionholders are also entitled to receive a contingent aggregate cash payment of up to $7.0 million on January 31, 2008, based upon license and software maintenance revenues arising from the sale of QCSI products for the 12-month period commencing on January 1, 2007 and ending on December 31, 2007. The contingent consideration, if and when it is earned, will be recorded as additional purchase price and allocated to goodwill.

In connection with the QCSI acquisition, the Company adopted the Quality Care Solutions, Inc. Stock Option Plan based upon QCSI’s existing stock option plan. The maximum aggregate number of shares that may be issued under this plan is 375,446, and options may only be awarded to those individuals that were employed by QCSI at the time of the merger. Unless previously terminated by the stockholders, the plan shall terminate at the close of business on December 31, 2007, and no options shall be granted under it thereafter.

 

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The purchase price allocations for the acquisitions described above were based on the estimated fair value of the assets acquired and liabilities assumed on the date of purchase, as follows (in thousands). These amounts are preliminary pending final resolution of related tax adjustments.

 

     PDM     QCSI  

Total current assets

   $ 3,758     $ 23,883  

Property, plant, equipment and other non-current assets

     861       2,603  

Goodwill

     11,372       99,322  

Other intangible assets

     9,800       48,500  
                

Total assets acquired

     25,791       174,308  

less: liabilities assumed

     (3,137 )     (17,752 )
                

Total purchase price of net assets acquired

   $ 22,654     $ 156,556  
                

9. Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 applies to all tax positions accounted for under SFAS No. 109, “Accounting for Income Taxes,” and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained then no benefits of the position are to be recognized. FIN 48 requires additional disclosures and is effective as of the beginning of the first fiscal year beginning after December 15, 2006.

On January 1, 2007, the Company adopted FIN 48. In connection with the adoption of FIN 48, the Company recorded increases to goodwill and deferred tax assets of $1.3 million and $700,000, respectively, and reclassified $700,000 from accrued liabilities to other long-term liabilities. The adoption of FIN 48 did not impact the January 1, 2007 balance of retained earnings. As of the date of adoption, the Company had $7.1 million of unrecognized tax benefits, of which $1.8 million would reduce its effective tax rate if recognized. The difference primarily relates to: (a) unrecognized tax benefit amounts arising from business combinations that, if recognized, would be recorded to goodwill, and (b) unrecognized tax benefit amounts associated with temporary differences and carryforwards.

The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2007, the Company had recorded approximately $335,000 of accrued interest and penalties related to uncertain tax positions.

At January 1, 2007, the Company’s December 31, 2003 through December 31, 2006 tax years remain open to examination by the tax authorities. However, the Company has consolidated and acquired NOL’s beginning in tax years December 31, 1995 which would cause the statute of limitations to remain open for the year in which the NOL was incurred.

10. Subsequent Events

On July 26, 2007, the Company entered into amendments with each of the holders of the warrants sold in connection with the 2012 Notes (see also Note 6, “Debt”). The amendments corrected a documentation error and amended the maximum shares issuable under the warrants to an amount below the Company’s total authorized and unissued shares currently available. As a result of the amendments, the requirement to classify certain of the warrants as derivative liabilities was eliminated and the liability was reclassified to stockholders’ equity in the third quarter of 2007. Due to the decrease in the underlying fair value of the derivative instruments from July 1, 2007 to July 26, 2007, the Company recorded income during the third quarter of 2007 of approximately $2.9 million.

 

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

We offer a broad portfolio of proprietary information technology products and services targeted to the payer industry, which is comprised of health insurance plans and third party benefits administrators. We offer enterprise claims administration software, including Facets Extended Enterprise™ and QicLink Extended Enterprise™, and enterprise cost and quality of care software, including Clinical CareAdvance™ and Personal CareAdvance™, our NetworX™ suite for provider network management, and recently acquired QNXT™ for consumer retail health solutions. The Company also provides a number of component software solutions and add-ons to the enterprise software solutions, including CDH Account Management, Workflow, HealthWeb® and Benefit Cost Modeler. In addition, in connection with the recent acquisition of PDM, we provide business solutions for Medicare Advantage, Detection and Recovery Services and Healthcare Informatics. To support these software products, the Company provides software hosting services and business process outsourcing services, giving customers variable cost alternatives to licensing software, as well as strategic, implementation and optimization consulting services. We serve 357 unique customers in the health plan and benefits administrator markets, which we collectively refer to as payers. In the second quarter of 2007, these markets represented 91% and 9% of our total revenue, respectively.

We measure financial performance by monitoring revenue, bookings, backlog and net income. Total revenue in the second quarter of 2007 was $114.8 million compared to $87.7 million for the same period in 2006. Services and other revenue in the second quarter of 2007 was $91.4 million compared to $69.8 million for the same period in 2006. Products revenue in the second quarter of 2007 was $23.4 million compared to $17.9 million for the same period in 2006. Bookings in the second quarter of 2007 were $93.8 million compared to $78.6 million for the same period in 2006. Backlog at June 30, 2007 was $944.4 million compared to $717.5 million at June 30, 2006. Net income in the second quarter of 2007 was $3.6 million compared to $6.4 million for the same period in 2006. These financial comparisons are further explained in the section below, “Results of Operations.”

We generate services revenue from several sources, including the provision of outsourcing services, such as software hosting and business process outsourcing services, the sale of maintenance and support for our proprietary and certain of our non-proprietary software products, and from consulting fees for implementation, installation, configuration, business process engineering, data conversion, testing and training related to the use of our proprietary, and third-party licensed products. We generate products revenue from the licensing of our software. Cost of revenue includes costs related to the products and services we provide to our customers and costs associated with the operation and maintenance of our customer connectivity centers. These costs include salaries and related expenses for consulting personnel, customer connectivity centers’ personnel, customer support personnel, application software license fees, amortization of capitalized software development costs, telecommunications costs, facility costs, and maintenance costs. Research and development (“R&D”) expenses are salaries and related expenses associated with the development of software applications prior to establishing technological feasibility. Such expenses include compensation paid to software engineering personnel and other administrative, infrastructure and facility expenses and fees to outside contractors and consultants. Selling, general and administrative expenses consist primarily of salaries and related expenses for sales, sales commissions, account management, marketing, administrative, finance, legal, human resources and executive personnel, and fees for certain professional services.

As part of our growth strategy, we intend to increase revenue per customer by continuing to introduce new complementary products and services, including new cost and quality of care products and services, to our established enterprise software and hosting and business process outsourcing services. Some of these service offerings, including hosting, business process outsourcing, and consulting have a higher cost of revenue, resulting in lower gross profit margins. Therefore, to the extent that our revenue increases through the sale of these lower margin product and service offerings, our total gross profit margin may decrease.

We are continuing to target larger health plan customers. This has given us the opportunity to sell additional services such as software hosting, business intelligence, and business process outsourcing services. As the technology requirements of our customers become more sophisticated, our service offerings have become more complex. This has lengthened our sales cycles and made it more difficult for us to predict the timing of our software and services sales.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Those estimates are based on our experience, terms of existing contracts, observance of trends in the industry, information provided by our customers and information available from other outside sources, which are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

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The following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements, and may potentially result in materially different results under different assumptions and conditions. We have identified the following as critical accounting policies to our company:

 

   

Revenue recognition;

 

   

Up-front payments to customers;

 

   

Sales returns and allowance for doubtful accounts;

 

   

Capitalization of software development costs;

 

   

Goodwill and other intangible assets;

 

   

Litigation accruals;

 

   

Self-insurance;

 

   

Bonus accrual;

 

   

Income taxes; and

 

   

Stock-based compensation.

This listing is not a comprehensive list of all of our accounting policies. For a detailed discussion on the application of these and other accounting policies, see Note 2 of Notes to Consolidated Financial Statements in our annual Form 10-K filed with the Securities and Exchange Commission on March 16, 2007.

Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, the product or service has been delivered, fees are fixed or determinable, collection is reasonably assured and all other significant obligations have been fulfilled. Our revenue is classified into two categories: services and other, and products. For the quarter ended June 30, 2007, approximately 80% of our total revenue was generated from services and other revenue and 20% was from products revenue.

We follow the provisions of the Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition,” AICPA Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended, EITF Issue 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,” and EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables.”

We generate services and other revenue from several sources, including the provision of outsourcing services, such as software hosting and other business services, and the sale of maintenance and support for our proprietary software products. We apply EITF 00-3 to hosting arrangements that include the licensing of software. A software element covered by SOP 97-2 is present in a hosting arrangement if the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software. Outsourcing services revenue is typically billed and recognized monthly over the contract term, generally three to seven years. Many of our outsourcing agreements require us to maintain a certain level of operating performance. We record revenue net of estimated penalties resulting from any failure to maintain the level of operating performance. These penalties have not been significant in the past. Software maintenance and support revenues are typically based on one-year renewable contracts and are recognized ratably over the contract period. Payment for software maintenance received in advance is recorded on the balance sheet as deferred revenue. Certain royalty costs paid to third-party software vendors associated with software maintenance are amortized over the software maintenance period.

We also generate services and other revenue from consulting fees for implementation, installation, configuration, business process engineering, data conversion, testing and training related to the use of our proprietary and third party licensed products. In certain instances, we also generate services revenue from customization services of our proprietary licensed products. We recognize revenue for these services as they are performed. When we cannot reasonably estimate the cost to complete, we recognize revenue using the completed contract method, upon completion of all contractual obligations. We also generate services revenue from set-up fees, which are services, hardware, and software associated with preparing our customer connectivity center or a customer’s data center in order to ready a specific customer for software hosting services. The set-up fees are usually separate and distinct from the hosting fees, and performance of the set-up services represents the culmination of the earnings process. We recognize revenue for these services as they are performed. We generate other

 

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revenue from certain one-time charges, including certain contractual fees such as termination fees and change of control fees, and we recognize the revenue for these fees once the termination or change of control is guaranteed, there are no remaining substantive performance obligations and collection is reasonably assured. Other revenue is also generated from fees related to our product-related customer conferences.

For multiple element arrangements, such as software license, consulting services, outsourcing services and maintenance, and where vendor-specific objective evidence (“VSOE”) of fair value exists for all undelivered elements, we account for the delivered elements in accordance with the “residual method.” VSOE of fair value is determined for each undelivered element based on how it is sold separately, or in the case of maintenance, the renewal rate. For arrangements in which VSOE does not exist for each undelivered element, including specified product and upgrade rights, revenue for the delivered element is deferred and not recognized until VSOE is available for the undelivered element or delivery of each element has occurred. In determining VSOE for the undelivered elements, no portion of the discount is allocated to specified or unspecified product or upgrade rights.

Under the residual method, the arrangement fee is recognized as follows: (1) the total fair value of the undelivered elements, as indicated by VSOE, is deferred and subsequently recognized in accordance with the relevant sections of SOP 97-2 and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements.

We generate products revenue from the licensing of our software. Under SOP 97-2, software license revenue is recognized upon the execution of a license agreement, upon delivery of the software, when fees are fixed or determinable, when collectibility is probable and when all other significant obligations have been fulfilled. For software license agreements in which customer acceptance is a significant condition of earning the license fees, revenue is not recognized until acceptance occurs. For software license agreements that require significant customization or modification of the software, revenue is recognized as the customization services are performed. For software license arrangements that include a right to use the product for a defined period of time, revenue is recognized over the term of the license.

Up-front Payments to Customers. We may pay certain up-front amounts to our customers in connection with the establishment of our hosting and outsourcing services contracts. Under EITF 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products),” these payments are capitalized and amortized over the life of the contract as a reduction to revenue, provided that such amounts are recoverable from future revenue under the contract. If an up-front payment is not recoverable from future revenue, or it cannot be offset by contract cancellation penalties paid by the customer, the amount will be expensed in the period it is deemed unrecoverable. Unamortized up-front fees were $5.5 million and $6.9 million as of June 30, 2007 and 2006, respectively.

Sales Returns and Allowance for Doubtful Accounts. We maintain an allowance for sales returns and doubtful accounts to reserve for estimated discounts, pricing adjustments, and other sales allowances. The reserve is charged to revenue in amounts sufficient to maintain the allowance at a level we believe is adequate based on historical experience and current trends. We also maintain an allowance for doubtful accounts to reflect estimated losses resulting from the inability of customers to make required payments. We base this allowance on estimates after consideration of factors such as the composition of the accounts receivable aging and bad debt history and our evaluation of the financial condition of the customers. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional sales allowances and bad debt expense may be required. We typically do not require collateral. Historically, our estimates for sales returns and doubtful account reserves have been adequate to cover accounts receivable exposures. We continually monitor these reserves and make adjustments to these provisions when we believe actual credits or other allowances may differ from established reserves.

Capitalization of Software Development Costs. The capitalization of software costs includes developed technology acquired in acquisitions and costs incurred by us in developing our products that qualify for capitalization. We account for our software development costs, other than costs for internal-use software, in accordance with FASB Statement No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” We capitalize costs associated with product development, coding and testing subsequent to establishing technological feasibility of the product. Technological feasibility is established after completion of a detailed program design or working model. Capitalization of computer software costs ceases upon a product’s general availability release. Capitalized software development costs are amortized over the estimated useful life of the software product starting from the date of general availability.

On a quarterly basis, we monitor the expected net realizable value of the capitalized software for factors that would indicate impairment, such as a decline in the demand, the introduction of new technology, or the loss of a significant customer. As of June 30, 2007, our evaluation determined that the carrying amount of these assets was not impaired.

 

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Goodwill and Other Intangible Assets. Acquisitions are accounted for using the purchase method of accounting. The purchase price is allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their estimated fair market values on the acquisition date. The excess of the purchase price over the estimated fair market value of the assets purchased and liabilities assumed is allocated to goodwill and other intangible assets.

Under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets deemed to have indefinite lives are subject to annual (or more often if indicators of impairment exist) impairment tests using a two-step process. The first step looks for indicators of impairment. If indicators of impairment are revealed in the first step, then the second step is conducted to measure the amount of the impairment, if any. We performed our annual impairment test on March 31, 2007, and this test did not reveal indications of impairment.

Litigation Accruals. Pending unsettled lawsuits involve complex questions of fact and law and may require expenditure of significant funds. From time to time, we may enter into confidential discussions regarding the potential settlement of such lawsuits; however, there can be no assurance that any such discussions will occur or will result in a settlement. Moreover, the settlement of any pending litigation could require us to incur settlement payments and costs. In the period in which a new legal case arises, an expense will be accrued if our liability to the other party is probable and can be reasonably estimated. On a quarterly basis, we review and analyze the adequacy of our accruals for each individual case for all pending litigations. Adjustments are recorded as needed to ensure appropriate levels of reserve. Our attorney fees and other defense costs related to litigation are expensed as incurred.

Self-Insurance. Effective January 1, 2006, we became self-insured for certain losses related to employee health and dental benefits. We record a liability based on an estimate of claims incurred but not recorded determined based on actuarial analysis of historical claims experience and historical industry data. We maintain individual and aggregate stop-loss coverage with a third party insurer to limit our total exposure for these programs. Our self-insurance liability contains uncertainties because the calculation requires management to make assumptions and apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date. We do not believe that there is a reasonable likelihood that there will be a material change in the future assumptions or estimates we use to calculate our self-insurance liability. However, if actual results are not consistent with our assumptions and estimates, we may be exposed to losses or gains that could be material.

Bonus Accrual. Our bonus model is designed to project the level of funding required under the bonus program as approved by the Compensation Committee of the Board of Directors. A significant portion of the bonus program is based on the Company meeting certain financial objectives, such as revenue, earnings per share, and the level of capital spending. The expense related to the bonus program is accrued in the year of performance and paid in the first quarter following the fiscal year end. The bonus model is analyzed and adjusted on a quarterly basis as necessary based on achievement of targets.

Income Taxes. We account for income taxes under FASB Statement No. 109, “Accounting for Income Taxes.” This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in our financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of our assets and liabilities result in a deferred tax asset, FASB Statement No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such an asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or the entire deferred tax asset will not be realized.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 applies to all tax positions accounted for under SFAS No. 109, “Accounting for Income Taxes,” and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained then no benefits of the position are to be recognized. FIN 48 requires additional disclosures and is effective as of the beginning of the first fiscal year beginning after December 15, 2006. On January 1, 2007, we adopted FIN 48 Accounting for Uncertainty in Income Taxes.

Stock-Based Compensation. Effective January 1, 2006, we adopted the fair value recognition provisions of FASB Statement No. 123R, “Share-Based Payment,” using the modified prospective transition method, and therefore have not restated prior periods’ results. Under this method, we recognize compensation expense for all share-based payments granted after January 1, 2006 and for all share-based payments granted prior to, but not yet vested as of, January 1, 2006. Under the fair value recognition provisions of FASB Statement No. 123R, stock-based compensation cost is estimated at the grant date based on the award’s fair-value and is recognized as expense ratably over the requisite service period. We use the Black-Scholes option-pricing model to calculate fair value which requires the input of highly subjective assumptions. These

 

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assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation could be materially different in the future. In addition, if our actual forfeiture rate is materially different from our estimate, stock-based compensation expense could be significantly different from what we have recorded in the current period.

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 applies to all tax positions accounted for under SFAS No. 109, “Accounting for Income Taxes,” and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained then no benefits of the position are to be recognized. FIN 48 requires additional disclosures and is effective as of the beginning of the first fiscal year beginning after December 15, 2006.

On January 1, 2007, we adopted FIN 48. In connection with the adoption of FIN 48, we recorded increases to goodwill and deferred tax assets of $1.3 million and $700,000, respectively, and reclassified $700,000 from accrued liabilities to other long-term liabilities. The adoption of FIN 48 did not impact the January 1, 2007 balance of retained earnings. As of the date of adoption, we had $7.1 million of unrecognized tax benefits, of which $1.8 million would reduce our effective tax rate if recognized. The difference primarily relates to: (a) unrecognized tax benefit amounts arising from business combinations that, if recognized, would be recorded to goodwill, and (b) unrecognized tax benefit amounts associated with temporary differences and carryforwards.

Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2007, we have recorded approximately $335,000 of accrued interest and penalties related to uncertain tax positions.

At January 1, 2007, our December 31, 2003 through December 31, 2006 tax years remain open to examination by the tax authorities. However, we have consolidated and acquired NOL’s beginning in tax years December 31, 1995 which would cause the statute of limitations to remain open for the year in which the NOL was incurred.

 

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Revenue Information

Revenue by customer type and revenue mix for the three and six months ended June 30, 2007, and 2006, respectively, is as follows (amounts in thousands):

 

    

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
     2007     2006     2007     2006  

Revenue by customer type:

                    

Health plans

   $ 104,740    91 %   $ 78,673    90 %   $ 209,031    92 %   $ 155,067    90 %

Benefits administration

     10,095    9 %     9,037    10 %     19,307    8 %     17,961    10 %
                                                    

Total revenue

   $ 114,835    100 %   $ 87,710    100 %   $ 228,338    100 %   $ 173,028    100 %
                                                    

Revenue mix:

                    

Services and other revenue

                    

Outsourced business services

   $ 23,273    20 %   $ 21,426    24 %   $ 47,441    21 %   $ 43,988    25 %

Software maintenance

     30,755    27 %     22,251    25 %     60,568    26 %     43,399    25 %

Consulting services and other

     37,404    33 %     26,116    30 %     73,198    32 %     48,178    28 %
                                    

Services and other revenue total

     91,432        69,793        181,207        135,565   
                                    

Products revenue

                    

Software license fees

     23,403    20 %     17,917    21 %     47,131    21 %     37,463    22 %
                                                    

Total revenue

   $ 114,835    100 %   $ 87,710    100 %   $ 228,338    100 %   $ 173,028    100 %
                                                    

Our total backlog is defined as the revenue we expect to generate in future periods from existing customer contracts. Our 12-month backlog is defined as the revenue we expect to generate from existing customer contracts over the next 12 months. Most of the revenue in our backlog is derived from multi-year service revenue contracts (including software hosting, business process outsourcing, IT outsourcing, and software maintenance with periods up to seven years) and consulting contracts. Consulting revenue is included in the backlog when the revenue from such consulting contract is expected to be recognized over a period exceeding 12 months.

Backlog can change due to a number of factors, including unforeseen changes in implementation schedules, contract cancellations (subject to penalties paid by the customer), or customer financial difficulties. In such event, unless we enter into new customer agreements that generate enough revenue to replace or exceed the revenue we expect to generate from our backlog in any given quarter, our backlog will decline. Our backlog at any date may not indicate demand for our products and services and may not reflect actual revenue for any period in the future. Our 12-month and total backlog data are as follows (in thousands):

 

     6/30/07    3/31/07    12/31/06    9/30/06    6/30/06

12-month backlog

   $ 229,000    $ 236,700    $ 213,300    $ 191,600    $ 186,100
                                  

Total backlog

   $ 944,400    $ 964,800    $ 858,200    $ 747,800    $ 717,500
                                  

Total quarterly bookings equal the estimated total dollar value of the contracts signed in the quarter. Bookings can vary substantially from quarter to quarter, based on a number of factors, including the number and type of prospects in our pipeline, the length of time it takes a prospect to reach a decision and sign the contract, and the effectiveness of our sales force. Included in quarterly bookings are up to seven years of maintenance revenue and hosting and other services revenue. Bookings for each of the quarters are as follows (in thousands):

 

     6/30/07    3/31/07    12/31/06    9/30/06    6/30/06

Quarterly bookings

   $ 93,800    $ 99,900    $ 139,700    $ 75,900    $ 78,600
                                  

 

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RESULTS OF OPERATIONS

Quarter Ended June 30, 2007 Compared to the Quarter Ended June 30 2006.

Revenue. Total revenue increased $27.1 million, or 31%, to $114.8 million in the second quarter of 2007 from $87.7 million for the same period in 2006. Of this increase, $21.6 million related to services and other revenue and $5.5 million related to products revenue.

Services and Other Revenue. Services and other revenue includes outsourced business services (primarily software hosting and business process outsourcing), maintenance fees related to our software license contracts, consulting services and other revenue. Services and other revenue increased $21.6 million, or 31%, to $91.4 million in the second quarter of 2007 from $69.8 million for the same period in 2006, which includes the impact of the PDM and QCSI acquisitions. This increase was the result of an $11.3 million increase in consulting services and other revenue, an $8.5 million increase in software maintenance revenue, and an increase of $1.8 million in outsourced business services. The increase in consulting services and other revenue was due primarily to new Facets®, NetworX™ and QNXT™ implementations. The increase in software maintenance revenue was attributable primarily to new agreements for certain Facets®, NetworX™, HealthWeb®, CareAdvance™ and QNXT™ customers, as well as annual rate increases from existing customers. The increase in outsourced business services revenue was primarily due to new Facets®, NetworX™, HealthWeb® and CareAdvance™ hosted customers and increased membership from existing customers.

Products Revenue. Products revenue, which includes software license sales, increased $5.5 million, or 31%, to $23.4 million in the second quarter of 2007, which includes the impact of the QCSI acquisition, from $17.9 million for the same period in 2006. The increase was due primarily to new license sales of our QNXT™ software product.

Cost of Revenue—Services and Other. Cost of revenue for services and other increased $8.9 million, or 21%, to $50.9 million in the second quarter of 2007 from $42.0 million for the same period in 2006 to support the increase in our outsourced business services, software maintenance, and consulting services and other revenue.

Cost of revenue for outsourced business services and software maintenance revenue increased approximately $2.9 million, primarily attributable to a $1.0 million increase in utilization of outside consultants, higher compensation costs of approximately $700,000, a $600,000 increase in telecommunication costs and a $600,000 net increase in other costs. Increased fees from outside consultants were attributable to a higher utilization of external resources for product support services. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option and award grants. Telecommunication costs were also impacted by increased headcount as well as increased spending related to customer connectivity. The increase in other costs was due primarily to an overall net increase in other employee related expenses, postage and freight, and facilities related expenses, offset by a slight decrease in investment in infrastructure and technology costs.

Cost of revenue for consulting services and other revenue increased $6.0 million, primarily attributable to higher compensation costs of $2.6 million, a $2.0 million increase in outside services, increased travel costs of $1.2 million, and a net increase in other costs of approximately $200,000. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. The increase in outside services was primarily attributable to higher utilization of outside consultants on implementation projects. The overall increase in travel costs were also impacted by increased headcount and the increased level of implementation projects. The increase in other costs primarily included a net increase in other employee related expenses and facilities related expenses, slightly offset by a decrease in investment in infrastructure and technology costs.

As a percentage of total revenue, cost of revenue for services and other approximated 56% in the second quarter of 2007 compared with 60% for the same period in 2006.

Cost of Revenue—Products. Cost of revenue for products, which excludes the amortization of acquired technology, increased $1.6 million or 48%, to $4.8 million in the second quarter of 2007 from $3.2 million for the same period in 2006 to support the increase in our software license sales. The overall increase was due primarily to higher compensation costs of $800,000, an increase of $500,000 in amortization of capitalized software development costs and a $300,000 increase in other costs. Higher compensation and related costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, and the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option and award grants. The increase in amortization of capitalized software development costs resulted from the release for sale of new versions of certain of our proprietary software products over the past year. The increase in other costs primarily included

 

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an overall increase in depreciation expense, facility-related costs and increased travel costs, offset by a decrease in investment in infrastructure and technology costs. As a percentage of total revenue, cost of revenue for products approximated 20% in the second quarter of 2007 compared with 18% for the same period in 2006.

Research and Development (R&D) Expenses. R&D expenses increased $5.7 million, or 53%, to $16.4 million in the second quarter of 2007 from $10.7 million for the same period in 2006. The overall increase in R&D expenses was due primarily to $3.7 million in higher compensation costs, $1.1 million in higher utilization of outside consultants, increased investment in infrastructure and technology costs of $400,000 and a $500,000 increase in other costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. The increase in utilization of outside consultants is primarily attributed to the development of QNXT™ and continued development of our existing proprietary software. Higher infrastructure and technology costs resulted from increased purchases of computer equipment and supplies. The increase in other costs was due primarily to an overall increase in facility-related costs and travel. As a percentage of total revenue, R&D expenses approximated 14% in the second quarter of 2007 compared with 12% for the same period in 2006. R&D expenses, as a percentage of total R&D expenditures (which includes capitalized R&D expenses of $2.1 million in the second quarter of 2007 and $2.3 million for the same period in 2006), was 89% in the second quarter of 2007 compared with 82% for the same period in 2006.

Selling, General and Administrative (SG&A) Expenses. SG&A expenses increased $4.8 million, or 20%, to $28.8 million in the second quarter of 2007 from $24.0 million for the same period in 2006. The overall increase resulted primarily from higher compensation and related costs of $3.6 million, a $1.0 million increase in sales and marketing related expenses, a $900,000 increase in professional services and outsourced consultants, an increase in bad debt expense of $600,000, a $500,000 increase in overall travel costs, and an increase of $500,000 in depreciation expense. These increases were offset by a decrease of approximately $2.3 million in legal costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. Professional services and outsourced consultants increased due primarily to consulting services provided for corporate and market strategy. Bad debt expense increased due primarily to additional reserves required for outstanding invoices. Travel costs were impacted by increased headcount, an increase in employee meetings for strategic planning, and conferences and trade shows held in the second quarter of 2007. The increase in depreciation is primarily due to the acquisition of assets and increased computer hardware and software purchases. Higher infrastructure and technology costs were driven primarily by support for internal growth and upgrades. The decrease in legal fees was primarily attributed to defense costs accrued in the second quarter of 2006 for the McKesson litigation which was settled in the third quarter of 2006. As a percentage of total revenue, selling, general and administrative expenses approximated 25% in the second quarter of 2007 compared with 27% for the same period in 2006. The increase in other costs primarily included an increase in bad debt expense and an overall increase in travel.

Amortization of Intangible Assets. Amortization of intangible assets is comprised of acquired technology and acquired other intangible assets. In total, amortization of intangible assets increased $1.5 million, or 143%, to $2.6 million in the second quarter of 2007 from $1.1 million for the same period in 2006.

Amortization of Acquired Technology. The amortization of acquired technology is excluded from cost of revenue – products and consists primarily of amounts amortized with respect to core or completed technology and existing software. Amortization of acquired technology increased $300,000, or 32%, to $1.2 million in the second quarter of 2007 from $940,000 for the same period in 2006. The increase was due to the amortization of acquired technology from the acquisitions of PDM and QCSI, which was slightly offset by a decrease resulting from the adjustment of CareKey acquired technology based on the final valuation determined in the third quarter of 2006.

Amortization of Acquired Other Intangible Assets. Amortization of acquired other intangible assets increased $1.3 million, or 963%, to $1.4 million in the second quarter of 2007 from $128,000 for the same period in 2006. The increase was due primarily to acquired other intangible assets from the acquisitions of PDM and QCSI. This increase was slightly offset by a decrease resulting from the adjustment of CareKey acquired other intangibles based on the final valuation determined in the third quarter of 2006.

Interest Income. Interest income increased $1.9 million, or 197%, to $2.8 million in the second quarter of 2007 from $945,000 for the same period in 2006. The increase was due primarily to higher cash balances in our investment accounts resulting from the proceeds received on the 2012 convertible notes and borrowings from the term loan.

 

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Interest Expense. Interest expense increased $2.7 million, or 317%, to $3.5 million in the second quarter of 2007 from $835,000 for the same period in 2006. The increase is due primarily to a $1.5 million increase related to borrowings from the term loan and revolving line of credit and a $1.0 million increase related to the 2012 convertible.

Change in Fair Value of Derivative Liabilities. The change in fair value of derivative liabilities was $2.5 million in the second quarter of 2007 resulting from derivative liabilities in connection with our 2012 convertible notes entered into in April 2007. Derivative liabilities are presented at fair value and are marked to market each period with changes in the fair value recorded in earnings.

Provision for Income Taxes. Provision for income taxes was $4.5 million in the second quarter of 2007 compared to $356,000 for the same period in 2006. The provision increase is due primarily to the fact that as of January 1, 2007, the Company’s valuation allowance, which was available to offset the provision for income taxes as it reversed in 2006, was eliminated. The effective tax rate was 55.4% for the second quarter of 2007 compared with 5.3% for the same period in 2006.

Six Months Ended June 30, 2007 Compared to the Six Months Ended June 30 2006.

Revenue. Total revenue increased $55.3 million, or 32%, to $228.3 million in the first six months of 2007 from $173.0 million for the same period in 2006. Of this increase, $45.6 million related to services and other revenue and $9.7 million related to products revenue.

Services and Other Revenue. Services and other revenue includes outsourced business services (primarily software hosting and business process outsourcing), maintenance fees related to our software license contracts, consulting services and other revenue. Services and other revenue increased $45.6 million, or 34%, to $181.2 million in the first six months of 2007 from $135.6 million for the same period in 2006, which includes the impact of the PDM and QCSI acquisitions. This increase was the result of a $25.0 million increase in consulting services and other revenue, a $17.2 million increase in software maintenance revenue, and an increase of $3.4 million in outsourced business services. The increase in consulting services and other revenue was due primarily to new Facets®, NetworX™ and QNXT™ implementations. The increase in software maintenance revenue was attributable primarily to new agreements for certain Facets®, NetworX™, HealthWeb®, CareAdvance™ and QNXT™ customers, as well as annual rate increases from existing customers. The increase in outsourced business services revenue was primarily due to new Facets®, NetworX™, HealthWeb® and CareAdvance™ hosted customers and increased membership from existing customers.

Products Revenue. Products revenue, which includes software license sales, increased $9.6 million, or 26%, to $47.1 million in the first six months of 2007, which includes the impact of the QCSI acquisition, from $37.5 million for the same period in 2006. The increase was due primarily to new license sales of our QNXT™ software product.

Cost of Revenue – Services and Other. Cost of revenue for services and other increased $18.7 million, or 23%, to $101.0 million in the first six months of 2007 from $82.3 million for the same period in 2006 to support the increase in our outsourced business services, software maintenance, and consulting services and other revenue.

Cost of revenue for outsourced business services and software maintenance revenue increased approximately $6.8 million, primarily attributable to higher compensation costs of $3.6 million, a $1.5 million increase in utilization of outside consultants, a $1.1 million increase in telecommunications expense and a $600,000 net increase in other costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases and an increase in SFAS 123R expense related to stock option and award grants. Increased fees from outside consultants were attributable to a higher utilization of external resources for product support services. Telecommunication costs were impacted by increased spending related to customer connectivity and employee telecom equipment. The increase in other costs included an overall net increase in postage and freight, facilities related expenses and other employee related expenses. These costs were offset in part by a decrease in depreciation expense related primarily to fully depreciated assets and a lower mix of equipment with longer estimated useful lives, offset in part by depreciation for new additions in the first six months of 2007, primarily related to the acquisitions of PDM and QCSI.

Cost of revenue for consulting services and other revenue increased $11.9 million, primarily attributable to higher compensation costs of $5.1 million, a $4.2 million increase in outside services, increased travel costs of $2.4 million and a $200,000 increase in other costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. The increase in outside services was primarily attributable to higher utilization of outside consultants on implementation projects. The overall increase in travel costs were also impacted by increased headcount and the increased level of implementation projects. The increase in other costs primarily included facilities related expenses and employee relocation, recruiting and other employee related expenses.

 

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As a percentage of total revenue, cost of revenue for services and other approximated 56% in the first six months of 2007 compared with 61% for the same period in 2006.

Cost of Revenue—Products. Cost of revenue for products, which excludes the amortization of acquired technology, increased $2.3 million, or 30%, to $10.0 million in the first six months of 2007 from $7.7 million for the same period in 2006 to support the increase in our software license sales. The overall increase was due primarily to higher compensation costs of $2.8 million, an increase of $800,000 in amortization of capitalized software development costs and a $900,000 increase in other costs. These increases were partly offset by a $2.2 million decrease in royalty expense and decreased investment in infrastructure and technology. Higher compensation and related costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, and the impact of the 2007 annual merit increases. The increase in amortization of capitalized software development costs resulted from the release for sale of new versions of certain of our proprietary software products over the past year. The increase in other costs included an overall increase in depreciation expense, facility-related costs and travel. The decrease in royalty expense was due primarily to the termination of a pre-existing royalty agreement with CareKey, as well as a decrease related to existing royalty agreements with various clients. Investment in infrastructure and technology was impacted primarily from purchases of hardware for client resale. As a percentage of total revenue, cost of revenue for products approximated 21% in the first six months of 2007 and 2006.

Research and Development (R&D) Expenses. R&D expenses increased $11.0 million, or 52% to $32.2 million in the first six months of 2007 from $21.2 million for the same period in 2006. The overall increase in R&D expenses was due primarily to $6.7 million in higher compensation costs, $2.3 million in higher utilization of outside consultants, increased investment in infrastructure and technology costs of $900,000, and a $1.1 million increase in other costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases, and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. The increase in utilization of outside consultants is primarily attributed to the development of QNXT™. Higher infrastructure and technology costs resulted from increased purchases of computer equipment and supplies. The increase in other costs included an overall increase in facility-related costs, an increase in travel and an increase in telecommunication expense. As a percentage of total revenue, R&D expenses approximated 14% in the first six months of 2007 compared with 12% for the same period in 2006. R&D expenses, as a percentage of total R&D expenditures (which includes capitalized R&D expenses of $3.8 million in the first six months of 2007 and $4.6 million for the same period in 2006), was 89% in the first six months of 2007 compared with 82% for the same period in 2006.

Selling, General and Administrative (SG&A) Expenses. SG&A expenses increased $10.8 million, or 24%, to $56.1 million in the first six months of 2007 from $45.3 million for the same period in 2006. The overall increase resulted primarily from higher compensation and related costs of $8.4 million, a $1.9 million increase in outsourced consultants and professional services, a $1.1 million increase in investment and infrastructure and technology costs, an increase of $1.1 million in depreciation expense, a $900,000 increase in travel, an $800,000 increase in sales and marketing related expenses, and a $300,000 increase in other costs. These increases were slightly offset by a decrease of approximately $3.7 million in legal costs. Higher compensation costs were impacted by increased headcount, resulting from the acquisition of PDM and QCSI, the impact of the 2007 annual merit increases and an increase in SFAS 123R expense related to stock option grants and restricted stock awards. Professional services and outsourced consultants increased due primarily to higher audit, internal audit and tax fees, in addition to consulting services provided for corporate and market strategy. Higher infrastructure and technology costs were driven primarily by support for internal initiatives and upgrades. The increase in depreciation is primarily due to the acquisition of assets from PDM and QCSI, in addition to leasehold improvements related to expansion projects completed in late 2006 for some of our existing facilities. Travel costs were impacted by increased headcount, an increase in employee meetings for strategic planning, and conferences and trade shows held in the first six months of 2007. Sales and marketing related expenses also increased due to conferences and trade shows held in the first six months of 2007. The increase in other expense included investment in infrastructure and technology, telecommunications expense and bad debt expense. The decrease in legal fees was primarily attributed to defense costs accrued in the first six months of 2006 for the McKesson litigation which was settled in the third quarter of 2006. As a percentage of total revenue, selling, general and administrative expenses approximated 25% in the first six months of 2007 compared with 26% for the same period in 2006.

Amortization of Intangible Assets. Amortization of intangible assets is comprised of acquired technology and acquired other intangible assets. In total, amortization of intangible assets increased $3.0 million, or 118%, to $5.6 million in the first six months of 2007 from $2.6 million for the same period in 2006.

Amortization of Acquired Technology. The amortization of acquired technology is excluded from cost of revenue – products and consists primarily of amounts amortized with respect to core or completed technology and existing software. Amortization of acquired technology increased approximately $700,000, or 37%, to $2.9 million in the first six months of 2007 from $2.2 million for the same period in 2006. The increase was due to the amortization of acquired technology from the acquisitions of PDM and QCSI, which was slightly offset by a decrease resulting from the adjustment of CareKey acquired technology based on the final valuation determined in the third quarter of 2006.

 

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Amortization of Acquired Other Intangible Assets. Amortization of acquired other intangible assets increased $2.3 million, or 532%, to $2.7 million in the first six months of 2007 from $421,000 for the same period in 2006. The increase was due primarily to acquired other intangible assets from the acquisitions of PDM and QCSI. This increase was slightly offset by a decrease resulting from the adjustment of CareKey acquired other intangibles based on the final valuation determined in the third quarter of 2006 and certain intangible assets acquired in previous years, which were fully amortized in the first six months of 2006.

Interest Income. Interest income increased $1.7 million, or 94%, to $3.6 million in the first six months of 2007 from $1.8 million for the same period in 2006. The increase was due primarily to higher cash balances in our investment accounts resulting from the proceeds received on the 2012 convertible notes and borrowings from the term loan.

Interest Expense. Interest expense increased $4.4 million, or 267%, to $6.1 million in the first six months of 2007 from $1.7 million for the same period in 2006. The increase is due primarily to a $3.2 million increase related to borrowings from the term loan and revolving line of credit and a $900,000 increase related to the 2012 convertible

Change in Fair Value of Derivative Liabilities. The change in fair value of derivative liabilities was $2.5 million in the first six months of 2007 resulting from derivative liabilities in connection with our 2012 convertible notes entered into in April 2007. Derivative liabilities are presented at fair value and are marked to market each period with changes in the fair value recorded in earnings.

Other Income. Other income decreased $180,000 due to the gain on sale of an internet domain name in the first six months of 2006.

Provision for Income Taxes. Provision for income taxes was $8.9 million in the first six months of 2007 compared to approximately $950,000 for the same period in 2006. The provision increase is due primarily to the fact that as of January 1, 2007, the Company’s valuation allowance, which was available to offset the provision for income taxes as it reversed in 2006, was eliminated. The effective tax rate was 48.2% for the first six months of 2007 compared with 6.7% for the same period in 2006.

LIQUIDITY AND CAPITAL RESOURCES

Capital Resources

As of June 30, 2007, the following sources of cash available to fund our operations include cash and cash equivalents totaling $203.8 million, including $1.7 million restricted cash, and short-term investments of $53.1 million. Our principal sources of liquidity include cash from operations, borrowings under our debt facility, proceeds from the issuance of convertible debt, cash obtained from our acquisitions, employee exercises of stock options and private financings, described as follows:

 

   

In October 2005, we issued $100.0 million aggregate principal amount of 2.75% Convertible Senior Notes due 2025 (the “2025 Notes”). The 2025 Notes are convertible into shares of our common stock at an initial conversion price of $18.85 per share, or 53.0504 shares for each $1,000 principal amount of 2025 Notes, subject to certain adjustments. The maximum conversion rate is 68.9655 shares for each $1,000 principal amount of 2025 Notes. The 2025 Notes bear interest at a rate of 2.75%, which is payable in cash semi-annually.

 

   

In January 2007, we amended and restated our Credit Agreement, initially established December 21, 2004, to add a term loan of up to $150.0 million and to extend the expiration date of the Credit Agreement, including our $100.0 million revolving credit facility, to January 5, 2011. As of June 30, 2007, we had outstanding borrowings on the revolving line of credit of $17.0 million and were in compliance with all applicable covenants and other restrictions under the Credit Agreement. In January 2007, we borrowed $75.0 million under the term loan to help fund our acquisition of QCSI. We can borrow up to an additional $75.0 million under the term loan through and including October 1, 2007, at which time no additional funds can be borrowed under the term loan.

 

   

In April 2007, we issued $230.0 million aggregate principal amount, including $30.0 million to cover over-allotments, of 1.125% Convertible Senior Notes due 2012 (the “2012 Notes”). The 2012 Notes are convertible, at the holder’s option in certain circumstances, into common stock of the Company at an initial conversion rate of 45.5114 shares of the Company’s common stock per $1,000 principal amount of 2012 Notes, which is equivalent to an initial conversion price of approximately $21.97. The maximum conversion rate is 53.4759 shares for each $1,000 principal amount of 2012 Notes. The 2012 Notes bear interest at an annual rate of 1.125%.

 

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Based on our current operating plan, we believe that existing cash and cash equivalents balances, short-term investments balances, cash forecasted by management to be generated by operations and borrowings from existing credit facilities will be sufficient to meet our working capital and capital requirements for at least the next 12 months. However, if events or circumstances occur such that we do not meet our operating plan as expected, we may be required to seek additional capital and/or reduce certain discretionary spending, which could have a material adverse effect on our ability to achieve our business objectives. We may seek additional financing, which may include debt and/or equity financing or funding through third party agreements. There can be no assurance that any additional financing will be available on acceptable terms, if at all. Any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants.

Summary of Cash Activities

As of June 30, 2007, we had cash and cash equivalents totaling $203.8 million, which included $1.7 million restricted cash. Significant cash flow activities for the six months ended June 30, 2007 and 2006 are as follows (in thousands):

 

    

Six Months Ended

June 30,

 
     2007     2006  

Cash provided by operating activities

   $ 27,132     $ 11,569  

Purchase of short-term investments

     (53,065 )     —    

Purchase of property and equipment and software licenses

     (9,333 )     (6,252 )

Capitalization of software development costs

     (3,829 )     (4,605 )

Acquisitions, net of cash acquired

     (143,196 )     (42,370 )

Proceeds from revolving line of credit, debt financings and capital leases

     369,759       19,992  

Payments on revolving line of credit, notes payable and capital leases

     (101,191 )     (16,700 )

Employee exercises of stock options and purchase of common stock

     8,728       6,921  

Cash and cash equivalents increased $95.0 million in the first six months of 2007 from $107.1 million at December 31, 2006 to $202.1 million at June 30, 2007. This increase was due primarily to net proceeds of $369.8 million from our revolving line of credit and debt financings (which included $230.0 million from our convertible debt offering in April 2007), cash provided by operating activities of $27.6 million, and $8.7 million in proceeds from employee option exercises and purchase of common stock. These cash inflows were partially offset by cash payments, net of cash acquired, of $143.2 million related to the acquisitions of PDM and QCSI, payments on our debt (including our revolving line of credit) of $101.2 million and $53.1 million in the purchase of short-term investment securities.

Commitments and Contingencies

The following tables summarize our estimated contractual obligations and other commercial commitments as of June 30, 2007 (in thousands):

 

     Payments (including interest) Due by Period

Contractual obligations

   Total   

Less than

1 Year

  

1-3

Years

  

3-5

Years

  

More than 5

Years

Short-term debt

   $ 616    $ 616    $ —      $ —      $ —  

Capital lease obligations

     2,993      1,321      1,304      368      —  

Operating leases

     66,665      14,037      21,883      13,055      17,690

Convertible debt

     393,844      5,338      7,925      240,675      139,906
                                  

Total contractual obligations

   $ 464,118    $ 21,312    $ 31,112    $ 254,098    $ 157,596
                                  
     Amount of Commitment Expiration per Period

Other commercial commitments

  

Total Amounts

Committed

  

Less Than

1 Year

  

1-3

Years

  

3-5

Years

  

More than 5

Years

Line of credit

   $ 17,000    $ —      $ —      $ 17,000    $ —  

Term loan

     89,355      15,716      73,639      —        —  

Standby letters of credit

     1,740      348      1,308      84   
                                  

Total other commercial commitments

   $ 108,095    $ 16,064    $ 74,947    $ 17,084    $ —  
                                  

Convertible debt represents scheduled principal and interest payments for our 2025 Notes and 2012 Notes, which includes $100.0 million and $230.0 million aggregate principal amounts, respectively. The 2025 Notes bear interest at a rate

 

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of 2.75%, which is payable in cash semi-annually in arrears on April 1 and October 1 of each year, and commenced on April 1, 2006, to the holders of record on the preceding March 15 and September 15, respectively. The 2025 Notes mature on October 1, 2025. However, on or after October 5, 2010, we may from time to time at our option redeem the 2025 Notes, in whole or in part, for cash, at the applicable redemption date. Additionally, holders of the 2025 Notes may require us to purchase all or a portion of their 2025 Notes in cash on each of October 1, 2010, October 1, 2015 and October 1, 2020. The 2012 Notes bear interest at a rate of 1.125%, which is payable in cash semi-annually in arrears on April 15 and October 15 of each year, commencing on October 15, 2007, to the holders of record on the preceding April 1 and October 1, respectively. The 2012 Notes mature on April 15, 2012.

As of June 30, 2007, we had outstanding four unused standby letters of credit in the aggregate amount of $1.7 million, which serve as security deposits for certain operating leases. We are required to maintain a cash balance equal to the outstanding letters of credit, which is classified as restricted cash on our balance sheet.

Excluded from the tables above are certain potential payments to CareKey stockholders and optionholders as these payments are contingent upon the achievement of financial milestones and are payable in either cash or stock at our election. CareKey stockholders and optionholders are entitled to receive three contingent consideration payments of $8.3 million each (up to $25.0 million), upon the achievement of certain revenue milestones during the period beginning upon acquisition and ending December 31, 2008. In addition, further consideration payable in cash or stock at our election, may be paid to former CareKey stockholders and optionholders if, prior to December 31, 2008, the acquired CareKey products generate revenues in excess of certain revenue milestones and/or if a negotiated multiple of software maintenance revenues of acquired CareKey products during the fiscal year ended December 31, 2009 exceed total purchase consideration made to those former CareKey stockholders and optionholders.

Also excluded from the tables above are certain potential payments to former PDM and QCSI stockholders and option and warrant holders. In addition to the $8.0 million and 491,488 shares of common stock with the value of $16.28 per share (which represents the average closing price of TriZetto’s common stock for the 20 trading days ending October 27, 2006) paid and issued in January 2007, we paid the former PDM security holders a contingent consideration of approximately $5.2 million, consisting of 149,664 shares of common stock with the value of $19.36 per share (which represents the closing price of TriZetto common stock on June 29, 2007) and cash payments totaling $2.3 million in July 2007. The issuance of the 149,664 shares of common stock and the $2.3 million cash payment were accrued as of June 30, 2007. PDM security holders may also be entitled to receive additional contingent consideration as follows: $5.0 million on or before December 31, 2008 and $8.0 million on or before December 31, 2009, each subject to reduction if certain revenue thresholds are not satisfied during the applicable measurement period or to the extent TriZetto is entitled to claims for indemnification as specified in the Merger Agreement. Additional contingent consideration of up to $8.0 million may be paid on June 30, 2009 if certain revenue thresholds are satisfied, provided that in no event will the aggregate consideration of all payments exceed $42.0 million. The contingent consideration is payable in either cash or the Company’s common stock, however, the Company expects that 50% of each payment will be made in cash and 50% will be paid in shares of TriZetto’s common stock.

QCSI stockholders, warrantholders and optionholders are entitled to receive contingent consideration up to a total of $12.0 million, including (i) an aggregate cash payment of $5.0 million on January 31, 2008 (the “Holdback”), and (ii) a contingent aggregate cash payment of up to $7.0 million on January 31, 2008, based upon license and software maintenance revenues arising from the sale of QCSI products for the twelve (12) month period commencing on January 1, 2007 and ending on December 31, 2007. The amount of the Holdback will be reduced if QCSI has negative working capital, as defined in the Merger Agreement, on the closing date, or to the extent TriZetto is entitled to claims for indemnification as specified in the Merger Agreement.

Additionally, FIN 48 liabilities have not been included in the tables above as management cannot make a reasonably reliable estimate of the period of cash settlements, if any, with taxing authorities.

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not currently have any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet or other contractually narrow or limited purposes.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

Market risk associated with adverse changes in financial and commodity market prices and rates could impact our financial position, operating results or cash flows. We are exposed to market risk due to changes in interest rates such as the prime rate and LIBOR. This exposure is directly related to our normal operating and funding activities. Historically, and as of June 30, 2007, we have not used derivative instruments or engaged in hedging activities.

 

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The interest rate on our $100.0 million revolving credit facility and $150.0 million term loan is a per annum rate equal to either (i) the LIBOR rate plus an adjustable applicable margin of between 1.75% and 3.50% or (ii) the lending institution’s prime rate plus an adjustable applicable margin of between 0.0% and 2.0%, at our election, subject to specified restrictions, and is payable monthly in arrears or upon maturity date. The revolving credit facility and term loan expire in January 2011. As of June 30, 2007, we had outstanding borrowings on the revolving line of credit of $17.0 million and $75.0 million outstanding borrowings on the term loan.

In October 2005, we issued $100.0 million aggregate principal amount of 2.75% Convertible Senior Notes due 2025 (the “2025 Notes”). The 2025 Notes are convertible into shares of our common stock at an initial conversion price of $18.85 per share, or 53.0504 shares for each $1,000 principal amount of 2025 Notes, subject to certain adjustments. The maximum conversion rate is 68.9655 shares for each $1,000 principal amount of 2025 Notes. The 2025 Notes were issued pursuant to an Indenture, dated October 5, 2005, by and between us and Wells Fargo Bank, National Association, as trustee. The 2025 Notes bear interest at a rate of 2.75%, which is payable in cash semi-annually in arrears on April 1 and October 1 of each year, and commenced on April 1, 2006, to the holders of record on the preceding March 15 and September 15, respectively.

In April 2007, we issued $230.0 million aggregate principal amount of 1.125% Convertible Senior Notes due 2012 (the “2012 Notes”). The 2012 Notes are convertible into shares of our common stock at an initial conversion price of $21.97 per share, or 45.5114 shares for each $1,000 principal amount of 2012 Notes, subject to certain adjustments. The maximum conversion rate is 53.4759 shares for each $1,000 principal amount of 2012 Notes. The 2012 Notes were issued pursuant to an Indenture, dated April 17, 2007, by and between us and Wells Fargo Bank, National Association, as trustee. The 2012 Notes bear interest at a rate of 1.125%, which is payable in cash semi-annually in arrears on April 15 and October 15 of each year, commencing on October 15, 2007, to the holders of record on the preceding April 1 and October 1, respectively.

We manage interest rate risk by investing excess funds in cash equivalents and short-term investments bearing variable interest rates, which are tied to various market indices. We also manage interest rate risk by closely managing our borrowings on our credit facility based on our operating needs in order to minimize the interest expense incurred. As a result, we do not believe that near-term changes in interest rates will result in a material effect on our future earnings, fair values or cash flows.

Item 4.     Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal accounting officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal accounting officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Additionally, there were no changes in our internal controls over financial reporting during the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1.     Legal Proceedings

We are involved in litigation from time to time relating to claims arising out of our operations in the normal course of business. As of the filing date of this quarterly report on Form 10-Q, we were not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations, financial position and/or cash flows.

Item 1A.     Risk Factors

Cautionary Statement

This report, and other documents and statements provided or made by us, contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These statements may include statements about our future revenues, profits, results, the market for our products and services, future service offerings, industry trends, client and partner relationships, our operational capabilities, future financial structure and uses of cash or proposed transactions. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “forecasts,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms and other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the following risks:

We cannot predict if we will be able to sustain our revenue or positive net income.

We may not be able to sustain or increase our current level of revenue or positive net income. We currently derive our revenue primarily from providing hosted solutions, software licensing and maintenance, and other services such as consulting. We depend on the continued demand for healthcare information technology and related services. We plan to continue investing in administrative infrastructure, research and development, sales and marketing, and acquisitions. If we are not able to sustain our current levels of revenue or maintain our profitability, our operations may be adversely affected.

Revenue from a limited number of customers comprises a significant portion of our total revenue, and if these customers terminate or modify existing contracts or experience business difficulties, it could adversely affect our earnings.

As of June 30, 2007, we were providing services to 357 unique customers. Two of our customers, WellPoint (including its affiliate, WPMI) and the Regence Group, represented approximately 19% of our consolidated revenue in the first six months of 2007.

Although we typically enter into multi-year customer agreements, a majority of our customers are able to reduce or cancel their use of our services before the end of the contract term, subject to monetary penalties which are not significant. We also provide services to some hosted customers without long-term contracts. In addition, many of our contracts are structured so that we generate revenue based on units of volume, which include the number of members, number of workstations or number of users. If our customers experience business difficulties and the units of volume decline or if a customer ceases operations for any reason, we will generate less revenue under these contracts and our operating results may be materially and adversely impacted.

Our operating expenses are relatively fixed and cannot be reduced on short notice to compensate for unanticipated contract cancellations or reductions. As a result, any termination, significant reduction or modification of our business relationships with any of our significant customers could have a material adverse effect on our business, financial condition, operating results and cash flows.

Our business is changing rapidly, which could cause our quarterly operating results to vary and our stock price to fluctuate.

Our quarterly operating results have varied in the past, and we expect that they will continue to vary in future periods. Our quarterly operating results can vary significantly based on a number of factors, such as:

 

   

our mix of products and services revenue;

 

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whether our customers choose to license our software under terms and conditions that require revenues to be deferred or recognized ratably over time rather than upfront;

 

   

our ability to add new customers and renew existing accounts;

 

   

selling additional products and services to existing customers;

 

   

long and unpredictable sales cycles;

 

   

meeting project milestones and customer expectations;

 

   

seasonality in information technology purchases;

 

   

the timing of new customer sales; and

 

   

general economic conditions.

Variations in our quarterly operating results could cause us to not meet the earnings estimates of securities analysts or the expectations of our investors, which could affect the market price of our common stock in a manner that may be unrelated to our long-term operating performance.

We base our expense levels in part upon our expectations concerning future revenue, and these expense levels are relatively fixed in the short-term. If we do not achieve our expected revenue targets, we may not be able to reduce our short-term spending in response. Any shortfall in revenue would have a direct impact on our results of operations.

The intensifying competition we face from both established entities and new entries in the market may adversely affect our revenue and profitability.

The market for our technology and services is highly competitive and rapidly changing and requires potentially expensive technological advances. Many of our competitors and potential competitors have significantly greater financial, technical, product development, marketing and other resources, and greater market recognition than we have. Many of our competitors also have, or may develop or acquire, substantial installed customer bases in the healthcare industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion, and sale of their applications or services than we can devote.

Our competitors can be categorized as follows:

 

   

information technology and outsourcing companies, such as Perot Systems Corporation, IBM, Affiliated Computer Services, DST (who acquired the healthcare division of Computer Sciences Corporation), Electronic Data Systems Corporation and Infocrossing;

 

   

healthcare information software vendors, including the newly combined DST/Amisys Synertech Inc., Perot Systems Corporation and Electronic Data Systems Corporation and Plexis in the health plan market, as well as Eldorado and SBPA in the benefits administration market and MMC 2020, Gorman and Dynamics in the Medicare Advantage market;

 

   

healthcare information technology consulting firms, such as First Consulting Group, Inc., Proxicom (ACS) and the consulting divisions or former affiliates of the major accounting firms, such as Deloitte Consulting and Accenture;

 

   

healthcare e-commerce and portal companies, such as Emdeon Corporation (formerly WebMD Corporation), HealthTrio, Avolent, edocs and BenefitFocus;

 

   

enterprise application integration vendors such as Vitria, SeeBeyond, TIBCO, Fuego and M2;

 

   

care management software and service companies such as HealthTrio, MEDecision, McKesson, Emdeon, HealthAtoZ and Click4Care;

 

   

consumer retail software and services companies such as, CareGain and FiServ; and

 

   

health plans, themselves, some of whom are providing hosting and BPO services to the marketplace and leveraging capabilities across the aggregated membership of multiple organizations.

Further, other entities that do not presently compete with us may do so in the future, including major software information systems companies and financial services entities.

We believe our ability to compete will depend in part upon our ability to:

 

   

enhance our current technology and services;

 

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respond effectively to technological changes;

 

   

introduce new capabilities for current and new market segments;

 

   

meet the increasingly sophisticated needs of our customers; and

 

   

maintain and continue to develop partnerships with vendors.

Increased competition may result in price reductions, reduced margins, and loss of market share, any of which could have a material adverse effect on our results of operations. In addition, pricing, margins, and market share could be negatively impacted further as a greater number of available products in the marketplace increases the likelihood that product and service offerings in our markets become more fungible and price sensitive.

Our sales and implementation cycles are long and unpredictable.

We have experienced and continue to experience long and unpredictable sales cycles, particularly for contracts with large customers, or customers purchasing multiple products and services. Enterprise software typically requires significant capital expenditures by customers, and the decision to outsource IT-related services is complicated and time-consuming. Major purchases by large payer organizations typically range from nine to 12 months or more from initial contact to contract execution. The prospects currently in our pipeline may not sign contracts within a reasonable period of time or at all.

In addition, our implementation cycle has ranged from 12 to 24 months or longer from contract execution to completion of implementation. During the sales cycle and the implementation cycle, we will expend substantial time, effort, and financial resources preparing contract proposals, negotiating the contract, and implementing the solution. We may not realize any revenue to offset these expenditures, and, if we do, accounting principles may not allow us to recognize the revenue during corresponding periods, which could harm our future operating results. Additionally, any decision by our customers to delay implementation may adversely affect our revenues.

Consolidation of healthcare payer organizations and benefits administrators could decrease the number of our existing and potential customers.

There has been and continues to be acquisition and consolidation activity among healthcare payers and benefits administrators. Mergers or consolidations of payer organizations in the future could decrease the number of our existing and potential customers. The acquisition of a customer could reduce our revenue and have a negative impact on our results of operations and financial condition. A smaller overall market for our products and services could also result in lower revenue and margins. In addition, healthcare payer organizations are increasing their focus on consumer directed healthcare, in which consumers interact directly with health plans through administrative services provided by health plans to employer groups. These services compete with the services provided by benefits administrators and could result in additional consolidation in the benefits administration market.

Some of our significant customers may develop their own software solutions, which could decrease the demand for our products.

Some of our customers in the healthcare payer industry have, or may seek to acquire, the financial and technological resources necessary to develop software solutions to perform the functions currently serviced by our products and services. Additionally, consolidation in the healthcare payer industry could result in additional organizations having the resources necessary to develop similar software solutions. If these organizations successfully develop and utilize their own software solutions, they may discontinue their use of our products or services, which could materially and adversely affect our results of operations.

We depend on our software application vendor relationships, and if our software application vendors terminate or modify existing contracts or experience business difficulties, or if we are unable to establish new relationships with additional software application vendors, it could harm our business.

We depend, and will continue to depend, on our licensing and business relationships with third-party software application vendors. Our success depends significantly on our ability to maintain our existing relationships with our vendors and to build new relationships with other vendors in order to enhance our services and application offerings and remain competitive. Although most of our licensing agreements are perpetual or automatically renewable, they are subject to termination in the event that we materially breach such agreements. We may not be able to maintain relationships with our vendors or establish relationships with new vendors. The software, products or services of our third-party vendors may not achieve or maintain market acceptance or commercial success. Accordingly, our existing relationships may not result in sustained business partnerships, successful product or service offerings or the generation of significant revenue for us.

 

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Our arrangements with third-party software application vendors are not exclusive. These third-party vendors may not regard our relationships with them as important to their own respective businesses and operations. They may reassess their commitment to us at any time and may choose to develop or enhance their own competing distribution channels and product support services. If we do not maintain our existing relationships or if the economic terms of our business relationships change, we may not be able to license and offer these services and products on commercially reasonable terms or at all. Our inability to obtain any of these licenses could delay service development or timely introduction of new services and divert our resources. Any such delays could materially adversely affect our business, financial condition, operating results and cash flows.

Our licenses for the use of third-party software applications are essential to the technology solutions we provide for our customers. Loss of any one of our major vendor agreements may have a material adverse effect on our business, financial condition, operating results and cash flows.

We rely on third-party software vendors for components of our software products.

Our software products contain components developed and maintained by third-party software vendors, and we expect that we may have to incorporate software from third-party vendors in our future products. We may not be able to replace the functions provided by the third-party software currently offered with our products if that software becomes obsolete, defective, or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the availability of these third-party software products or defects in these products could harm the sale of our products unless and until we can secure or develop an alternative source. Although we believe there are adequate alternate sources for the technology currently licensed to us, such alternate sources may not be available to us in a timely manner, may not provide us with the same functions as currently provided to us or may be more expensive than products we currently use.

We have sustained rapid growth, and our inability to manage this growth could harm our business.

We have rapidly and significantly expanded our operations since inception and may continue to do so in the future. This growth has placed, and may continue to place, a significant strain on our managerial, operational, and financial resources, and information systems. If we are unable to manage our growth effectively, it could have a material adverse effect on our business, financial condition, operating results, and cash flows.

Our acquisition strategy may disrupt our business and require additional financing.

Since our initial public offering in October 1999, we have completed ten acquisitions. A significant portion of our historical growth has occurred through acquisitions and we may continue to seek strategic acquisitions as part of our growth strategy. We compete with other companies to acquire businesses, making it difficult to acquire suitable companies on favorable terms or at all. Acquisitions may require significant capital, typically entail many risks, and can result in difficulties integrating operations, personnel, technologies, products and information systems of acquired businesses.

We may be unable to successfully integrate companies that we have acquired or may acquire in the future in a timely manner. If we are unable to successfully integrate acquired businesses, we may incur substantial costs and delays or other operational, technical or financial problems. In addition, the integration of our acquisitions may divert our management’s attention from our existing business, which could damage our relationships with our key customers and employees.

To finance future acquisitions, we may issue equity securities that could be dilutive to our stockholders. We may also incur debt and additional amortization expenses related to goodwill and other intangible assets as a result of acquisitions. The interest expense related to this debt and additional amortization expense may significantly reduce our profitability and have a material adverse effect on our business, financial condition, operating results and cash flows. Acquisitions may also result in large one-time charges as well as goodwill and intangible assets and impairment charges in the future that could negatively impact our operating results.

Our need for additional financing is uncertain as is our ability to raise capital if required.

If we are not able to sustain our positive net income, we may need additional financing to fund operations or growth. We may not be able to raise additional funds through public or private financings at any particular point in the future or on favorable terms. Future financings could adversely affect our common stock and debt securities.

Our business will suffer if our software products contain errors.

The proprietary and third party software products we offer are inherently complex. Despite our testing and quality control procedures, errors may be found in current versions, new versions or enhancements of our products. Significant

 

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technical challenges may also arise with our products because our customers purchase and deploy those products across a variety of computer platforms and integrate them with a number of third-party software applications and databases. If new or existing customers have difficulty deploying our products or require significant amounts of customer support, our costs would increase. Moreover, we could face possible claims and higher development costs if our software contains undetected errors or if we fail to meet our customers’ expectations. As a result of the foregoing, we could experience:

 

   

loss of or delay in revenue and loss of market share;

 

   

loss of customers;

 

   

damage to our reputation;

 

   

failure to achieve market acceptance;

 

   

diversion of development resources;

 

   

increased service and warranty costs;

 

   

legal actions by customers against us which could, whether or not successful, increase costs and distract our management; and

 

   

increased insurance costs.

We could lose customers and revenue if we fail to meet contractual obligations including performance standards and other material obligations.

Many of our service agreements contain performance standards and other post contract obligations. Our failure to meet these standards or breach other material obligations under our agreements could trigger remedies for our customers including termination, financial penalties and refunds that could have a material adverse effect on our business, financial condition, operating results and cash flows.

If our ability to expand our network and computing infrastructure is constrained in any way, we could lose customers and damage our operating results.

We must continue to expand and adapt our network and technology infrastructure to accommodate additional users, increased transaction volumes, changing customer requirements and technological obsolescence. We may not be able to accurately project the rate or timing of increases, if any, in the use of our hosted solutions or be able to expand and upgrade our systems and infrastructure to accommodate such increases. We may be unable to expand or adapt our network infrastructure to meet additional demand or our customers’ changing needs on a timely basis, at a commercially reasonable cost or at all. Our current information systems, procedures and controls may not continue to support our operations while maintaining acceptable overall performance and may hinder our ability to exploit the market for healthcare applications and services. Service lapses could cause our users to switch to the services of our competitors, which could have a material adverse effect on our business, financial condition, operating results and cash flows.

Performance or security problems with our systems could damage our business.

Our customers’ satisfaction and our business could be harmed if we, or our customers, experience any system delays, failures, or loss of data.

Although we devote substantial resources to avoid performance problems, errors may occur. Errors in the processing of customer data may result in loss of data, inaccurate information, and delays. Such errors could cause us to lose customers and be liable for damages. We currently process a substantial number of our customers’ transactions and data at our data centers in Colorado. Although we have safeguards for emergencies and we have contracted backup processing for our customers’ critical functions, the occurrence of a major catastrophic event or other system failure at any of our facilities could interrupt data processing or result in the loss of stored data. In addition, we depend on the efficient operation of telecommunication providers that have had periodic operational problems or experienced outages.

A material security breach could damage our reputation or result in liability to us. We retain confidential customer and federally protected patient information in our data centers. Therefore, it is critical that our facilities and infrastructure remain secure and that our facilities and infrastructure are perceived by the marketplace to be secure. Despite the implementation of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties, or similar disruptive problems.

Our services agreements generally contain limitations on liability, and we maintain insurance with appropriate coverage limits for general liability and professional liability to protect against claims associated with the use of our products

 

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and services. However, the contractual provisions and insurance coverage may not provide adequate coverage against all possible claims that may be asserted. In addition, appropriate insurance may be unavailable in the future at commercially reasonable rates. A successful claim in excess of our insurance coverage could have a material adverse effect on our business, financial condition, operating results, and cash flows. Even unsuccessful claims could result in litigation or arbitration costs and may divert management’s attention from our existing business.

Our success depends on our ability to attract, retain and motivate management and other key personnel.

Our success depends in large part on the continued services of management and key personnel. Competition for personnel in the healthcare information technology market is intense, and there are a limited number of persons with knowledge of, and experience in, this industry. We do not have employment agreements with most of our executive officers, so any of these individuals may terminate his or her employment with us at any time. The loss of services from one or more of our management or key personnel, or the inability to hire additional management or key personnel as needed, could have a material adverse effect on our business, financial condition, operating results, and cash flows. Although we currently experience relatively low rates of turnover for our management and key personnel, the rate of turnover may increase in the future. In addition, we expect to further grow our operations and our needs for additional management and key personnel will increase. Our continued ability to compete effectively in our business depends on our ability to attract, retain, and motivate these individuals.

We rely on an adequate supply and performance of computer hardware and related equipment from third parties to provide services to larger customers and any significant interruption in the availability or performance of third-party hardware and related equipment could adversely affect our ability to deliver our products to certain customers on a timely basis.

As we offer our hosted solution services and software to a greater number of customers and particularly to larger customers, we may be required to obtain specialized computer equipment from third parties that can be difficult to obtain on short notice. Any delay in obtaining such equipment may prevent us from delivering large systems to our customers on a timely basis. We also may rely on such equipment to meet required performance standards. We may have no control over the resources that third parties may devote to service our customers or satisfy performance standards. If such performance standards are not met, we may be adversely impacted under our service agreements with our customers.

Any failure or inability to protect our technology and confidential information could adversely affect our business.

Our success depends in part upon proprietary software and other confidential information. The software and information technology industries have experienced widespread unauthorized reproduction of software products and other proprietary technology. We rely on a combination of copyright, patent, trademark and trade secret laws, confidentiality procedures, and contractual provisions to protect our intellectual property. However, these protections may not be sufficient, and they do not prevent independent third-party development of competitive products or services.

We execute confidentiality and non-disclosure agreements with certain employees and our suppliers, as well as limit access to and distribution of our proprietary information. The departure of any of our management and technical personnel, the breach of their confidentiality and non-disclosure obligations to us, or the failure to achieve our intellectual property objectives could have a material adverse effect on our business, results of operations and financial condition. We have had, and may continue to have, employees leave us and go to work for competitors. If we are not successful in prohibiting the unauthorized use of our proprietary technology or the use of our processes by a competitor, our competitive advantage may be significantly reduced which would result in reduced revenues.

Our products may infringe the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.

We cannot be certain that our products do not infringe issued patents or other intellectual property rights of others. In addition, because patent applications in the United States and many other countries are not publicly disclosed until a patent is issued, applications covering technology used in our software products may have been filed without our knowledge. We may be subject to legal proceedings and claims from time to time, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Intellectual property litigation is expensive and time-consuming and could divert our management’s attention away from running our business and seriously harm our business. If we were to discover that our products violated the intellectual property rights of others, we would have to obtain licenses from these parties in order to continue marketing our products without substantial reengineering. We might not be able to obtain the necessary licenses on acceptable terms or at all, and if we could not obtain such licenses, we might not be able to reengineer our products successfully or in a timely fashion. If we

 

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fail to address any infringement issues successfully, we would be forced to incur significant costs, including damages and potentially satisfying indemnification obligations that we have with our customers, and we could be prevented from selling certain of our products.

If our consulting services revenue does not grow substantially, our revenue growth could be adversely impacted.

Our consulting services revenue represents a significant component of our total revenue and we anticipate that it will continue to represent a significant percentage of total revenue in the future. The level of consulting services revenue depends upon the healthcare industry’s demand for outsourced information technology services and our ability to deliver products that generate implementation and follow-on consulting services revenue. Our ability to increase services revenue will depend in part on our ability to increase the capacity of our consulting group, including our ability to recruit, train and retain a sufficient number of qualified personnel.

The insolvency of our customers or the inability of our customers to pay for our services could negatively affect our financial condition.

Healthcare payers are often required to maintain restricted cash reserves and satisfy strict balance sheet ratios promulgated by state regulatory agencies. In addition, healthcare payers are subject to risks that physician groups or associations within their organizations become subject to costly litigation or become insolvent, which may adversely affect the financial stability of the payer. If healthcare payers are unable to pay for our services because of their need to maintain cash reserves or failure to maintain balance sheet ratios or solvency, our ability to collect fees for services rendered would be impaired and our financial condition could be adversely affected.

Changes in government regulation of the healthcare industry could adversely affect our business.

During the past several years, the healthcare industry has been subject to increasing levels of government regulation of, among other things, reimbursement rates and certain capital expenditures. In addition, proposals to substantially reform Medicare, Medicaid, and the healthcare system in general have been or are being considered by Congress. These proposals, if enacted, may further increase government involvement in healthcare, lower reimbursement rates, and otherwise adversely affect the healthcare industry which could adversely impact our business. The impact of regulatory developments in the healthcare industry is complex and difficult to predict, and our business could be adversely affected by existing or new healthcare regulatory requirements or interpretations.

Participants in the healthcare industry, such as our payer customers, are subject to extensive and frequently changing laws and regulations, including laws and regulations relating to the confidential treatment and secure transmission of patient medical records, and other healthcare information. Legislators at both the state and federal levels have proposed and enacted additional legislation relating to the use and disclosure of medical information, and the federal government may enact new federal laws or regulations in the near future. Pursuant to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), the Department of Health and Human Services has issued a series of regulations setting forth security, privacy and transactions standards for all health plans, clearinghouses, and healthcare providers to follow with respect to individually identifiable health information. Many of our customers are also subject to state laws implementing the federal Gramm-Leach-Bliley Act, relating to certain disclosures of nonpublic personal health information and nonpublic personal financial information by insurers and health plans.

Our payer customers must comply with HIPAA, its regulations, and other applicable healthcare laws and regulations. In addition, we may be deemed to be a covered entity subject to HIPAA because we offer our customers products that convert data to a HIPAA compliant format. Accordingly, we must comply with certain provisions of HIPAA and in order for our products and services to be marketable, they must contain features and functions that allow our customers to comply with HIPAA and other healthcare laws and regulations. We believe our products currently allow our customers to comply with existing laws and regulations. However, because HIPAA and its regulations have yet to be fully interpreted, our products may require modification in the future. If we fail to offer solutions that permit our customers to comply with applicable laws and regulations, our business will suffer.

We perform billing and claims services that are governed by numerous federal and state civil and criminal laws. The federal government in recent years has imposed heightened scrutiny on billing and collection practices of healthcare providers and related entities, particularly with respect to potentially fraudulent billing practices, such as submissions of inflated claims for payment and upcoding. Violations of the laws regarding billing and coding may lead to civil monetary penalties, criminal fines, imprisonment, or exclusion from participation in Medicare, Medicaid and other federally funded healthcare programs for our customers and for us. Any of these results could have a material adverse effect on our business, financial condition, operating results, and cash flows.

 

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In addition, laws governing healthcare payers are often not uniform among states. This could require us to undertake the expense and difficulty of tailoring our products in order for our customers to be in compliance with applicable state and local laws and regulations.

Part of our business is subject to government regulation relating to the Internet that could impair our operations.

The Internet and its associated technologies are subject to increasing government regulation. A number of legislative and regulatory proposals are under consideration by federal, state, local, and foreign governments, and agencies. Laws or regulations may be adopted with respect to the Internet relating to liability for information retrieved from or transmitted over the Internet, on-line content regulation, user privacy, taxation and quality of products and services. Many existing laws and regulations, when enacted, did not anticipate the methods of the Internet-based hosted, software and information technology solutions we offer. We believe, however, that these laws may be applied to us. We expect our products and services to be in substantial compliance with all material federal, state and local laws and regulations governing our operations. However, new legal requirements or interpretations applicable to the Internet could decrease the growth in the use of the Internet, limit the use of the Internet for our products and services or prohibit the sale of a particular product or service, increase our cost of doing business, or otherwise have a material adverse effect on our business, results of operations and financial conditions. To the extent that we market our products and services outside the United States, the international regulatory environment relating to the Internet and healthcare services could also have an adverse effect on our business.

Increased leverage as a result of our convertible note offerings may harm our financial condition and results of operations.

On October 5, 2005, we completed a private placement of $100.0 million aggregate principal amount of our 2.75% Convertible Senior Notes due 2025 (the “2025 Notes”). On April 17, 2007, we completed a private placement of $230.0 million aggregate principal amount of our 1.125% Convertible Senior Notes due 2012 (the “2012 Notes,” and together with the 2025 Notes, defined as the “Notes”). The indebtedness under the Notes constitutes senior unsecured obligations and will rank equal in right of payment with all of the Company’s existing and future senior unsecured debt and senior to all of the Company’s future subordinated debt. The Notes were issued pursuant to indentures with Wells Fargo Bank, National Association, as trustee (the “Indentures”).

As of June 30, 2007, our total consolidated long-term debt was $413.0 million. In addition, the Indentures do not restrict our ability to incur additional indebtedness, and we may choose to incur additional debt in the future. Our level of indebtedness could have important consequences to you, because:

 

   

it could affect our ability to satisfy our debt obligations under the Notes or our credit facility;

 

   

a substantial portion of our cash flows from operations will have to be dedicated to interest and principal payments of our debt obligations and may not be available for operations, expansion, acquisitions or other purposes;

 

   

it may impair our ability to obtain additional financing in the future;

 

   

it may limit our flexibility in planning for, or reacting to, changes in our business and industry; and

 

   

it may make us more vulnerable to downturns in our business, our industry or the economy in general.

Our ability to make payments of principal and interest on our indebtedness depends upon our future performance, which will be subject to our success in marketing our products and services, general economic conditions and financial, business and other factors affecting our operations, many of which are beyond our control. If we are not able to generate sufficient cash flow from operations in the future to service our indebtedness, we may be required, among other things:

 

   

to seek additional financing in the debt or equity markets;

 

   

to refinance or restructure all or a portion of our indebtedness;

 

   

to sell assets; and/or

 

   

to reduce or delay planned expenditures on research and development and/or commercialization activities.

Such measures might not be sufficient to enable us to service our debt. In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms or at all.

 

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We have certain repurchase and payment obligations under the Notes and we may not be able to repurchase such Notes or pay the amounts due upon conversion of the Notes when necessary.

On various dates, holders of certain of the Notes may require us to purchase, for cash, all or a portion of their Notes at 100% of their principal amount, plus any accrued and unpaid interest. If a fundamental change occurs, as defined in the Indentures, including a change in control transaction, holders of such Notes may also require us to repurchase, for cash, all or a portion of their Notes. In addition, upon conversion of such Notes if we have made an irrevocable election to settle conversion in cash, we would be required to satisfy our conversion obligation up to the principal amount of the Notes in cash. Our ability to repurchase the Notes and settle the conversion of the Notes in cash is effectively subordinated to our senior credit facility and may be limited by law, by the Indentures, by the terms of other agreements relating to our senior debt and by indebtedness and agreements that we may enter into in the future which may replace, supplement or amend our existing or future debt. Our failure to repurchase the Notes or make the required payments upon conversion would constitute an event of default under the Indentures, which would in turn constitute a default under the terms of our senior credit facility and other indebtedness at that time.

Our common stock price has been, and may continue to be, volatile and our shareholders may not be able to resell shares of our stock at or above the price paid for such shares.

The price for shares of our common stock has exhibited high levels of volatility with significant volume and price fluctuations, which makes our common stock unsuitable for many investors. For example, for the six months ended June 30, 2007, the closing price of our common stock ranged from a high of $21.68 to a low of $17.02. The fluctuations in price of our common stock have occasionally been related to our operating performance. These broad fluctuations may negatively impact the market price of shares of our common stock. The price of our common stock has also been influenced by:

 

   

fluctuations in our results of operations or the operations of our competitors or customers;

 

   

failure of our results of operations to meet the expectations of stock market analysts and investors;

 

   

changes in stock market analyst recommendations regarding us, our competitors or our customers; and

 

   

the timing and announcements of new products or financial results by us or our competitors.

Future issuances of common stock may depress the trading price of our common stock.

Any future issuance of equity securities, including the issuance of shares upon conversion of the Notes, could dilute the interests of our existing stockholders and could substantially decrease the trading price of our common stock. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options or for other reasons.

Our stockholder rights plan and charter documents could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders.

Our stockholder rights plan and certain provisions of our certificate of incorporation and Delaware law are intended to encourage potential acquirers to negotiate with us and allow our Board of Directors the opportunity to consider alternative proposals in the interest of maximizing shareholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which in turn, could harm our stock price.

 

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Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth all purchases made by us of our common stock during each month within the second quarter of 2007. No purchases were made pursuant to a publicly announced repurchase plan or program.

 

Period   Total number of Shares (or Units) Purchased
(1)
      Average Price Paid Per Share (or Unit)       Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs       Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
April 1, 2007 – April 30, 2007   1,104       $19.51            
May 1, 2007 – May 31, 2007   1,817       $19.19            
June 1, 2007 – June 30, 2007                    
TOTAL   2,921       $19.31            

 

(1) All share acquisitions set forth in this table were made in connection with the satisfaction of employee tax obligations upon the vesting of restricted stock awards.

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

The Company’s 2007 Annual Meeting of Stockholders (the “Annual Meeting”) was held on May 25, 2007. At the Annual Meeting, the Company’s stockholders: (a) elected three Class II Directors with terms expiring at the 2010 Annual Meeting of Stockholders; and (b) ratified the appointment of Ernst & Young LLP as our independent registered public accountants for the year ending December 31, 2007.

Following the Annual Meeting, two Class I Directors, having terms expiring in 2009, and two Class III Directors, having terms expiring in 2008, continued in office.

The following table sets forth the results of voting at the Annual Meeting:

 

Matter    For    Against    Abstentions   

Broker

Non-Votes

Election of Directors for a term expiring at the 2010 Annual Meeting of Stockholders*

           

•     Nancy H. Handel

   33,725,690    67,339    *    *

•     Thomas B. Johnson

   33,703,790    89,239    *    *

•     L. William Krause

   33,515,542    277,487    *    *

Ratification of appointment of Ernst & Young LLP as independent registered public accountants for 2007

   33,775,151    17,228    650    0

 

* With respect to the election of directors, the form of proxy permitted stockholders to check boxes indicating votes either “For All” or “Withhold Authority,” or to vote “For All Except” and to name exceptions; votes relating to directors designated above as “Against” include votes cast as “Withhold Authority” and for named exceptions.

 

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Item 6.     Exhibits

The following exhibits are filed as part of this report:

 

EXHIBIT
NUMBER
  

DESCRIPTION

4.1*    Indenture, dated April 17, 2007, between The TriZetto Group, Inc. and Wells Fargo Bank, National Association, as trustee (including form of 1.125% Convertible Senior Note due April 15, 2012) (Incorporated by reference to Exhibit 4.1 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
4.2*    Registration Rights Agreement, dated April 17, 2007, between The TriZetto Group, Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co. and UBS Investment Bank, as the initial purchasers (Incorporated by reference to Exhibit 4.2 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.1*    Confirmation, dated April 11, 2007, between Deutsche Bank AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.1 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.2*    Confirmation, dated April 11, 2007, between Deutsche Bank AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.2 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.3*    Confirmation, dated April 11, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.3 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.4*    Confirmation, dated April 11, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.4 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.5*    Confirmation, dated April 11, 2007, between UBS AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.5 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.6*    Confirmation, dated April 11, 2007, between UBS AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.6 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.7    First Amendment to the Amended and Restated Credit Agreement, dated July 1, 2007, by and among TriZetto, each of TriZetto’s subsidiaries, and Wells Fargo Foothills, Inc.
10.8    Amendment to Confirmation, dated July 26, 2007, between Deutsche AG, London Branch and The TriZetto Group, Inc.
10.9    Amendment to Confirmation, dated July 26, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc.
10.10    Amendment to Confirmation, dated July 26, 2007, between UBS AG, London Branch and The TriZetto Group, Inc.
31.1    Certification of CEO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of CFO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* Previously filed.

 

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SIGNATURES

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

 

     THE TRIZETTO GROUP, INC.

Date: August 8, 2007

   By:    /s/ Ronald L. Scarboro
       
      Ronald L. Scarboro
     

(Principal Accounting Officer

and Duly Authorized Officer)

 

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EXHIBIT INDEX

 

EXHIBIT

NUMBER

  

DESCRIPTION

4.1*    Indenture, dated April 17, 2007, between The TriZetto Group, Inc. and Wells Fargo Bank, National Association, as trustee (including form of 1.125% Convertible Senior Note due April 15, 2012) (Incorporated by reference to Exhibit 4.1 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
4.2*    Registration Rights Agreement, dated April 17, 2007, between The TriZetto Group, Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co. and UBS Investment Bank, as the initial purchasers (Incorporated by reference to Exhibit 4.2 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.1*    Confirmation, dated April 11, 2007, between Deutsche Bank AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.1 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.2*    Confirmation, dated April 11, 2007, between Deutsche Bank AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.2 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.3*    Confirmation, dated April 11, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.3 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.4*    Confirmation, dated April 11, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.4 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.5*    Confirmation, dated April 11, 2007, between UBS AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.5 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.6*    Confirmation, dated April 11, 2007, between UBS AG, London Branch and The TriZetto Group, Inc (Incorporated by reference to Exhibit 10.6 of TriZetto’s Form 8-K as filed with the SEC on April 17, 2007, File No. 000-27501).
10.7    First Amendment to the Amended and Restated Credit Agreement, dated July 1, 2007, by and among TriZetto, each of TriZetto’s subsidiaries, and Wells Fargo Foothills, Inc.
10.8    Amendment to Confirmation, dated July 26, 2007, between Deutsche AG, London Branch and The TriZetto Group, Inc.
10.9    Amendment to Confirmation, dated July 26, 2007, between Goldman, Sachs & Co. and The TriZetto Group, Inc.
10.10    Amendment to Confirmation, dated July 26, 2007, between UBS AG, London Branch and The TriZetto Group, Inc.
31.1    Certification of CEO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of CFO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* Previously filed.

 

39

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