UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2007

o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transitional period from                    to

Commission file number 0-29100

eResearchTechnology, Inc.

(Exact name of registrant as specified in its charter)

Delaware		22-3264604
(State or other jurisdiction of incorporation		(I.R.S. Employer Identification No.)
or organization)

30 South 17th Street
Philadelphia, PA		19103
(Address of principal executive offices)		(Zip code)

215-972-0420

     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 þ No o

     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 o       Accelerated filer þ       Non-accelerated filer o

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

Yes o No þ

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

The number of shares of Common Stock, $.01 par value, outstanding as of October 26, 2007, was 50,615,672.

 

 

eResearchTechnology, Inc. and Subsidiaries

INDEX

						Page
Part I. Financial Information
		Item 1.		Financial Statements
				Consolidated Balance Sheets-December 31, 2006 and September 30, 2007 (unaudited)			3
				Consolidated Statements of Operations (unaudited)—Three and Nine Months Ended September 30, 2006 and 2007			4
				Consolidated Statements of Cash Flows (unaudited)—Nine Months Ended September 30, 2006 and 2007			5
				Notes to Consolidated Financial Statements (unaudited)			6-14
		Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations			15-27
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk			27
		Item 4.		Controls and Procedures			27
Part II. Other Information
		Item 6.		Exhibits			28
Signatures							29
Exhibit Index							30
Certification of Chief Executive Officer
Certification of Chief Financial Officer
Statement of Chief Executive Officer
Statement of Chief Financial Officer

Part 1. Financial Information

Item 1. Financial Statements

eResearchTechnology, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

		December 31, 2006				September 30, 2007
						(unaudited)
Assets
Current Assets:
Cash and cash equivalents		$	15,497			$	27,198
Short-term investments			41,416				43,591
Accounts receivable, net			17,866				21,790
Prepaid income taxes			2,819				754
Prepaid expenses and other			2,761				3,613
Deferred income taxes			912				913
Total current assets			81,271				97,859
Property and equipment, net			31,129				33,127
Goodwill			1,212				1,212
Long-term investments			928				244
Other assets			524				311
Total assets		$	115,064			$	132,753
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable		$	4,360			$	2,505
Accrued expenses			3,445				4,968
Income taxes payable			781				966
Current portion of capital lease obligations			40				1,621
Deferred revenues			11,325				12,415
Total current liabilities			19,951				22,475
Capital lease obligations, excluding current portion			—				66
Deferred income taxes			1,491				2,203
Total liabilities			21,442				24,744
Commitments and contingencies
Stockholders’ Equity:
Preferred stock — $10.00 par value, 500,000 shares authorized, none issued and outstanding			—				—
Common stock — $.01 par value, 175,000,000 shares authorized, 58,356,546 and 58,854,254 shares issued, respectively			584				589
Additional paid-in capital			83,493				87,331
Accumulated other comprehensive income			1,510				1,961
Retained earnings			70,225				80,318
Treasury stock, 8,247,119 shares at cost			(62,190	)			(62,190	)
Total stockholders’ equity			93,622				108,009
Total liabilities and stockholders’ equity		$	115,064			$	132,753

The accompanying notes are an integral part of these statements.

eResearchTechnology, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2006				2007				2006				2007
Net revenues:
Licenses		$	602			$	651			$	2,336			$	2,013
Services			14,493				16,453				42,040				47,982
Site support			7,131				6,867				22,067				19,794
Total net revenues			22,226				23,971				66,443				69,789
Costs of revenues:
Cost of licenses			75				70				228				199
Cost of services			6,674				7,567				19,130				21,590
Cost of site support			4,548				4,831				14,492				13,143
Total costs of revenues			11,297				12,468				33,850				34,932
Gross margin			10,929				11,503				32,593				34,857
Operating expenses:
Selling and marketing			2,471				2,487				8,687				8,079
General and administrative			3,945				2,527				11,758				8,915
Research and development			980				1,128				3,328				3,155
Total operating expenses			7,396				6,142				23,773				20,149
Operating income			3,533				5,361				8,820				14,708
Other income, net			339				584				1,067				1,703
Income before income taxes			3,872				5,945				9,887				16,411
Income tax provision			1,407				2,239				3,821				6,318
Net income		$	2,465			$	3,706			$	6,066			$	10,093
Basic net income per share		$	0.05			$	0.07			$	0.12			$	0.20
Diluted net income per share		$	0.05			$	0.07			$	0.12			$	0.20
Shares used to calculate basic net income per share			49,540				50,594				49,302				50,430
Shares used to calculate diluted net income per share			51,376				51,829				51,525				51,681

The accompanying notes are an integral part of these statements.

eResearchTechnology, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

		Nine Months Ended
		September 30,
		2006				2007
Operating activities:
Net income		$	6,066			$	10,093
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			8,537				11,066
Cost of sales of equipment			3,483				1,004
Non-cash share-based compensation			2,319				1,576
Changes in operating assets and liabilities:
Accounts receivable			44				(3,777	)
Prepaid expenses and other			(452	)			(595	)
Accounts payable			1,966				(1,888	)
Accrued expenses			(1,156	)			1,500
Income taxes			(3,062	)			2,749
Deferred revenues			(8,744	)			995
Net cash provided by operating activities			9,001				22,723
Investing activities:
Purchases of property and equipment			(12,269	)			(10,066	)
Purchases of investments			(24,516	)			(50,108	)
Proceeds from sales of investments			21,040				48,617
Net cash used in investing activities			(15,745	)			(11,557	)
Financing activities:
Repayment of capital lease obligations			(114	)			(1,962	)
Proceeds from exercise of stock options			3,548				1,600
Stock option income tax benefit			3,702				628
Repurchase of common stock for treasury			(5,803	)			—
Net cash provided by financing activities			1,333				266
Effect of exchange rate changes on cash			244				269
Net (decrease) increase in cash and cash equivalents			(5,167	)			11,701
Cash and cash equivalents, beginning of period			18,432				15,497
Cash and cash equivalents, end of period		$	13,265			$	27,198

The accompanying notes are an integral part of these statements.

eResearchTechnology, Inc. and Subsidiaries

Note 1. Basis of Presentation

          The accompanying unaudited consolidated financial statements, which include the accounts of eResearchTechnology, Inc. (the “Company”, “eRT” or “we”) and its wholly-owned subsidiaries, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. Further information on potential factors that could affect our financial results can be found in our Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission and in this Form 10-Q.

Note 2. Summary of Significant Accounting Policies

Principles of Consolidation

          The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

          The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition

          We recognize revenues primarily from three sources: license fees, services and site support. Our license revenues consist of license fees for perpetual license sales and monthly and annual term license sales. Our services revenues consist of Cardiac Safety services, technology consulting and training services and software maintenance services. Our site support revenues consist of cardiac safety equipment rentals and sales along with related supplies and freight.

          We recognize software revenues in accordance with the Accounting Standards Executive Committee Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, ‘Software Revenue Recognition’, With Respect to Certain Transactions.” Accordingly, we recognize up-front license fee revenues under the residual method when a formal agreement exists, delivery of the software and related documentation has occurred, collectability is probable and the license fee is fixed or determinable. We recognize monthly and annual term license fee revenues over the term of the arrangement. Hosting service fees are recognized evenly over the term of the service. Cardiac Safety services revenues consist of services that we provide on a fee for services basis and are recognized as the services are performed. Site support revenues are recognized at the time of sale or over the rental period. We recognize revenues from software maintenance contracts on a straight-line basis over the term of the maintenance contract, which is typically twelve months. We provide consulting and training services on a time and materials basis and recognize revenues as we perform the services.

          At the time of the transaction, management assesses whether the fee associated with our revenue transactions is fixed or determinable and whether or not collection is reasonably assured. The assessment of whether the fee is fixed or determinable is based upon the payment terms of the transaction. If a significant portion of a fee is due after our normal payment terms or upon implementation or client acceptance, the fee is accounted for as not being fixed or determinable. In these cases, revenue is recognized as the fees become due or after implementation or client acceptance has occurred.

          Collectability is assessed based on a number of factors, including past transaction history with the client and the creditworthiness of the client. If it is determined that collection of a fee is not reasonably assured, the fee is deferred and revenue is recognized at the time collection becomes reasonably assured, which is generally upon receipt of cash. Under a typical contract for Cardiac Safety services, clients pay us a portion of our fee for these services upon contract execution as an upfront deposit, some of which is typically nonrefundable upon contract termination. Revenues are then recognized under Cardiac Safety service contracts as the services are performed.

          For arrangements with multiple deliverables where the fair value of each element is known, the revenue is allocated to each component based on the relative fair values of each element. For arrangements with multiple deliverables where the fair value of one or more delivered elements is not known, revenue is allocated to each component of the arrangement using the residual method provided that the fair value of all undelivered elements is known. Fair values for undelivered elements are based primarily upon stated renewal rates for future products or services.

Property and Equipment

          Pursuant to SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” we capitalize costs associated with internally developed or purchased software systems for new products and enhancements to existing products that have reached the application development stage and meet recoverability tests. These costs are included in property and equipment. Capitalized costs include external direct costs of materials and services utilized in developing or obtaining internal-use software, and payroll and payroll-related expenses for employees who are directly associated with and devote time to the internal-use software project.

          Amortization of capitalized software development costs is charged to cost of revenues. Amortization of capitalized software development costs was $0.2 million and $0.7 million for the three months ended September 30, 2006 and 2007, respectively, and $1.0 million and $2.2 million for the nine months ended September 30, 2006 and 2007, respectively. For the nine months ended September 30, 2006 and 2007, we capitalized $3.6 million and $1.4 million, respectively, of software development costs related to labor and consulting and $0 and $1.7 million, respectively, related to capitalized software. As of September 30, 2007, $3.1 million of capitalized costs have not yet been placed in service and are therefore not being amortized.

          The largest component of property and equipment is cardiac safety equipment. Our clients use the cardiac safety equipment to perform the ECG and Holter recordings, and it also provides the means to send such recordings to eRT. We provide this equipment to clients primarily through rentals via cancellable agreements and, in some cases, through non-recourse equipment sales. The equipment rentals and sales are included in, or associated with, our Cardiac Safety services agreements with our clients and the decision to rent or buy equipment is made by our clients prior to the start of the cardiac safety study. The decision to buy rather than rent is usually predicated upon the economics to the client based upon the length of the study and the number of ECGs to be performed each month. The longer the study and the fewer the number of ECGs performed, the more likely it is that the client may request to purchase cardiac safety equipment rather than rent. Regardless of whether the client rents or buys the cardiac safety equipment, we consider the resulting cash flow to be part of our operations and reflect it as such in our consolidated statements of cash flows.

     Our Cardiac Safety services agreements contain multiple elements. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting. In doing so, we consider factors, such as whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes and, if so, how the contract value should be allocated among the deliverable elements and when to recognize revenue for each element. We recognize revenue for delivered elements only when the fair values of undelivered elements are known, uncertainties regarding client acceptance are resolved and there are no client-negotiated refund or return rights affecting the revenue recognized for delivered elements.

          The gross cost for cardiac safety equipment was $29.2 million and $36.3 million at December 31, 2006 and September 30, 2007, respectively. The accumulated depreciation for cardiac safety equipment was $15.2 million and $20.1 million at December 31, 2006 and September 30, 2007, respectively.

          Prior to 2007, a portion of our cardiac safety equipment was obtained under operating leases. During the first quarter of 2007, we entered into an agreement to purchase all of our leased cardiac safety equipment at an established price at the end of each lease schedule’s term, rather than return the equipment at that time. As a result, in accordance with Statement of Financial Accounting Standards (SFAS) No. 13, “Accounting for Leases,” we re-evaluated the classification of the leases and

determined that the classification should be converted from operating leases to capital leases. As a result, we recorded a non-cash addition to property, plant and equipment of $3.6 million and $3.6 million of capital lease obligations.

Long-lived Assets

          In accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” when events or circumstances so indicate, we assess the potential impairment of our long-lived assets based on anticipated undiscounted cash flows from the assets. Such events and circumstances include a sale of all or a significant part of the operations associated with the long-lived asset, or a significant decline in the operating performance of the asset. If an impairment is indicated, the amount of the impairment charge would be calculated by comparing the anticipated discounted future cash flows to the carrying value of the long-lived asset. No impairment was indicated during either of the nine-month periods ended September 30, 2006 or September 30, 2007.

Software Development Costs

          Research and development expenditures are charged to operations as incurred. SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,” requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility. Since software development costs have not been significant after the establishment of technological feasibility, all such costs have been charged to expense as incurred.

Stock-Based Compensation

Accounting for Stock-Based Compensation

          On January 1, 2006, we adopted the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), which requires that the costs resulting from all share-based payment transactions be recognized in the financial statements at their fair values. We adopted SFAS No. 123R using the modified prospective application method under which the provisions of SFAS No. 123R apply to new awards and to awards modified, repurchased or cancelled after the adoption date. Additionally, compensation cost for the portion of the awards for which the requisite service had not been rendered that were outstanding as of January 1, 2006 is recognized in the Consolidated Statements of Operations over the remaining service period after such date based on the award’s original estimate of fair value. The aggregate share-based compensation expense recorded in the Consolidated Statements of Operations for the three and nine months ended September 30, 2006 under SFAS No. 123R was $0.7 million and $2.3 million, respectively. The aggregate share-based compensation expense recorded in the Consolidated Statements of Operations for the three and nine months ended September 30, 2007 under SFAS No. 123R was $0.4 million and $1.6 million, respectively. For the three months ended September 30, 2006, this additional share-based compensation lowered pre-tax earnings by $0.7 million, lowered net income by $0.6 million and lowered basic and diluted earnings per share by $0.01. For the three months ended September 30, 2007, this additional share-based compensation lowered pre-tax earnings by $0.4 million, lowered net income by $0.4 million and lowered basic and diluted earnings per share by $0.01. For the nine months ended September 30, 2006, this additional share-based compensation lowered pre-tax earnings by $2.3 million, lowered net income by $1.9 million and lowered basic and diluted earnings per share by $0.04. For the nine months ended September 30, 2007, this additional share-based compensation lowered pre-tax earnings by $1.6 million, lowered net income by $1.3 million and lowered basic and diluted earnings per share by $0.03. SFAS No. 123R also amended SFAS No. 95, “Statement of Cash Flows,” to require that tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

Valuation Assumptions for Options Granted

          The fair value of each stock option granted during the nine months ended September 30, 2006 and 2007 was estimated at the date of grant using Black-Scholes, assuming no dividends and using the weighted-average valuation assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees. Expected volatility was based on historical volatility for a period equal to the stock option’s expected life, calculated on a daily basis.

		2006				2007
Risk-free interest rate			4.82	%			4.68	%
Expected dividend yield			0.00	%			0.00	%
Expected life		3.5 years				3.5 years
Expected volatility			59.68	%			55.89	%

          The above assumptions were used to determine the weighted-average per share fair value of $6.15 and $3.38 for stock options granted during the first nine months of 2006 and 2007, respectively.

Stock Option Plans

     In 1996, we adopted a stock option plan (the “1996 Plan”) that authorized the grant of both incentive and non-qualified options to acquire up to 3,375,000 shares of the Company’s common stock. Our Board of Directors determined the exercise price of the options under the 1996 Plan. The exercise price of incentive stock options was not below the fair value of the common stock on the grant date. Incentive stock options under the 1996 Plan expire ten years from the grant date and are exercisable in accordance with vesting provisions set by the Board, which generally are over three to five years. In May 1999, the stockholders approved an amendment to the 1996 Plan that increased the number of shares which could be acquired through option grants under the 1996 Plan by 4,050,000 to 7,425,000 and provided for an annual option grant of 5,000 shares to each outside director. In April 2001, the stockholders approved an amendment to the 1996 Plan that increased the number of shares which could be acquired through option grants under the 1996 Plan by 2,025,000 to 9,450,000. No additional options have been granted under this plan, as amended, since December 31, 2003 and no additional options may be granted thereunder in accordance with the terms of the 1996 Plan.

     In May 2003, the stockholders approved a new stock option plan (the “2003 Plan”) that authorized the grant of both incentive and non-qualified options to acquire shares of our common stock and provided for an annual option grant of 10,000 shares to each outside director. The Compensation Committee of our Board of Directors determines the recipients of option grants, the exercise price and other terms of the options under the 2003 Plan. The exercise price of incentive stock options may not be set below the fair value of the common stock on the grant date. Incentive stock options under the 2003 Plan expire ten years from the grant date, or at the end of such shorter period as may be designated by the Compensation Committee, and are exercisable in accordance with vesting provisions set by the Compensation Committee, which generally are over four years. In April 2006, the stockholders approved an amendment to the 2003 Plan that increased the number of shares which could be acquired through option grants under the 2003 Plan by 3,500,000. In accordance with the terms of the 2003 Plan, there are a total of 7,318,625 shares reserved for issuance under the 2003 Plan. The Company normally issues new shares to satisfy option exercises under these plans. On February 15, 2007, the Board of Directors of the Company, based on the recommendation of the Compensation Committee, adopted, subject to stockholder approval at the Annual Meeting, the Company’s Amended and Restated 2003 Equity Incentive Plan (the “2003 Equity Plan”). On April 26, 2007, the stockholders approved the adoption of the Plan. The 2003 Equity Plan amended the Company’s existing 2003 Plan in two material respects. First, it prohibits repricing of any stock options granted under the Plan unless the stockholders approve such repricing. Second, it permits awards of stock appreciation rights, restricted stock, long term performance awards and performance shares in addition to grants of stock options.

     On February 7, 2006, we entered into a new employment agreement with our former President and Chief Executive Officer in connection with the announcement of his retirement from his position as President and Chief Executive Officer and Director of the Company. His employment terminated on September 11, 2006 and any options not then exercisable became exercisable in full. As a result of this modification to his option terms, we revalued his options as of February 7, 2006 and amortized the resulting expense through September 11, 2006. This change resulted in additional pre-tax compensation expense of $0.3 million in the first nine months of 2006.

     Information with respect to outstanding options under our plans is as follows:

						Weighted				Remaining				Intrinsic
						Average				Contractual				Value
		Shares				Exercise Price				Term				(in thousands)
Outstanding as of January 1, 2007			4,387,033			$	8.56
Granted			599,900				7.54
Exercised			(498,708	)			3.21
Cancelled/forfeited			(344,652	)			16.12
Outstanding as of September 30, 2007			4,143,573				7.68				5.0			$	19,937
Options exercisable or expected to vest at September 30, 2007			3,974,257				8.37				5.0			$	19,564
Options exercisable at September 30, 2007			3,014,798				7.68				4.8			$	17,447

     The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing common stock price on the last trading day of the third quarter of 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2007. This amount changes based on the fair market value of the Company’s common stock. The total intrinsic value of options exercised for the nine months ended September 30, 2006 and 2007 was $10.6 million and $2.4 million, respectively.

     As of September 30, 2007, there was $3.8 million of total unrecognized compensation cost related to non-vested stock options granted under the plans. That cost is expected to be recognized over a weighted-average period of 2.3 years.

Tax Effect Related to Stock-based Compensation Expense

     SFAS No. 123R provides that income tax effects of share-based payments are recognized in the financial statements for those awards that will normally result in tax deductions under existing tax law. Under current U.S. federal tax law, we receive a compensation expense deduction related to non-qualified stock options only when those options are exercised. Accordingly, the financial statement recognition of compensation cost for non-qualified stock options creates a deductible temporary difference which results in a deferred tax asset and a corresponding deferred tax benefit in the statement of operations. We do not recognize a tax benefit for compensation expense related to incentive stock options (ISOs) unless the underlying shares are disposed of in a disqualifying disposition. Accordingly, compensation expense related to ISOs is treated as a permanent difference for income tax purposes. The tax benefit recognized in our Consolidated Statement of Operations in the nine months ended September 30, 2007 related to stock-based compensation expense was approximately $0.3 million. There was no tax benefit recognized in the nine months ended September 30, 2006.

Note 3. Net Income per Common Share

     Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period, adjusted for the dilutive effect of common stock equivalents, which consist of stock options. The dilutive effect of stock options is calculated using the treasury stock method.

     The tables below set forth the reconciliation of the numerators and denominators of the basic and diluted net income per share computations (in thousands, except per share amounts):

		Net								Per Share
Three Months Ended September 30,		Income				Shares				Amount
2006
Basic net income		$	2,465				49,540			$	0.05
Effect of dilutive shares			—				1,836				—
Diluted net income		$	2,465				51,376			$	0.05
2007
Basic net income		$	3,706				50,594			$	0.07
Effect of dilutive shares			—				1,235				—
Diluted net income		$	3,706				51,829			$	0.07

		Net								Per Share
Nine Months Ended September 30,		Income				Shares				Amount
2006
Basic net income		$	6,066				49,302			$	0.12
Effect of dilutive shares			—				2,223				—
Diluted net income		$	6,066				51,525			$	0.12
2007
Basic net income		$	10,093				50,430			$	0.20
Effect of dilutive shares			—				1,251				—
Diluted net income		$	10,093				51,681			$	0.20

     In computing diluted net income per share, options to purchase 1,877,000 and 1,276,000 shares of common stock were excluded from the computations for the three months ended September 30, 2006 and 2007, respectively and options to purchase 1,436,000 and 1,593,000 shares of common stock were excluded from the computations for the nine months ended September 30, 2006 and 2007, respectively. These options were excluded from the computations because the exercise prices of such options were greater than the average market price of our common stock during the respective period.

Note 4. Comprehensive Income

     SFAS No. 130, “Reporting Comprehensive Income,” requires companies to classify items of other comprehensive income by their nature in the financial statements and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the stockholders’ equity section of the balance sheet. Our comprehensive income includes net income and unrealized gains and losses from foreign currency translation as follows (in thousands):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2006				2007				2006				2007
Net income		$	2,465			$	3,706			$	6,066			$	10,093
Other comprehensive income:
Currency translation adjustment			(173	)			222				502				451
Comprehensive income, net of tax		$	2,292			$	3,928			$	6,568			$	10,544

Note 5. Recent Pronouncements

     In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements,” which establishes a framework for reporting fair value and expands disclosures about fair value measurements. SFAS No. 157 becomes effective beginning with our first quarter 2008 fiscal period. We are currently evaluating the potential impact of this standard.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 allows companies to elect to measure certain assets and liabilities at fair value and is effective for fiscal years beginning after November 15, 2007. This standard is not expected to have any impact on our financial condition or results of operations.

Note 6. Income Taxes

     We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) an interpretation of SFAS 109, on January 1, 2007. We did not recognize any adjustment in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48. At the adoption date, we had $0.8 million of unrecognized tax benefits, all of which would affect our effective tax rate if recognized. At September 30, 2007, we had $1.0 million of unrecognized tax benefits under the provisions of FIN 48. We recognize interest and penalties related to unrecognized tax benefits in income tax expense. The tax years 2003 through 2006 remain open to examination by the major taxing jurisdictions to which we are subject.

Note 7. Commitments and Contingencies

Royalties

     In the second quarter of 2007, we entered into a long-term strategic relationship with Healthcare Technology Systems, Inc. (HTS), a leading authority in the research, development and validation of computer administered clinical rating instruments. The strategic relationship includes the exclusive licensing (subject to one pre-existing license agreement) of 57 interactive voice response (IVR) clinical assessments offered by HTS along with HTS’s IVR system. As of September 30, 2007, we paid HTS $1.5 million for the license and a $0.25 million advanced payment against future royalties. Royalty payments will be made to HTS based on the level of revenues received from the assessments and the IVR system. An additional $0.75 million of royalty payments are guaranteed, and will be made in two payments — the later of (i) 12 months from the date of the first EXPeRT^® ePRO™ sale and (ii) when the system is validated, and 6 months after this date. Any royalties earned by HTS will be applied against these payments. After these two payments are made, all future payments to HTS will be royalty payments based on revenues received from EXPeRT^® ePRO™ sales.

Note 8. Operating Segments / Geographic Information

     We consider our operations to consist of one segment as this represents management’s view of our operations. We operate on a worldwide basis with two locations in the United States and one location in the United Kingdom, which are categorized below as North America and Europe, respectively. The majority of our revenues are allocated based upon the profit split transfer pricing methodology.

     Geographic information is as follows (in thousands of dollars):

		Three Months Ended September 30, 2006
		North
		America				Europe				Total
License revenues		$	602			$	—			$	602
Service revenues			11,813				2,680				14,493
Site support revenues			5,304				1,827				7,131
Net revenues from external customers		$	17,719			$	4,507			$	22,226
Operating income		$	3,271			$	262			$	3,533
Long-lived assets		$	21,361			$	8,363			$	29,724
Identifiable assets		$	90,784			$	16,132			$	106,916

		Three Months Ended September 30, 2007
		North
		America				Europe				Total
License revenues		$	651			$	—			$	651
Service revenues			13,108				3,345				16,453
Site support revenues			4,473				2,394				6,867
Net revenues from external customers		$	18,232			$	5,739			$	23,971
Operating income		$	4,428			$	933			$	5,361
Long-lived assets		$	25,574			$	7,553			$	33,127
Identifiable assets		$	112,552			$	20,201			$	132,753

		Nine Months Ended September 30, 2006
		North
		America				Europe				Total
License revenues		$	2,336			$	—			$	2,336
Service revenues			34,255				7,785				42,040
Site support revenues			16,391				5,676				22,067
Net revenues from external customers		$	52,982			$	13,461			$	66,443
Operating income		$	8,005			$	815			$	8,820
Long-lived assets		$	21,361			$	8,363			$	29,724
Identifiable assets		$	90,784			$	16,132			$	106,916

		Nine Months Ended September 30, 2007
		North
		America				Europe				Total
License revenues		$	2,013			$	—			$	2,013
Service revenues			38,415				9,567				47,982
Site support revenues			13,153				6,641				19,794
Net revenues from external customers		$	53,581			$	16,208			$	69,789
Operating income		$	12,329			$	2,379			$	14,708
Long-lived assets		$	25,574			$	7,553			$	33,127
Identifiable assets		$	112,552			$	20,201			$	132,753

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

Cautionary Statement for Forward-Looking Information

     The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes to the consolidated financial statements appearing elsewhere in this Form 10-Q. The following discussion includes a number of forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995 that reflect our current views with respect to future events and financial performance. We use words such as anticipate, believe, expect, intend and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. These forward-looking statements are subject to risks and uncertainties such as competitive factors, technology development, market demand and our ability to obtain new contracts and accurately estimate net revenues due to uncertain regulatory guidance, variability in size, scope and duration of projects and internal issues at the sponsoring client. These and other risk factors have been further discussed in our Form 10-K for the year ended December 31, 2006. Such risks and uncertainties could cause actual results to differ materially from historical results or future predictions. Further information on potential factors that could affect our financial results can be found throughout this Form 10-Q and our other reports filed with the Securities and Exchange Commission.

Overview

     We were founded in 1977 to provide Cardiac Safety services to evaluate the safety of new drugs. We provide technology and services that enable the pharmaceutical, biotechnology and medical device industries to collect, interpret and distribute cardiac safety and clinical data more efficiently. We are a market leader in providing centralized electrocardiographic services (Cardiac Safety services or EXPeRT^® ECG services) and a leading provider of technology and services that streamline the clinical trials process by enabling our clients to evolve from traditional, paper-based methods to electronic processing using our eClinical products and services.

     Our solutions improve the accuracy, timeliness and efficiency of trial set-up, data collection from sites worldwide, data interpretation and new drug, biologic and device application submissions. We offer Cardiac Safety services, which are utilized by sponsors and clinical research organizations (CROs) during the conduct of clinical trials. These services include the centralized collection, evaluation, and reporting of electrocardiograms (ECG) and continuous Holter recordings performed in Phase I through Phase IV clinical trials. Thorough QTc studies are comprehensive studies that typically are of large volume and of short duration, with ECGs performed over a two- to six-month period. The Digital ECG Franchise program was designed to address the capacity demands for eRT’s ECG services through partnerships with sponsors that desired dedicated resources within eRT to address specific levels of cardiac safety monitoring transactions. In 2006, we decided to discontinue the offering of the Digital ECG Franchise program as we feel we can offer our clients a better value proposition in other ways in the current operating environment. Our cardiac safety services are supported by an integrated Project Assurance methodology to provide study management including logistical support to clinical sites, including the rental and sale of cardiac safety equipment along with related supplies and freight. We also offer cardiac safety consulting services through our eRT Consulting Group. Additionally, we offer the licensing and, at the client’s option, hosting of our proprietary eClinical software products and the provision of maintenance and consulting services in support of our proprietary eClinical software products. We offer the following products and services on a global basis:

EXPeRT^® Cardiac Safety. EXPeRT^® Cardiac Safety services provide for workflow-enabled cardiac safety data collection, interpretation and distribution of electrocardiographic (ECG) data and images as well as for analysis and cardiologist interpretation of ECGs performed on research subjects in connection with our clients’ clinical trials. In addition, we establish rules for standardized, semi-automated and automated workflow management, allowing audit trail accounting and generating safety and operational metrics reports for sponsors and investigators. Also included in EXPeRT^® Cardiac Safety services is FDA XML delivery, which provides for the delivery of ECGs in a format compliant with the United States Food and Drug Administration’s XML standard for digital ECGs. We also provide ECG equipment through rental and sales to clients to perform the ECG recordings and give them means to send such recordings to us.

eClinical™. The process of designing, implementing and managing a clinical trial requires a well defined process and set of supporting products to effectively handle the variety of tasks and information comprising a clinical trial. eRT provides a suite of products to address the capture, management and dissemination of clinical trial data. Our integrated suite is comprised of the following:

	•		eResearch Community™ (eRC™) is an easy to use portal application that provides real-time information related to monitoring clinical trial activities, data quality and safety.
	•		eData Entry™ (eDE™) technology provides a comprehensive electronic data capture (EDC) system comprised of technology and consulting services formulated to deliver rapid time to benefit for electronic trial initiatives.
	•		eData Management™ (eDM™) is a clinical data management application for collecting, cleaning and managing clinical trial data.
	•		eSafety Net™ (eSN™) is an adverse event management system enabling the generation of key regulatory reports, including CIOMS and Medwatch.
	•		eStudy Conduct™ (eSC™) is a clinical trial management technology that can be used to set up clinical trials, establish standards, track study activities, plan resources, distribute supplies, manage the financial aspects of a trial and electronically view clinical trial data.

EXPeRT^® ePRO™. EXPeRT^® ePRO™ is an Integrated Voice Response (IVR) system that allows subjects to easily and quickly report data for a clinical trial. Because it can be accessed from a standard phone, the EXPeRT^® ePRO™ system is cost effective while being extremely scalable and suitable from Phases I through Phase IV. Diaries, screening, recruitment and all clinical assessments can be completed directly by the subject without requiring clinician involvement.

Project Assurance/Implementation Assurance. We provide a full spectrum of consulting services for all of our products that augment the study management and implementation efforts of clients in support of their clinical research requirements.

     Our license revenues consist of license fees for perpetual licenses and monthly and annual term licenses. Our services revenues consist of Cardiac Safety services, technology consulting and training services and software maintenance services. Our site support revenues consist of cardiac safety equipment rentals and sales along with related supplies and freight.

     We recognize software revenues in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Accordingly, we recognize up-front license fee revenues under the residual method when a formal agreement exists, delivery of the software and related documentation has occurred, collectability is probable and the license fee is fixed or determinable. We recognize monthly and annual license fee revenues over the term of the arrangement. Hosting service fees are recognized evenly over the term of service. Cardiac Safety services revenues consist of services that we provide on a fee for services basis and are recognized as the services are performed. Site support revenues are recognized at the time of sale or over the rental period. We recognize revenues from software maintenance contracts on a straight-line basis over the term of the maintenance contract, which is typically twelve months. We provide consulting and training services on a time and materials basis and recognize revenues as we perform the services.

     For arrangements with multiple deliverables where the fair value of each element is known, the revenue is allocated to each component based on the relative fair values of each element. For arrangements with multiple deliverables where the fair value of one or more delivered elements is not known, revenue is allocated to each component of the arrangement using the residual method provided that the fair value of all undelivered elements is known. Fair values for undelivered elements are based primarily upon stated renewal rates for future products or services.

     Cost of licenses consists primarily of application service provider (ASP) fees for those clients that choose hosting, the cost of producing compact disks and related documentation and royalties paid to third parties in connection with their contributions to our product development. Cost of services includes the cost of Cardiac Safety services and the cost of technology consulting, training and maintenance services. Cost of Cardiac Safety services consists primarily of direct costs related to our centralized Cardiac Safety services and includes wages, depreciation and other direct operating costs. Cost of technology consulting, training and maintenance services consists primarily of wages, fees paid to outside consultants and

other direct operating costs related to our consulting and client support functions. Cost of site support consists primarily of wages, cardiac safety equipment rent and depreciation, related supplies, cost of equipment sold, shipping expenses and other direct operating costs. Selling and marketing expenses consist primarily of wages and commissions paid to sales personnel, travel expenses and advertising and promotional expenditures. General and administrative expenses consist primarily of wages and direct costs for our finance, administrative, corporate information technology, legal and executive management functions, in addition to professional service fees and corporate insurance. Research and development expenses consist primarily of wages paid to our product development staff, costs paid to outside consultants and direct costs associated with the development of our technology products.

     We conduct our operations through offices in the United States (U.S.) and the United Kingdom (UK). Our international net revenues represented approximately 20% and 23% of total net revenues for the nine months ended September 30, 2006 and 2007, respectively. The majority of our revenues are allocated among our geographic segments based upon the profit split transfer pricing methodology, and revenues are generally attributed to the geographic segment where the work is performed.

Results of Operations

Executive Overview

We reported revenues of $24.0 million for the third quarter of 2007, a 7.9% increase from $22.2 million in the third quarter of 2006. The revenue for 2006 included the recognition of $1.2 million in revenue for the ending of a franchise agreement. The total ECG volume was up 40% in the third quarter of 2007 as compared to the third quarter of 2006. Equipment sales were $969,000 in the third quarter of 2007 compared to $1,812,000 in the third quarter of 2006.

Gross margin percentage in the third quarter of 2007 was 48.0% compared to 49.2% in the third quarter of 2006. The gross margin in 2006 was favorably affected by the recognition of $1.2 million for the ending of a franchise agreement. Pre-tax income margin in the third quarter of 2007 was 24.8% compared to 17.4% in the third quarter of 2006. Our tax rate for the third quarter of 2007 was 37.7% compared to 36.3% in the third quarter of 2006.

Net income was $3.7 million for the third quarter of 2007, a 50.3% increase from $2.5 million in the third quarter of 2006. This resulted in net income per diluted share of $0.07 in the third quarter of 2007, compared to $0.05 in the third quarter of 2006.

For the nine months ended September 30, 2007, we reported revenues of $69.8 million compared to $66.4 million for the nine months ended September 30, 2006. Our gross margin percentage for the nine months ended September 30, 2007 was 49.9% compared to 49.1% for the nine months ended September 30, 2006. Pre-tax income margin for the nine months ended September 30, 2007 was 23.5% compared to 14.9% for the nine months ended September 30, 2006. Our tax rate was 38.5% for the nine months ended September 30, 2007 compared to 38.6% for the nine months ended September 30, 2006.

Net income of $10.1 million, or $0.20 per diluted share, for the nine months ended September 30, 2007 compared to net income of $6.1 million, or $0.12 per diluted share, for the nine months ended September 30, 2006.

On November 1, 2007, we announced backlog of $115.0 which represents a 23.4% growth in our backlog as of September 30, 2007 compared to September 30, 2006. The annualized cancellation rate for the third quarter of 2007 was 13.4%. The $35.5 million in new bookings of contracts and work orders in the third quarter of 2007 represented a 40.3% increase from the same quarter a year ago. The book-to-bill ratio for the third quarter was 1.5, an increase from the book-to-bill ratio of 1.4 in the second quarter of 2007 and 1.1 in the third quarter of 2006.

     The following table presents certain financial data as a percentage of total net revenues:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2006				2007				2006				2007
Net revenues:
Licenses			2.7	%			2.7	%			3.5	%			2.9	%
Services			65.2	%			68.6	%			63.3	%			68.7	%
Site support			32.1	%			28.7	%			33.2	%			28.4	%
Total net revenues			100.0	%			100.0	%			100.0	%			100.0	%
Costs of revenues:
Cost of licenses			0.3	%			0.3	%			0.3	%			0.3	%
Cost of services			30.0	%			31.6	%			28.8	%			31.0	%
Cost of site support			20.5	%			20.1	%			21.8	%			18.8	%
Total costs of revenues			50.8	%			52.0	%			50.9	%			50.1	%
Gross margin			49.2	%			48.0	%			49.1	%			49.9	%
Operating expenses:
Selling and marketing			11.1	%			10.4	%			13.1	%			11.6	%
General and administrative			17.8	%			10.5	%			17.7	%			12.7	%
Research and development			4.4	%			4.7	%			5.0	%			4.5	%
Total operating expenses			33.3	%			25.6	%			35.8	%			28.8	%
Operating income			15.9	%			22.4	%			13.3	%			21.1	%
Other income, net			1.5	%			2.4	%			1.6	%			2.4	%
Income before income taxes			17.4	%			24.8	%			14.9	%			23.5	%
Income tax provision			6.3	%			9.3	%			5.8	%			9.0	%
Net income			11.1	%			15.5	%			9.1	%			14.5	%

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2007.

     The following table presents our consolidated statements of operations with product line detail (dollars in thousands):

		Three Months Ended September 30,
		2006				2007				Increase (Decrease)
Licenses:
Net revenues		$	602			$	651			$	49				8.1	%
Costs of revenues			75				70				(5	)			(6.7	%)
Gross margin		$	527			$	581			$	54				10.2	%
Services:
Cardiac Safety
Net revenues		$	12,668			$	14,927			$	2,259				17.8	%
Costs of revenues			5,913				6,918				1,005				17.0	%
Gross margin		$	6,755			$	8,009			$	1,254				18.6	%
Technology consulting and training
Net revenues		$	859			$	676			$	(183	)			(21.3	%)
Costs of revenues			502				446				(56	)			(11.2	%)
Gross margin		$	357			$	230			$	(127	)			(35.6	%)
Software maintenance
Net revenues		$	966			$	850			$	(116	)			(12.0	%)
Costs of revenues			259				203				(56	)			(21.6	%)
Gross margin		$	707			$	647			$	(60	)			(8.5	%)
Total services
Net revenues		$	14,493			$	16,453			$	1,960				13.5	%
Costs of revenues			6,674				7,567				893				13.4	%
Gross margin		$	7,819			$	8,886			$	1,067				13.6	%
Site support:
Net revenues		$	7,131			$	6,867			$	(264	)			(3.7	%)
Costs of revenues			4,548				4,831				283				6.2	%
Gross margin		$	2,583			$	2,036			$	(547	)			(21.2	%)
Total
Net revenues		$	22,226			$	23,971			$	1,745				7.9	%
Costs of revenues			11,297				12,468				1,171				10.4	%
Gross margin			10,929				11,503				574				5.3	%
Operating expenses:
Selling and marketing			2,471				2,487				16				0.6	%
General and administrative			3,945				2,527				(1,418	)			(35.9	%)
Research and development			980				1,128				148				15.1	%
Total operating expenses			7,396				6,142				(1,254	)			(17.0	%)
Operating income			3,533				5,361				1,828				51.7	%
Other income, net			339				584				245				72.3	%
Income before income taxes			3,872				5,945				2,073				53.5	%
Income tax provision			1,407				2,239				832				59.1	%
Net income		$	2,465			$	3,706			$	1,241				50.3	%

     The following table presents costs of revenues as a percentage of related net revenues and operating expenses as a percentage of total net revenues:

		Three Months Ended September 30,								Increase
		2006				2007				(Decrease)
Cost of licenses			12.5	%			10.8	%			(1.7	%)
Cost of services:
Cardiac Safety			46.7	%			46.3	%			(0.4	%)
Technology consulting and training			58.4	%			66.0	%			7.6	%
Software maintenance			26.8	%			23.9	%			(2.9	%)
Total cost of services			46.1	%			46.0	%			(0.1	%)
Cost of site support			63.8	%			70.4	%			6.6	%
Total costs of revenues			50.8	%			52.0	%			1.2	%
Operating expenses:
Selling and marketing			11.1	%			10.4	%			(0.7	%)
General and administrative			17.8	%			10.5	%			(7.3	%)
Research and development			4.4	%			4.7	%			0.3	%

     The increase in Cardiac Safety service revenues was primarily due to additional transactions performed in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006, partially offset by the recognition of the balance of deferred revenues of $1.2 million that remained upon the termination of a Digital ECG Franchise at the end of August 2006 as well as a decrease in average revenue per transaction that was largely due to the impact of increased activity in semi-automated processing, which generally includes lower fees per transaction than other studies, as well as competitive pricing pressure. Additionally, Cardiac Safety service revenue in the three months ended September 30, 2007 included $0.7 million of cardiac safety consulting services revenue, which was a new revenue source to eRT beginning in 2007. Beginning in 2007, we have an arrangement with a company owned by our chairman, Dr. Morganroth, whereby we will pay Dr. Morganroth’s company between 80% to 90% of the net amounts billed to certain customers for performing a portion of the consulting services provided on our behalf to those customers.

     The decrease in technology consulting and training revenues was primarily related to a $0.3 reduction in Clinical Data protocol set-up work in 2007 as compared to 2006 which is partially offset by additional revenue from Cardiac Safety service customers for reporting configuration, which is consistent with the increase in Cardiac Safety activity.

     Software maintenance revenues decreased due to the cancellation and non-renewals of maintenance agreements and a reduction in the number of users. Our current sales focus is on monthly and annual term license sales rather than perpetual license sales, which will lead to the erosion of maintenance revenue over time. Monthly and annual term license sales do not generate maintenance revenue as the license fee includes product upgrades and customer support.

     Site support revenues decreased primarily due to a $0.8 million decrease in the sale of cardiac safety equipment in the third quarter of 2007 as compared to the third quarter of 2006. Partially offsetting this decrease was an increase in freight revenue of $0.5 million related to the additional units rented and improvements in identifying recoverable freight costs and a $0.1 million increase in the rental of cardiac safety equipment due to an increase in the number of units rented, but at a lower average price.

     The increase in the cost of Cardiac Safety services was primarily due to $0.6 million in consulting costs related to cardiac safety consulting revenue discussed above, a $0.5 million increase in depreciation expense related to the EXPeRT^® 2 which was placed into production in January 2007, a $0.3 million increase in bonus expense as certain bonus targets are expected to be met in 2007 while there was no bonus in 2006 and a $0.2 million increase in labor. Partially offsetting the increase was a $0.3 million decrease in telecommunications expense due to unanticipated additional third-party service charges in 2006 for services previously provided. The decrease in the cost of Cardiac Safety services as a percentage of Cardiac Safety service revenues reflects the fact that some of the costs do not necessarily change in direct relation with changes in revenue.

     The increase in the cost of site support, both in absolute terms and as a percentage of site support revenues, was primarily due to a $0.5 million increase in freight associated with additional shipments of equipment as well as smaller increases in the costs of supplies and labor. Partially offsetting this decrease was a $0.4 million decrease in the cost of equipment sales commensurate with the decrease in revenue from equipment sales.

     The decrease in general and administrative expenses, both in absolute terms and as a percentage of total net revenues, was due primarily to $0.6 million of costs associated with management changes in the second quarter of 2006, a $0.2 million charitable contribution in 2006, a $0.2 million reduction in labor due to headcount reductions in 2007 and decreases in stock option compensation expense, telecommunications expense, depreciation and legal fees.

     The increase in research and development expenses, both in absolute terms and as a percentage of total net revenues, was primarily due to a $0.2 million reduction in the capitalization of salaries for internal-use software projects.

     Other income, net, consisted primarily of interest income realized from our cash, cash equivalents and investments, interest expense related to capital lease obligations and foreign exchange losses. Other income, net increased primarily due to higher interest income in the third quarter of 2007 due to higher average interest rates and cash balances.

     Our effective tax rate was 36.3% and 37.7% for the three months ended September 30, 2006 and 2007, respectively. We expect our effective tax rate for the fourth quarter of 2007 to be approximately 39.0%. The tax rate for the three months ended September 30, 2006 included a tax benefit of approximately $82,000 related to the reconciliation of the 2005 tax provision to the 2005 tax return and an adjustment to the year-to-date effective tax rate, primarily due to a reforecast of tax-exempt interest. The tax rate for the three months ended September 30, 2007 included a tax benefit of approximately $0.1 million related to the reconciliation of the 2006 tax provision to the 2006 U.S. federal tax return.

Nine months Ended September 30, 2006 Compared to Nine months Ended September 30, 2007.

     The following table presents our consolidated statements of operations with product line detail (dollars in thousands):

		Nine Months Ended September 30,
		2006				2007				Increase (Decrease)
Licenses:
Net revenues		$	2,336			$	2,013			$	(323	)			(13.8	%)
Costs of revenues			228				199				(29	)			(12.7	%)
Gross margin		$	2,108			$	1,814			$	(294	)			(13.9	%)
Services:
Cardiac Safety
Net revenues		$	37,030			$	43,376			$	6,346				17.1	%
Costs of revenues			16,964				19,699				2,735				16.1	%
Gross margin		$	20,066			$	23,677			$	3,611				18.0	%
Technology consulting and training
Net revenues		$	2,003			$	1,999			$	(4	)			(0.2	%)
Costs of revenues			1,401				1,268				(133	)			(9.5	%)
Gross margin		$	602			$	731			$	129				21.4	%
Software maintenance
Net revenues		$	3,007			$	2,607			$	(400	)			(13.3	%)
Costs of revenues			765				623				(142	)			(18.6	%)
Gross margin		$	2,242			$	1,984			$	(258	)			(11.5	%)
Total services
Net revenues		$	42,040			$	47,982			$	5,942				14.1	%
Costs of revenues			19,130				21,590				2,460				12.9	%
Gross margin		$	22,910			$	26,392			$	3,482				15.2	%
Site support:
Net revenues		$	22,067			$	19,794			$	(2,273	)			(10.3	%)
Costs of revenues			14,492				13,143				(1,349	)			(9.3	%)
Gross margin		$	7,575			$	6,651			$	(924	)			(12.2	%)
Total
Net revenues		$	66,443			$	69,789			$	3,346				5.0	%
Costs of revenues			33,850				34,932				1,082				3.2	%
Gross margin			32,593				34,857				2,264				6.9	%
Operating expenses:
Selling and marketing			8,687				8,079				(608	)			(7.0	%)
General and administrative			11,758				8,915				(2,843	)			(24.2	%)
Research and development			3,328				3,155				(173	)			(5.2	%)
Total operating expenses			23,773				20,149				(3,624	)			(15.2	%)
Operating income			8,820				14,708				5,888				66.8	%
Other income, net			1,067				1,703				636				59.6	%
Income before income taxes			9,887				16,411				6,524				66.0	%
Income tax provision			3,821				6,318				2,497				65.3	%
Net income		$	6,066			$	10,093			$	4,027				66.4	%

     The following table presents costs of revenues as a percentage of related net revenues and operating expenses as a percentage of total net revenues:

		Nine Months Ended September 30,								Increase
		2006				2007				(Decrease)
Cost of licenses			9.8	%			9.9	%			0.1	%
Cost of services:
Cardiac Safety			45.8	%			45.4	%			(0.4	%)
Technology consulting and training			69.9	%			63.4	%			(6.5	%)
Software maintenance			25.4	%			23.9	%			(1.5	%)
Total cost of services			45.5	%			45.0	%			(0.5	%)
Cost of site support			65.7	%			66.4	%			0.7	%
Total costs of revenues			50.9	%			50.1	%			(0.8	%)
Operating expenses:
Selling and marketing			13.1	%			11.6	%			(1.5	%)
General and administrative			17.7	%			12.7	%			(5.0	%)
Research and development			5.0	%			4.5	%			(0.5	%)

     License revenues decreased due to the sale of one significant license in 2006 with no comparable sale in 2007.

     The increase in Cardiac Safety service revenues was primarily due to additional transactions performed in 2007 as compared to 2006 partially offset by the recognition of the balance of deferred revenues of $1.2 million that remained upon the termination of a Digital ECG Franchise at the end of August 2006 as well as a decrease in average revenues per transaction. This decrease was largely due to the impact of increased activity in semi-automated processing, which generally includes lower fees per transaction than other studies, as well as competitive pricing pressure. Additionally, Cardiac Safety service revenue in the nine months ended September 30, 2007 included $1.2 million of cardiac safety consulting services revenue, which was a new revenue source to eRT beginning in 2007. There was also a $0.7 million increase in project management fees and a $0.5 million increase in miscellaneous revenue, commensurate with the increase in ECG transaction revenue.

     Software maintenance revenues decreased due to the cancellation and non-renewals of maintenance agreements and a reduction in the number of users. These declines were partially offset by maintenance on several software licenses sold during 2006 and 2007. Our current sales focus is on monthly and annual term license sales rather than perpetual license sales, which will lead to the erosion of maintenance revenue over time. Monthly and annual term license sales do not generate maintenance revenue as the license fee includes product upgrades and customer support.

     Site support revenues decreased primarily due to a $4.4 million decrease in the sale of cardiac safety equipment for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. Partially offsetting this decrease was a $1.1 million increase in the rental of cardiac safety equipment due to an increase in the number of units rented as well as an increase in freight revenue of $0.9 million related to the additional units rented.

     The increase in the cost of Cardiac Safety services was primarily due to a $1.2 million increase in depreciation expense related to the EXPeRT^® 2 which was placed into production in January 2007, $0.9 million in consulting costs related to cardiac safety consulting revenue discussed above, $0.6 million increase in bonus expense as certain bonus targets are expected to be met in 2007 while there was no bonus in 2006, $0.4 million increase in labor, and $0.2 million increase in software license and maintenance. Partially offsetting the increase were reductions of $0.1 million each in telecommunications, depreciation expense excluding EXPeRT^® 2, stock option compensation expense, pass-through costs and allocated expenses. The decrease in the cost of Cardiac Safety services as a percentage of Cardiac Safety service revenues reflects the fact that some of the costs do not necessarily change in direct relation with changes in revenue.

     The decrease in the cost of technology consulting and training revenues, both in absolute terms and as a percentage of technology consulting and training revenues, was the result of a number of small decreases in expenses such as labor, travel and placement fees.

     The decrease in the cost of software maintenance revenues, both in absolute terms and as a percentage of software maintenance revenues, was the result of lower labor costs due to reduced headcount.

     The decrease in the cost of site support was primarily due to a $2.5 million decrease in the cost of equipment sales commensurate with the decrease in revenue from equipment sales. Partially offsetting this decrease was a $0.9 million increase in freight and $0.2 million increase in supplies due to an increase in the number of units of equipment utilized by our clients. The increase in the cost of site support as a percentage of site support revenues reflects the fact that some of the costs do not necessarily change in direct relation with changes in revenue.

     The decrease in selling and marketing expenses, both in absolute terms and as a percentage of total net revenues, was primarily due to a $0.3 million decrease in bonus expense. In 2006, most of the selling staff was on a bonus plan that required the achievement of certain quarterly sales targets. In 2007, we implemented a commission plan under which payments are based upon a percentage of revenue earned. Payments under the commission plan will increase as signings convert into revenue (i.e. as work is performed for the contracts that were signed in the first nine months of 2007). There was also a $0.2 million decrease in labor costs due to reduced headcount in the nine months ended September 30, 2007. The decrease was also due to decreased stock option compensation expense and employee placement fees.

     The decrease in general and administrative expenses, both in absolute terms and as a percentage of total net revenues, was due primarily to $1.7 million of costs associated with management changes in the second quarter of 2006 and $0.6 million of costs in the first nine months of 2006 associated with the settlement of a contract dispute, for which there were no corresponding expenses in the first nine months of 2007. Additionally, there were decreases of $0.4 million in stock option compensation expense, $0.3 million in professional fees related to project and legal matters, $0.2 million in charitable contributions made in 2006 and not repeated in 2007 and $0.2 million in labor costs due to headcount reductions in 2007. Partially offsetting the decrease was $0.7 million in severance-related costs for employees terminated in February 2007.

     The decrease in research and development expenses, both in absolute terms and as a percentage of total net revenues, was primarily due to a $0.3 million decrease in expense for third-party consultants and a $0.3 million decrease in software license and maintenance expense. Smaller decreases totaling $0.3 million occurred in expenses such as labor, stock option compensation expense, allocated expenses, depreciation, training and placement fees. Partially offsetting the decrease was a reduction in the capitalization of salaries for internal-use software projects of $0.7 million.

     Other income, net, consisted primarily of interest income realized from our cash, cash equivalents and investments, interest expense related to capital lease obligations and foreign exchange losses. Other income, net, increased primarily due to higher interest income in the first nine months of 2007 as a result of higher average interest rates and cash balances.

     Our effective tax rate was 38.6% and 38.5% for the nine months ended September 30, 2006 and 2007, respectively. We expect our effective tax rate for the fourth quarter of 2007 to be approximately 39.0%.

Liquidity and Capital Resources

     At September 30, 2007, we had $27.2 million of cash and cash equivalents and $43.8 million invested in short-term and long-term investments. We generally place our investments in municipal securities, bonds of government sponsored agencies, certificates of deposit with fixed rates and maturities of less than one year and A1P1 rated commercial bonds and paper.

     For the nine months ended September 30, 2007, our operations provided cash of $22.7 million compared to $9.0 million during the nine months ended September 30, 2006. The change was primarily the result of a $1.0 million increase in deferred revenue in the first nine months of 2007 as compared to an $8.7 million decrease in the first nine months of 2006. A large Digital ECG Franchise ended in 2006, which resulted in the decrease in deferred revenues in 2006 as the franchise advanced payments were recognized as revenue as services were performed. Also, there was a $2.7 million decrease in net income taxes payable in the first nine months of 2007 as compared to a $3.1 million increase in net prepaid income taxes in the first nine months of 2006 due to the size and timing of estimated payments. Net income before non-cash items increased $3.3 million for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. Accrued expenses in the first nine months of 2007 increased $1.5 million as compared to a decrease of $1.2 million in 2006. The increase in 2007 was primarily related to accrued bonuses which were minimal in 2006. Partially offsetting these items was an increase in accounts receivable in the first nine months of 2007 of $3.8 million as compared to no change in the first nine months of 2006. This increase was largely due to the accounts receivables related to a client that had operated under the Digital ECG Franchise through mid-2006. Under the Digital ECG Franchise, the client prepaid most of its costs. There was also a decrease in accounts payable in the first nine months of 2007 of $1.9 million as compared to a $2.0 million increase in the first nine months of 2006. The 2006 accounts payable included higher amounts of equipment purchases and unanticipated additional third-party service charges for services previously provided.

     For the nine months ended September 30, 2007, our investing activities used cash of $11.6 million compared to $15.7 million during the nine months ended September 30, 2006. The change was the result of net activity related to investments, which used $1.5 million of cash for the nine months ended September 30, 2007, compared to $3.5 million for the nine months ended September 30, 2006, and a $2.2 million decrease in cash used for purchases of property and equipment for the nine months ended September 30, 2007 as compared to the first nine months of 2006.

     During the nine months ended September 30, 2007 and 2006, we purchased $10.1 million and $12.3 million, respectively, of property and equipment. Included in property and equipment is internal-use software associated with a data and communications management services software product (EXPeRT^®) used in connection with our centralized core cardiac safety ECG services. We capitalize certain internal-use software costs in accordance with Statement of Position (SOP) 98-1, “Accounting for Costs of Computer Software for Internal Use.” The amortization is charged to the cost of Cardiac Safety services beginning at the time the software is ready for its intended use. In April 2005, we began developing enhancements to EXPeRT^® which were necessary while an upgrade to EXPeRT^® (EXPeRT^® 2) was being developed. EXPeRT^® 2 was placed into production in January 2007. Beginning in January 2007, additional capitalizable development costs of EXPeRT^® 2 were incurred to develop new functionalities of and enhancements to EXPeRT^® 2. In addition to the $3.1 million capitalized in the nine months ended September 30, 2007, we expect to spend approximately $0.4 million for capitalizable development costs during the balance of 2007.

     In the first quarter of 2006, we began development of a data warehouse that enables centralized capture of cardiac safety data and the ability to integrate with the Food and Drug Administration’s ECG data warehouse. The data warehouse was placed into production in January 2007.

     In the second quarter of 2007, we announced that we were launching a new line of business focused on electronic patient reported outcomes (EXPeRT^® ePRO™) and entered into a long-term strategic relationship with Healthcare Technology Systems, Inc. (HTS), a leading authority in the research, development and validation of computer administered clinical rating instruments. The strategic relationship includes the exclusive licensing (subject to one pre-existing license agreement) of 57 IVR clinical assessments offered by HTS along with HTS’s IVR system. We are completing validation of the IVR system and expect to place the system into production by the end of 2007. As of September 30, 2007, we paid HTS $1.5 million for the license and a $0.25 million advanced payment against future royalties. Royalty payments will be made to HTS based on the level of revenues received from the assessments and the IVR system. An additional $0.75 million of royalty payments are guaranteed, and will be made in two payments — the later of (i) 12 months from the date of the first EXPeRT^® ePRO™ sale and (ii) when the system is validated, and 6 months after this date. Any royalties earned by HTS

will be applied against these payments. After these two payments are made, all future payments to HTS will be solely based on royalty payments based on revenues received from EXPeRT^® ePRO™ sales.

     The following table presents the internal-use software costs and related amortization as of September 30, 2007 (in thousands):

								Related				Total
				Labor and				Direct Costs				Capitalized				Monthly				Accumulated
		Amortization Period		Consulting				of Materials				Costs				Amortization				Amortization
EXPeRT® enhancements		October 2005-September 2007		$	463			$	—			$	463			$	20			$	463
Semi-automated ECG processing software
Initial costs		February 2004-January 2008			449				361				810				17				743
Enhancements		October 2004-September 2008			380				—				380				8				285
Additional enhancements		April 2005-March 2009			376				—				376				8				234
EXPeRT® 2
Initial costs		January 2007-December 2011			9,412				1,139				10,551				176				1,583
Enhancements		To be determined			1,369				—				1,369				—				—
Data warehouse		January 2007-December 2011			722				—				722				12				108
ePRO™		To be determined			65				1,658				1,723				—				—
Total				$	13,236			$	3,158			$	16,394			$	241			$	3,416