UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file number 000-29273

Quovadx, Inc.

(Exact name of registrant as specified in its charter)

6400 S. Fiddler’s Green Circle, Suite 1000, Englewood, Colorado 80111

(Address of principal executive offices)

(303) 488-2019

(Registrant’s telephone number)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

      At April 25, 2005, 40,561,880 shares of common stock were outstanding.

QUOVADX, INC.

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION

QUOVADX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

QUOVADX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

QUOVADX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

      The accompanying condensed consolidated financial statements of Quovadx, Inc. (“Quovadx,” the “Company,” the “Registrant,” “we” or “us”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to make the information presented not misleading. The unaudited financial statements have been prepared on the same basis as our annual financial statements and reflect all adjustments, which include only normal recurring adjustments necessary for a fair presentation in accordance with U.S. generally accepted accounting principles. The results for the three months ended March 31, 2005 are not necessarily indicative of the results expected for the full year. These financial statements should be read in conjunction with the audited financial statements and accompanying notes included in our Annual Report on Form 10-K and Amendment No. 1 to our Annual Report on Form 10-K/A, for the year ended December 31, 2004.

      The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

      Certain prior year information has been reclassified to conform to the current year presentation. Revenue and cost of revenue from the New Mexico Data Center have been reclassified to discontinued operations in the 2004 periods. The New Mexico Data Center was sold on December 31, 2004.

      At March 31, 2005, the Company had three stock option plans and one employee stock purchase plan. The Company has elected to account for stock-based compensation arrangements using the intrinsic value method under the provisions of Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees.” Under this method, stock compensation is recognized to the extent that the exercise price is less than the market price for the underlying stock on the date of grant. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In December 2004 the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation.” This Statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95 “Statement of Cash Flows.” SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair value. Pro forma disclosure and the intrinsic value method of accounting are no longer alternatives.

      In April 2005, the Securities and Exchange Commission adopted a new rule that allows companies to implement SFAS No. 123R in the first fiscal year beginning after June 15, 2005. We plan to adopt this standard when required, using one of the valuation models and adoption methods allowed by SFAS No. 123R, based on our evaluation of which of the models and methods is best for our circumstances. The Company currently accounts for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options based on the requirements of SFAS No. 123. The adoption of SFAS 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the Company has not determined which option-pricing model we will use to value the stock options granted.

      Net loss per common share (“EPS”) is calculated in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings per Share.” Under the provisions of SFAS No. 128, basic EPS is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if stock options were exercised, resulting in the issuance of common stock that would share in the earnings of the Company. Potential dilution of the stock options exercisable into common stock is computed using the treasury stock method based on the average fair market value of the stock. As the Company has a net loss, the effect of all common stock equivalents is excluded from the computation of diluted EPS since their effect would decrease the loss per share. The diluted weighted average common shares calculation for the three months ended March 31, 2005 and 2004 excludes 1,408,652 and 1,597,191 options, respectively, to purchase common stock because their effect would have been anti-dilutive under the treasury stock method and excludes all options to purchase common stock because their effect would have been anti-dilutive to the net loss.

      The Company periodically evaluates the carrying value of long-lived assets, including, but not limited to, property and equipment, software, and intangibles assets when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset, fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. There were no asset impairments in the first quarter of 2005.

      In the first quarter of 2004, the Company incurred impairment charges totaling $7.1 million. Impairment charges totaling $6.8 million were recorded as a component of cost of revenue and the remaining $0.3 million was recorded within amortization of intangibles assets. The Company wrote down $4.4 million of capitalized software in the first quarter of 2004 due to a decision to discontinue products that resulted from management’s effort to refocus the Company’s resources to products that will generate revenues in the near term and

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

conserve cash flows. In the fourth quarter of 2003, the Company prepaid $0.9 million to Infotech Network Group (“Infotech”) for professional services. In March 2004, the Company paid Infotech an additional $2.1 million prepayment under an outsourcing agreement. Payments totaling $1.7 million were written off in the first quarter of 2004 because a portion of the asset was deemed not recoverable due to Infotech’s inability to provide assurances that it could deliver services in the future. The Company also wrote down $0.7 million of deferred costs related to its transaction business in the first quarter of 2004. The deferred costs were written down to their expected realizable value because the total balance of the asset was not recoverable due to the cancellation of certain contracts and lower than expected revenues on other contracts

      On December 31, 2004, we sold the assets of our Albuquerque, New Mexico Data Center and our Managed Care Transaction Manager (“MCTM”) system. This hosting service center and MCTM system no longer fit into our new business strategy because they represent a niche area of the healthcare payer segment which is not an area of strategic growth. The assets were sold to Royal Health Care Data Center, LLC, a subsidiary of Royal Health Care, LLC (“Royal”) for $1.9 million in cash and a gain of $0.4 million was recognized on the sale in the fourth quarter of 2004. Revenue and cost of revenue of $1.4 million and $1.2 million, respectively, for the New Mexico Data Center for the three months ended March 31, 2004 have been reclassified to income from discontinued operations. Royal is a management services organization serving New York healthcare organizations. A director of the Company is on Royal’s board of directors.

      Segment information has been prepared in accordance with FASB SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The Company defines operating segments as components of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker or decision-making group, to evaluate performance and make operating decisions. Accounting policies of the segments are the same as those described in the summary of significant accounting policies.

      The Company’s operations consist of three divisions, the Integration Solutions division, which provides industry leading products and services to meet the growing challenges of healthcare integration, the CareScience division, which provides care management services and analytical solutions to hospitals and health systems and the Rogue Wave Software division, which provides reusable software components and services that facilitate application development. Each division has its own product and services line. Each division has a Division President whose responsibilities include financial management of the division. Corporate includes corporate marketing, general and administrative, and other corporate expenses.

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Segment information based on the three divisions for the three months ended March 31, 2005 and 2004 is as follows:

      Intangible assets recognized in the Company’s acquisitions are being amortized over their estimated lives ranging from three to eight years. The following table provides information relating to the Company’s intangible assets as of March 31, 2005:

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table provides information relating to the Company’s capitalized and acquired software as of March 31, 2005:

      Total capitalized software costs for the three months ended March 31, 2005 and 2004 was $116,000 and $837,000, respectively.

      Total comprehensive loss for the three months ended March 31, 2005 and 2004 was as follows:

      The foreign currency translation amounts relate to our subsidiaries in Europe and Japan. The Japan operations were closed in the first quarter of 2005.

      On November 14, 2001, a shareholder class action complaint was filed in the United States District Court, Southern District of New York. On April 19, 2002, plaintiffs filed an amended complaint. The amended complaint asserts that the prospectus from the Company’s February 10, 2000 initial public offering (“IPO”) failed to disclose certain alleged improper actions by various underwriters for the offering in the allocation of the IPO shares. The amended complaint alleges claims against certain underwriters, the Company and certain officers and directors under the Securities Act of 1933 and the Securities Exchange Act of 1934 (Bartula v. XCare.net, Inc., et al., Case No. 01-CV-10075). Similar complaints have been filed concerning more than 300 other IPO’s; all of these cases have been coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92. In a negotiated agreement, individual defendants, including all of the individuals named in the complaint filed against the Company, were dismissed without prejudice, subject to a tolling agreement. Issuer and underwriter defendants in these cases filed motions to dismiss and, on February 19, 2003, the Court issued an opinion and order on those motions that dismissed selected claims against certain defendants, including the Rule 10b-5 fraud claims against the Company, leaving only the Section 11 strict liability claims under the Securities Act of 1933 against the Company. A committee of our Board of Directors has approved a settlement proposal made by the plaintiffs On February 15, 2005, the Court issued an order granting conditional preliminary approval of the settlement. If the settlement is not achieved, the Company will continue to aggressively defend the claims. We do not believe that the outcome of this

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

action will have a material adverse effect on our financial position, results of operations or liquidity; however, litigation is inherently uncertain and we can make no assurance as to the ultimate outcome or effect.

      On March 18, 2004, a purported class action complaint was filed in the United States District Court for District of Colorado, entitled Smith v. Quovadx, Inc. et al, Case No. 04-M-0509, against Quovadx, Inc., its now-former Chief Executive Officer and its now-former Chief Financial Officer. The complaint alleged violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended, purportedly on behalf of all persons who purchased Quovadx common stock from October 22, 2003 through March 15, 2004. The claims are based upon allegations the Company (i) purportedly overstated its net income and earnings per share during the class period, (ii) purportedly recognized revenue from contracts between the Company and Infotech Networks Group prematurely, and (iii) purportedly lacked adequate internal controls and was therefore unable to ascertain the financial condition of the Company. Eight additional, nearly identical class action complaints were filed in the same Court based on the same facts and allegations. The actions seek damages against the defendants in an unspecified amount. On May 17 and 18, 2004, the Company filed motions to dismiss each of the complaints. Since then, all but one of the actions, entitled Heller v. Quovadx, Inc., et al., Case No. 04-M-0665 (OES) (D. Colo.), have been dismissed. Thereafter, the plaintiff in Heller filed a first amended complaint, which asserts the same claims as those asserted in the original complaint, and includes allegations regarding the Company’s accounting for certain additional transactions. On September 8, 2004, the Court approved the appointment of David Heller as lead plaintiff. On September 29, 2004, the Court denied defendants’ motions to dismiss the first amended complaint and approved the appointment of Mr. Heller’s counsel as lead plaintiff’s counsel. On October 14, 2004, the Company and the other defendants filed answers to the first amended complaint, denying allegations of wrongdoing and asserting various affirmative defenses. On January 13, 2005, the Court approved a scheduling order that, inter alia, requires fact discovery, which has commenced, to conclude eight months after the Court issues an order certifying a class. The Court issued its order certifying the class action on April 12, 2005. The deadline for completing fact discovery is December 12, 2005. The class action is still in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On March 22, 2004, a shareholder derivative action was filed in the District Court of Colorado, County of Arapahoe, entitled Marcoux v. Brown et al, against the members of the Board of Directors and certain now-former officers of Quovadx alleging breach of fiduciary duty and other violations of state law. The Company is named solely as a nominal defendant against which no recovery is sought. This complaint generally is based on the same facts and circumstances as alleged in the class action complaints discussed above, alleging that the defendants misrepresented Quovadx financial projections and that one of the defendants violated state laws relating to insider trading. The action seeks damages in an unspecified amount against the individual defendants, disgorgement of improper profits and attorney’s fees, among other forms of relief. On or about April 21, 2004, a second, nearly identical shareholder derivative complaint, seeking the same relief, was filed in the United States District Court for the District of Colorado, entitled Thornton v. Brown et al. The plaintiffs in both of the shareholder derivative actions are represented by the same local counsel. On or about May 20, 2004, a third, nearly identical shareholder derivative complaint, seeking the same relief, was filed in the District Court of Colorado, County of Arapahoe, entitled Jaroslawicz v. Brown, et al. The three shareholder derivative actions are now all pending in the Colorado state court. The Court has consolidated the three actions into a single consolidated action and set February 1, 2005 as the deadline for the filing of a consolidated amended complaint, subsequently extended to May 2, 2005. The parties requested, and the court approved, a further extension to August 1, 2005. The shareholder derivative action is still in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On May 17, 2004, a purported class action complaint was filed in the United States District Court for the District of Colorado, entitled Henderson v. Quovadx, Inc. et al, Case No. 04-M-1006 (OES), against Quovadx, Inc., its now-former Chief Executive Officer, its now-former Chief Financial Officer and its Board of Directors. The complaint alleged violations of Section 11 and Section 15 of the Securities Act of 1933, as

QUOVADX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

amended, purportedly on behalf of all former shareholders of Rogue Wave Software, Inc. who acquired Quovadx common stock in connection with the Company’s exchange offer effective December 19, 2003. The claims are based upon the same theories and allegations as asserted in the Section 10(b) class actions described above. The Court denied plaintiff’s motion to consolidate this Section 11 action with the Section 10(b) cases and authorized the two competing lead plaintiff candidates to take discovery of each other in advance of a hearing on the appointment of lead plaintiff. On July 14, 2004, the Company and outside director defendants filed an answer to the complaint, denying allegations of wrongdoing and asserting various affirmative defenses. On September 8, 2004, the Court directed the plaintiff to publish new notice of pendency of this action inviting potential class members to submit motions for appointment as lead plaintiff. Two putative class members filed competing motions for appointment as lead plaintiff, and their motions are scheduled for a hearing on June 24, 2005. The Court stayed all discovery related to the merits of the litigation pending the appointment of a lead plaintiff. On October 4, 2004, the Company’s former CEO and CFO filed an answer to the complaint, denying allegations of wrongdoing and asserting various affirmative defenses. This class action also is in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On April 12, 2004, the Company announced that the Securities and Exchange Commission (“SEC”) had notified the Company that it’s previously announced informal inquiry has become a formal investigation pursuant to an “Order Directing Private Investigation and Designating Officers to Take Testimony.” The SEC is investigating transactions entered into during the third quarter of 2002 and transactions entered into during 2003 including two distributor contracts totaling approximately $1 million and transactions between Quovadx and Infotech Network Group. The investigation is continuing, and the Company continues to provide documents and information to the SEC.

      The Company is engaged from time to time in routine litigation that arises in the ordinary course of our business.

      The individual, who until February 10, 2005, was the Corporate Secretary of the Company is a partner of a law firm which performs legal services for the Company. The accompanying financial statements include expenses related to this law firm of $0.5 million and $0.2 million for the three months ended March 31, 2005 and March 31, 2004, respectively. At March 31, 2005 the outstanding payable balance to the law firm totaled $0.6 million.

      The Company acquired its WebAccel product from CMI Corporate Marketing, d/b/a Compuflex International (“Compuflex”) in August, 2003. An executive officer of the Company is the sole stockholder of Compuflex. Compuflex has received, and will continue to receive, royalty fees of $0.5 million over two years from the Company in accordance with the terms of the purchase agreement. Through March 31, 2005, the Company had paid Compuflex $0.4 million in royalty payments and the remaining payments totaling $0.1 million will be paid in 2005. At March 31, 2004, the Company had paid $0.1 million and the outstanding balance was $0.4 million.

      The following discussion should be read in conjunction with the condensed financial statements and the related notes that appear elsewhere in this document.

FORWARD-LOOKING STATEMENTS

      All statements, trend analysis and other information contained in this Annual Report on Form 10-K (“Annual Report”) of Quovadx, Inc. (“Quovadx,” the “Company,” the “Registrant,” “we” or “us”) and the information incorporated by reference which are not historical in nature are forward-looking statements within the meaning of the Private-Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, discussion relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as “anticipate,” “believe,” “plan,” “estimate,” “expect” and “intend” and other similar expressions. All statements regarding the Company’s expected financial position and operating results, business strategy, financing plans, and forecast trends relating to our industry are forward-looking statements. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Risk Factors” below.

Overview

      Quovadx is a global software and services firm that has helps enterprise customers worldwide develop, extend and integrate applications based on open standards. The Company is comprised of three primary divisions, the Integration Solutions division (“ISD”), which provides industry leading products and services to meet the growing challenges of healthcare integration, the CareScience division (“CareScience”), which provides care management services and analytical solutions to hospitals and health systems and, the Rogue Wave Software division (“Rogue Wave”), which provides reusable software components and services that facilitate application development. Our software and service offerings include an integrated suite of application development tools and vertical enterprise applications for companies in healthcare, financial services, software, telecommunications, and the public sector.

Critical Accounting Policies and Estimates

      The consolidated financial statements are prepared in conformity with U.S. general accepted accounting principles in the United States which require 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 amounts of revenue and expenses during the reporting period. The Company relied on significant estimates in preparing the financial statements, allocating the purchase price of its acquisitions to the assets and liabilities acquired, evaluating the adequacy of the allowance for bad debt, the percentage of completion of fixed priced professional service contracts, the recoverability of deferred tax assets and the recoverability of capitalized software costs. Actual results could differ from those estimates. The Company believes that the following accounting policies involve a higher degree of judgment and complexity.

      The Company recognizes revenue in accordance with the provisions of Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended, and SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.”

      Our license agreements generally provide either that customers pay a perpetual license fee based on a specified number of instances of the software or the type of software modules licensed or pay a subscription fee for a set number of years. Customers that purchase licenses, under a perpetual license agreement, generally enter into renewable one-year maintenance agreements that entitle the customer to receive unspecified updates on the licensed software, error corrections and telephone support, generally for a fixed fee.

      The methodology the Company uses to recognize perpetual license software license and related services revenue is dependent on whether the Company has established vendor-specific objective evidence (“VSOE”) of fair value for the separate elements of a multiple-element agreement. If an agreement includes both license and service elements, the license fee is recognized on delivery of the software if the remaining services are not essential to the functionality of the software, the collection of the fees is probable, the fees are fixed and determinable, an agreement is signed and the Company has established VSOE of fair value for the remaining services. Revenue from the related services is recognized as the services are provided. When the related services are essential to the functionality of the base product, or when the Company has not established VSOE of fair value for the remaining services, the software license fees are deferred and the entire contract is recognized as the services are provided. Utilizing the criteria provided in SOP 97-2, we evaluate the vendor specific objective evidence for contracts to determine the fair value of elements delivered in situations where multiple element arrangements exist.

      Professional services revenue represents software development, implementation, consulting services and education/ training. When derived from a fixed price contract and collection of fees is probable, the Company recognizes professional services revenue using the percentage-of-completion method of accounting. When derived from a time-and-materials contract, and the collection of fees is probable, the Company recognizes professional services revenue as the services are provided.

      When revenue is recognized using the percentage-of-completion basis of accounting, the Company’s management estimates the costs to complete the services to be provided under the contract. Because the percentage-of-completion method is an estimation process, it has risks and uncertainties. The Company may encounter budget and schedule overruns caused by external factors beyond our control such as the utilization and efficiency of our consultants and the complexity of our customers’ IT environment. Adjustments to cost estimates are made in the period in which the facts requiring such revisions become known. Estimated losses, if any, are recorded in the period in which the current estimates of the costs to complete the services exceed the revenue to be recognized under the contract.

      Maintenance revenue is derived from agreements for providing unspecified software updates, error corrections and telephone support. Maintenance revenue is recognized ratably over the maintenance period, which is generally 12 months.

      Other recurring services revenue includes subscription services, transaction processing and other services. When the fees are fixed and determinable, and collection of the fees is probable, revenue is recognized over the service period. When the fees are charged on a per-transaction basis and collection of the fees is probable, revenue is recognized as the transactions are processed.

      When collection of fees is not probable, revenue is recognized as cash is collected. The Company does not require collateral from its customers.

      The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of certain customers to pay their accounts receivable balances. The Company assesses the financial condition of its customers to determine if there is an impairment of their ability to make payments and additional allowances may be required if the financial condition of the Company’s customers deteriorates. A considerable amount of judgment is required in order to determine the realization of our receivables, including assessing the likelihood of collection and the creditworthiness of each customer.

      In connection with acquisitions, we assessed the fair value of assets acquired and liabilities assumed. Items such as accounts receivable, property and equipment, other intangible assets, certain accrued liabilities, and other reserves require a high degree of judgment from management. We may use third parties to assist us with such valuations. In connection with our acquisitions, we are required to recognize other intangible assets separate and apart from goodwill if such assets arise from contractual or other legal rights or if such assets are

separable from the acquired businesses. Other intangible assets include, developed technology, customer-related assets such as order backlog, and trade name. The Company recorded $46.7 million of goodwill resulting from its Rogue Wave and CareScience acquisitions. At March 31, 2005, we had intangible assets of $16.8 million, net of amortization.

      Software development costs are required to be expensed until the point that technological feasibility of the product is established. Once technological feasibility is established, such costs are capitalized until the product has reached general availability. The establishment of technological feasibility and continuing evaluation of the recoverability of the capitalized software development costs requires management’s judgment with respect to the impact of external factors such as future revenue, estimated economic life and changes in software and hardware technologies. Capitalized software development costs are amortized on a straight-line basis over an estimated life, which is generally three years. The Company capitalizes internal and external labor costs incurred in developing the software once technological feasibility is attained. At March 31, 2005, the Company had $10.1 million of capitalized software development costs, net of amortization. The Company capitalized software development costs of $116,000 and $837,000 for the three months ended March 31, 2005 and 2004, respectively.

      SFAS No. 142 requires that goodwill at each reporting unit be tested annually for impairment and more frequently if events or changes in circumstances indicate assets might be impaired. The Company has identified the fourth quarter as the period for its annual impairment test. The Company performed its annual evaluation during the fourth quarter of 2004, and no impairment was indicated. However, changes in future market conditions or assumptions used in the evaluation could result in impairments in future periods.

      The Company periodically evaluates the carrying value of other long-lived assets, including, but not limited to, property and equipment, software, and intangible assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

      Significant estimates are utilized to calculate expected future cash flows utilized in impairment analyses. We also utilize judgment to determine other factors within fair value analyses, including the applicable discount rate.

      In December 2004 the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation.” This Statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95 “Statement of Cash Flows.” SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair value. Pro forma disclosure and the intrinsic value method of accounting are no longer alternatives.

      In April 2005, the Securities and Exchange Commission adopted a new rule that allows companies to implement SFAS No. 123R in the first fiscal year beginning June 15, 2005. We plan to adopt this standard when required, using one of the valuation models and adoption methods allowed by SFAS No. 123R, based on our evaluation of which of the models and methods is best for our circumstances. The Company currently accounts for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options based on the requirements of SFAS No. 123. The adoption of SFAS 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of

SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the Company has not determined which option-pricing model we will use to value the stock options granted.

      The following table sets forth financial data for the periods indicated, ($ in thousands).

      Total revenue. Total revenue decreased $1.5 million, or 7%, to $20.8 million for the three months ended March 31, 2005 from $22.3 million for the three months ended March 31, 2004. Software license revenue was $7.0 million for the three months ended March 31, 2005, a decrease of $0.4 million or 6% from the three months ended March 31, 2004. The decrease in software license revenue was due to decreases in license revenue from Rogue Wave and slightly lower software license revenue from ISD products. Professional services revenue decreased $0.9 million, or 20%, to $3.6 million for the first quarter of 2005 due to the completion of several large ISD contracts in the second and third quarters of 2004. Recurring services revenue decreased 2% to $10.2 million for the three months ended March 31, 2005 from $10.3 million in the comparable 2004 period. The decrease was due to lower transaction revenue in ISD offset by increases in CareScience recurring services revenue from the recognition of revenue previously deferred in association with long term contracts.

      Cost of revenue. Cost of revenue decreased $10.9 million, or 54%, to $9.3 million for the three months ended March 31, 2005 from $20.2 million for the three months ended March 31, 2004. Cost of revenue for the license segment decreased 47% or $1.9 million to $2.2 million for the three months ended March 31, 2005 from $4.1 million for the three months ended March 31, 2005. Software amortization, a component of cost of license revenue decreased $1.0 million, or 43%, to $1.4 million for the three months ended March 31, 2005 from $2.4 million for the period ended March 31, 2004. The decrease in software amortization was the result of the finalization of the valuation of Rogue Wave software and fewer software assets being amortized in 2005 due to the write off of software development costs in 2004, primarily in ISD. Professional services costs decreased 42% to $2.5 million for the three months ended March 31, 2005, from $4.3 million in the comparable period of 2004, related to the decrease in contractor costs of $0.4 million and reduced salary and related expenses of $1.0 million, as a result of lower headcount primarily in ISD. Recurring services costs decreased 8% to $4.7 million for the first quarter of 2005 from $5.1 million in the comparable period of 2004, as a result of the decrease in headcount resulting in lower salaries and related expenses of $0.4 million, in ISD.

      In the first quarter of 2004, the Company’s ISD division incurred impairment charges totaling $7.1 million. Impairment charges totaling $6.8 million were recorded as a component of cost of revenue and the remaining $0.3 million was recorded within amortization of intangibles assets. The Company wrote down $4.4 million of capitalized software in the first quarter of 2004 due to a decision to discontinue products that resulted from management’s effort to refocus the Company’s resources to products that will generate revenues in the near term and conserve cash flows. In the fourth quarter of 2003, the Company prepaid $0.9 million to Infotech Network Group (“Infotech”) for professional services. In March 2004, the Company paid Infotech an additional $2.1 million prepayment under an outsourcing agreement. Payments totaling $1.7 million were written off in the first quarter of 2004 because a portion of the asset was deemed not recoverable due to Infotech’s inability to provide assurances that it could deliver services in the future. The Company also wrote down $0.7 million of deferred costs related to its transaction business in the first quarter of 2004. The deferred costs were written down to their expected realizable value because the total balance of the asset was not recoverable due to the cancellation of certain contracts and lower than expected revenues on other contracts.

      Sales and marketing. Sales and marketing expenses decreased $2.1 million, or 33%, to $4.4 million for the three months ended March 31, 2005, from $6.5 million for the three months ended March 31, 2004. The decrease is primarily related to a decrease in ISD headcount from 63 to 29 full time sales employees in first quarter of 2005, or $1.7 million decrease in salaries and related expenses, when compared to the first quarter of 2004. The remainder of the decrease was due to a reduction in corporate marketing expenses.

      General and administrative. General and administrative expenses increased $1.0 million, or 28%, to $4.7 million for the three months ended March 31, 2005, from $3.7 million from the year earlier period. The increase in general and administrative expenses was primarily due to an increase in accounting expenses arising from increased costs related to audit fees and Sarbanes Oxley compliance of $0.4 million and an decrease in bad debt recoveries of $0.3 million. These items are not allocated to the divisions.

      Research and development. Research and development expense was $3.0 million for the three months ended March 31, 2005, a decrease of $0.7 million or 19% from $3.7 million for the three months ended March 31, 2004. The decrease was related to lower salaries and related expenses due to 35 fewer ISD and Rogue Wave employees.

      Amortization of acquired intangibles. The amortization of acquired intangibles results from assets purchased through our business acquisitions. Intangible assets amortization for the three months ended March 31, 2005 decreased $0.2 million from the three months ended March 31, 2004. The decrease is due to impairment of ISD acquired intangible assets in the first quarter of 2004, offset by an increase in Rogue Wave intangible asset amortization based on an increase in intangible assets from the final acquisition valuation, which was concluded in the fourth quarter of 2004.

      Other income and expense, net. Other income and expense includes interest income on cash and cash equivalents. Interest income remained constant for the first quarters of 2004 and 2005.

      Income tax. The provision for income taxes of $73,000 has been recorded for the three months ended March 31, 2005. The income tax expense is a result of net income in one of our foreign operations. A provision for U.S. federal and state income taxes was not recorded for the three months ended March 31, 2004, as we incurred a net operating loss. We believe that, based on the history of losses and other factors, the weight of available evidence indicates that it is more likely than not that we will not be able to realize our deferred tax assets, and thus a full valuation allowance has been recorded against such assets as of March 31, 2005 and December 31, 2004.

      Income from discontinued operations. On December 31, 2004 we sold the assets of our Albuquerque, New Mexico Data Center and its Managed Care Transaction Manager business (“MCTM”). The New Mexico operations had revenue of $1.4 million, cost of sales of $1.2 million and net income of $0.2 million for the three months ended March 31, 2004.

Liquidity and Capital Resources

      We expect to use our cash, cash equivalents and short-term investments for general corporate purposes, working capital and capital expenditures, to fund our operations and to continue expanding our product offerings. The amounts and timing of our actual expenditures will depend upon numerous factors, including the status of our product development efforts, marketing and sales activities and the amount of cash generated by our operations, and competition. We may find it necessary or advisable to use portions of our cash and cash equivalents for other purposes. Pending use of our cash, cash equivalents and short-term investments for the above purposes, we intend to invest such funds in short-term, interest-bearing, investment-grade securities.

      Net cash provided by operating activities was $2.3 million for the three months ended March 31, 2005 compared to net cash used in operating activities of $9.2 million for the three months ended March 31, 2004. The increase in net cash provided by operating activities in 2005 compared to 2004 is mainly due to a decrease in the net loss and decreases in accounts payable and accrued liabilities in the first quarter of 2004 as a result of paying 2003 acquisition related liabilities. In the first quarter of 2005 and 2004 cash was provided by improved accounts receivable collection efforts. In March 2004, $2.1 million was prepaid to Infotech Network Group (“Infotech”) for professional services. In the fourth quarter of 2003, the Company prepaid $0.9 million to Infotech. Also in March 2004, $1.7 million was written off as a portion of the asset was deemed not recoverable due to the deterioration of the Company’s relationship with Infotech and Infotech’s inability to provide assurances that it could deliver those services in the future.

      Net cash used in investing activities was $0.6 million for the three months ended March 31, 2005, compared to $1.1 million for the three months ended March 31, 2004. The decrease in cash used in investing activities is due to a decrease in capitalized software costs. Net cash used in investing activities for the three months ended March 31, 2005 is primarily due to purchases of equipment. Cash used in investing activities in 2004 resulted from the purchases of equipment and capitalized software costs.

      Net cash provided by financing activities was $0.1 million for the three months ended March 31, 2005 and $0.5 million for the three months ended March 31, 2004. Cash provided in 2005 and 2004 came from the exercise of stock options.

      Commitments. On March 31, 2005, the Company had $3.1 million in open purchase commitments for services, contractors, and capital purchases, many covering several months of anticipated activity in 2005.

      The Company acquired its WebAccel product from CMI Corporate Marketing, d/b/a Compuflex International (“Compuflex”) in August, 2003. An executive officer of the Company is the sole stockholder of Compuflex. Compuflex has received, and will continue to receive, royalty fees of $500,000 over two years from the Company in accordance with the terms of the purchase agreement. Through March 31, 2005, the Company had paid Compuflex $0.4 million in royalty payments, and the remaining payments, totaling $0.1 million, will be paid in 2005.

      The Company’s cash and cash equivalents balances are expected to be sufficient to meet its anticipated liquidity needs for working capital and capital expenditures for the next twelve months. If additional capital resources were required for working capital or to grow our business internally, we may seek other financing arrangements. We cannot be assured that any financing arrangements will be available in amounts or on terms acceptable to us in the future.

RISK FACTORS

      The following risk factors could materially and adversely affect our operating results and could cause actual events to differ materially from those predicted in any forward-looking statements related to our business.

      We incurred losses for the years ended December 31, 2004, 2003, and 2002. As of March 31, 2005, we had an accumulated deficit of $183 million. We expect to continue to incur significant sales and marketing, research and development and general and administrative expenses that may exceed our revenue. As a result, we may experience losses and negative cash flows in the future. Failure to achieve and maintain profitability, or have continued losses, may cause our stock price to decline and impair our business and financial prospects.

      We have been cooperating with the SEC with respect to a formal order of investigation and subpoena regarding certain transactions in 2002 and 2003. We cannot predict the outcome of the investigation. An unfavorable outcome with respect to this investigation could cause our stock price to decline significantly. If the SEC finds wrongdoing on our part, a financial or administrative penalty may be imposed which could jeopardize our financial viability. In addition, such findings could provide basis for additional lawsuits.

      Certain former officers, independent directors and the Company have been named defendants in various pending class action and derivative lawsuits. The findings and outcome of the SEC investigations may affect these pending lawsuits. Under Delaware law, our charter and bylaws, we are generally obligated to indemnify our directors and officers who are named defendants in any of these lawsuits and advance legal fees and costs. We are unable to estimate our liability in these matters and we may be required to pay judgments or settlements and incur expenses in aggregate amounts that could have a materially adverse effect on our business, financial condition, results of operations and cash flows.

      We currently have director and officer liability insurance that may pay a portion of the legal fees and costs incurred in defending against claims, settlement amounts, or, damages awarded. However, if the plaintiffs are successful, we may not have sufficient insurance to cover the judgment or our insurers may deny coverage.

      For a further description of the nature and status of these legal proceedings see, “Part II Item 1 — Legal Proceedings.”

      We failed to timely file our first quarter 2004 Form 10-Q with the SEC and NASDAQ. As a result, the NASDAQ Stock Market initiated delisting procedures. On August 9, 2004, NASDAQ informed us that we had been granted an exception to their continued listing standards. However, our continued listing depends on our ability to timely file all periodic reports for reporting periods ending on or before September 30, 2005, and we will not be able to request an automatic extension to prolong the deadline. If we are late in making any filing during that period, we may be delisted immediately with no right to a hearing or appeal. Additionally, we must continue to meet all other continued listing requirements; our failure to do so may result in a notice of delisting to which we would not be able to request a hearing. Our continued delisting vulnerability may result in potential loss of investor confidence, loss of analyst coverage and depression of our stock price, which could have a material adverse affect on our business and financial prospects.

      Our operating results have fluctuated significantly in the past and are likely to fluctuate in the future. Moreover, our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that event, our stock price would likely decline. Further declines in our stock price may impair our business prospects and our financial condition. As a result of our limited history of profitable operations, our business strategy, and the evolving nature of the markets in which we compete, we may have difficulty accurately forecasting our revenue in any given period. In addition to the factors discussed elsewhere in this section, a number of factors may cause our revenue to fall short of our expectations or cause fluctuations in our operating results, including:

      Additionally, fluctuating results and declining stock price may cause our analysts to withdraw their coverage, thus reducing our exposure in the market.

      The software market in which we compete is characterized by (1) rapid technological change, (2) frequent introductions of new products, (3) changing customer needs, (4) evolving industry standards, and (5) increased competition. To keep pace with technological developments, evolving industry standards and changing customer needs, we must support existing products and develop new products. We may not be successful in developing, marketing and releasing new products or new versions of our products that respond to technological developments, evolving industry standards or changing customer requirements. Further, we may face significant competition from open source software offerings, provided to users on a no-charge basis. We may also experience difficulties that could delay or prevent the successful development, introduction and sale of these new products and enhancements. In addition, these new products or enhancements may not adequately meet the requirements of the marketplace and may not achieve any significant degree of market acceptance. If release dates of any future products or enhancements are delayed, or if these products or enhancements fail to achieve market acceptance when released, our business, operating results and financial condition could be materially adversely affected. In addition, new products or enhancements by our competitors and open source offerings may cause customers to defer or forego purchases of our products, which could have a material adverse effect on our business, financial condition and results of operations.

      Our primary ISD product offering, the Cloverleaf® product, is sold primarily to the hospital market. Sub-segments of this market are close to saturation, and therefore revenues may decrease within this market segment. In addition, the primary development tools sold by our Rogue Wave Software division, the SourcePro® and Stingray® tools, target the C++ programming language, which is diminishing in usage when compared with other programming languages such as Java. The SourcePro tools are provided with accompanying source codes and due to this factor, customers have the ability to rewrite their applications without the use of these products. In other cases, customers may elect to acquire “end of life” rights to the products, paying a one-time fee for perpetual future use. Customers who elect to pursue either of these options no longer have an obligation to pay for the continuing updates and support fees, impacting ongoing revenue for the division. We expect that the revenues for these tools may decline over time. In addition, our performance depends on organizations requiring information delivery, and seeking outside vendors to develop, manage and maintain this software for their critical applications. Many of our potential customers have made significant investments in internally developed systems and would incur significant costs in switching to our products, which may substantially inhibit the growth of our software. If the market fails to grow, becomes saturated, or declines, our sales will be adversely affected. In addition, a weakening global economy or diverted focus of information technology departments on issues related to regulatory compliance may lead to longer sales cycle and slower sales growth.

      We are engaged in several large, multi-year, custom software development projects. These projects require that we staff them with experienced personnel. Personnel turnover could affect our ability to staff and manage these projects. Additionally, this type of development project requires close collaboration with the client, particularly in managing the change-order process, and presents factors that are often outside of our control. The length and nature of these projects expose us to the risks of not completing the project on time or at all, of not meeting client expectations, or of not staying within budget, any of which could result in our not being paid for work already performed or could lead to complex and expensive litigation, any of which could materially, adversely affect our financial and business prospects.

      Professional services is a very competitive market that is highly dependent on the quality of our staff and service image. We face much larger competitors in this market segment who have considerably more resources to draw from than we have. Additionally, we face smaller competitors that can be more cost competitive in the delivery of solutions. Our vulnerability to competition is a risk factor in this business. These issues also impact our service image to present and prospective customers and could cause contract delays. Consequently, professional services revenue may continue to decline for the Company.

      A major customer contract representing approximately 30% of total recurring revenue is an outsourcing arrangement. This contract is renewable annually. Non renewal of this contract would significantly impact our recurring revenue.

      Since the disclosure of our restatement of financial statements and the formal investigation by the SEC, our stock price has been trading well below the $5.00 per share minimum threshold established by many institutional investors as criteria for ownership. We have lost some analyst coverage over the past year. We have no assurance that the stock price will rise to previous levels. These factors may have contributed to reducing the trading activity in our stock and could continue to impair the investment quality of our stock.

      Relationships with established channel partners are critical to our success. These relationships include independent software vendor (“ISV”), distributor, co-marketer and system integrator relationships. We rely on these partners’ ability to assist us in generating increased acceptance and use of our applications, services, and product offerings. We have established a number of these relationships, and our future plans depend on establishing new relationships and maintaining existing ones. The other parties to these relationships may not view these relationships with us as significant to their own business, and they may reassess their commitment to us or decide to compete directly with us in the future. We generally do not have agreements that prohibit the other parties from competing against us directly or from contracting with our competitors. Additionally, we cannot guarantee that any such party will perform its obligations as agreed or contemplated or that we would be able to specifically enforce any agreement with it. Our failure to establish and maintain these relationships may significantly impair our business and financial prospects.

      We are exposed to infringement risks. Our intellectual property is important to our business. We may be subject to intellectual property infringement claims as the number of our competitors grows and the functionality of our applications overlaps with competitive offerings. These claims, whether or not meritorious, could be expensive, divert our attention from operating our company, result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements, any of which could seriously harm our business, financial condition and results of operations. If we become liable to third parties for infringing on their intellectual property rights, we would be required to pay a substantial damage award and to develop non-infringing technology, obtain a license or cease selling the applications that contain the infringing intellectual property. We may be unable to develop non-infringing technology or obtain a license on commercially reasonable terms, or at all. In the event an intellectual property claim against us was successful and we could not obtain a license on acceptable terms, license a substitute technology or redesign to avoid infringement, most of our contracts would require us to refund a portion of the software license fees, in which case our business, financial condition and results of operations would be seriously harmed. In addition, we may not be able to protect against misappropriation of our intellectual property. Third parties may infringe upon our

intellectual property rights, we may not detect this unauthorized use and we may be unable to enforce our rights.

      We rely on third parties for technology in our products. We depend upon third-party suppliers and licensors to provide software that is incorporated in certain of our products and the products that we distribute. We have no control over the scheduling and quality of work of these third-party software suppliers and licensors. Additionally, the third-party software may not continue to be available to us on commercially reasonable terms, or at all. Our agreements to license certain third-party software will terminate after specified dates unless they are renewed. In the event we were to have a dispute with a third party regarding our rights under an agreement, the third party may have the right to terminate our use of such software and/or obtain damages. We expect to sell multiple products to the same customers and problems with the third party technology in one product may adversely affect sales of other products to the same customer.

      Certain products include so called “open source” software. In some cases open source software imposes on us certain requirements to license others both the open source software as well as software that relates to, or interacts with, or that is a derivative work of the open source software. These open source license terms may be ambiguous and may result in unanticipated obligations regarding our products, including the obligation to make source code available. Because open source software is generally available, it cannot be protected as a trade secret and competitors and others would have access to such software and the right to modify or distribute such software. Also, in many instances where we obtain open source software, we would not be able to determine if the provider of such code has legal right to provide such code to the company on the open source license terms.

      Our products may be affected by unknown software defects. Our products depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when enhancements or new versions are released. Although we conduct extensive testing, we may not discover software defects that affect our new or current products or enhancements until after they are deployed. To date, we have not experienced any material software defects, however despite continued testing, defects may occur in our software. These defects could cause performance interruptions, which could damage our reputation with existing or potential customers, increase our service costs, cause us to lose revenue, delay market acceptance or divert our development resources, any of which could cause our business to suffer.

      Many aspects of our business relate to the use, sharing and processing of information. As a result, we are subject to many regulations, including HIPAA and other privacy regulations, that are designed to protect the privacy of the public and to prevent the misuse of personal information in the marketplace. Our operations involve collecting data, processing data and redistributing data, which includes data that we receive from other parties. As a result, we may become involved in any matter relating to the misuse of such data and we may incur liability for any such misuse of that information by other parties simply as a result of our involvement in the process. We are subject to risks that we may not be able to comply with changes in the regulatory environment in an efficient, cost-effective manner. Security breaches in our facilities, computer networks, and databases may cause harm to our business and reputation and result in a loss of customers. Many security measures have been instituted to protect the systems and to assure the marketplace that these systems are secure. If users gain improper access to our databases, they may be able to steal, publish, delete or modify confidential third-party information that is stored or transmitted on our databases. In addition, misuse by our customers of our information services could harm our business and reputation, result in loss of customers and expose us to liability.

      We retain confidential customer and patient information in our processing 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. Additionally, the security requirements under the Health Insurance and Accountability Act of 1996 (“HIPAA”), impose security requirements. 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. If we fail to meet our clients’ or regulatory expectations, we could be liable for damages and our reputation could suffer. Our insurance may not protect us from this risk.

      Participants in the healthcare industry are subject to extensive and frequently changing regulation under numerous federal, state and local laws. Some of these laws apply directly to our business; many other indirectly affect the way we do business. Our healthcare service provider, payer and plan customers are subject to a wide variety of laws and regulations that could affect the nature and scope of their relationships with us.

      The healthcare market is highly regulated and subject to changing political, economic and regulatory influences. These factors affect the purchasing practices and operations of healthcare organizations. Changes in current healthcare financing and reimbursement systems, such as the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA), as well as changes in healthcare administration and communications requirements, such as HIPAA, may cause us to make unplanned enhancements of software applications or services, result in delays or cancellations of orders, or result in the revocation of endorsement of our applications and services by healthcare participants. The immediate and long term effect of the laws such as MMA and HIPAA is difficult to predict. There can be no assurances that our products and services will adequately address the business and compliance needs created by these and other enactments, or that we will be able to take advantage of any resulting business opportunities.

      Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state level. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare market participants operate. At present, there is renewed and increasing interest in healthcare at the federal and state levels, including but not limited to proposing additional privacy, security and/or transaction standards for communicating health information; implementing national provider, payer and/or patient identifiers; revamping the scope or manner of coverages by state and federal health care programs; and promoting (while likely increasing the regulation of ) systems that enable the exchange of electronic health information. Healthcare market participants may respond to anticipated change in these areas by reducing their investments or postponing investment decisions, including investments in our applications and services. We do not know what effect these or other proposals would have on our business. The uncertainty over if, when, and in what form any such proposals would be implemented could have a deleterious impact on our business as customers may choose to wait to see the final form of any such legislation or regulations and/or demand guarantees or other concessions related to potential changes.

      Among other things, our core products contain strong encryption technology that is subject to export control regulation. These regulations prohibit us from selling in certain countries and to certain persons. Our inadvertent failure to properly restrict our sales could subject us and our management to fines and other sanctions and impair our financial condition and our reputation. Additionally, in the international marketplace we face increased uncertainty of enforcement of contractual provisions and enforcement of judgments in our dealings with non-U.S. persons. Our inability to properly defend or enforce our contract rights could materially impair our business prospects and financial condition.

      Although both we and our customers test our applications, services and product offerings, they may contain defects or result in system failures. These defects or problems could result in the loss of or delay in generating revenue, loss of market share, failure to achieve market acceptance, diversion of development resources, injury to our reputation or increased insurance costs. In particular, we market software products that are designed to assist our healthcare customers in meeting their HIPAA compliance obligations. Failure of these products to perform as intended could cause our customers to incur significant fines and penalties for non-compliance, which in turn could result in damages and claims against us. Our contracts generally limit our liability arising from our errors; however, these provisions may not be enforceable and may not adequately protect us from liability. While we have general liability insurance that we believe is adequate, including coverage for errors and omissions, we may not be able to maintain this insurance on reasonable terms in the future. In addition, our insurance may not be sufficient to cover large claims and our insurer could disclaim coverage on claims. If we are liable for an uninsured or underinsured claim or if our premiums increase significantly, our financial condition could be materially harmed.

      In order to increase our customer base, we must establish, maintain and strengthen our brands. For us to be successful in establishing our brands, professionals in the healthcare and other targeted markets must perceive us as offering quality, cost-effective, communications, information and administrative services. Our reputation and brand names could be harmed if we experience difficulties in introducing new applications, services and product offerings, if these applications, services and product offerings are not accepted by customers, if we are required to discontinue existing applications, services and product offerings or if our products and services do not function properly.

      Due to issues experienced in 2004 related to our restatements, late SEC filings, NASDAQ delisting activities and shareholder litigation, we experienced a significant increase in departures of key employees from the Company. While having taken steps to support employee retention, which have stabilized our workforce, there can be no assurances that in the event of adverse outcomes in the SEC investigation or class action lawsuits, key employees will not leave the Company for other jobs thus impairing our ability to meet commitments and sustain revenue.

      Goodwill at March 31, 2005 totaled $46.7 million which is 38% of total assets. The goodwill balance resulted from our 2003 acquisitions. Because we have adopted Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets,” we are required to test goodwill annually for impairment and more frequently if events or changes in circumstances indicate assets might be impaired. Risks described elsewhere in this section could impair the market value of our common stock or our ability to generate cash flow in the future, which could result in the impairment of this asset.

      We currently develop and market our products primarily in the United States. As a majority of sales are currently made in U.S. dollars, a strengthening of the dollar could make our product less competitive in foreign markets. Since the U.S. dollar is considered the primary currency for the Company’s international operations, transactions that are completed in a foreign currency are translated into U.S. dollars and recorded in the financial statements. In addition, as we expand our foreign operations we increase our exposure to market risk due to fluctuations in foreign currency exchange rates relates primarily to the intercompany balances with our subsidiaries located in Europe. Translation gains or losses were not significant in any of the

periods presented and the Company does not believe it is currently exposed to any material risk of loss on this basis. The Company does not currently use any hedging strategies to minimize any translation risks.

      Our interest income is sensitive to changes in the general level of U.S. interest rates. Due to the short term-term nature of our investments, we believe that there is no material interest risk exposure. Based on the foregoing, no quantitative disclosures have been provided.

Evaluation of Disclosure Controls and Procedures

      The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act of 1934, as of March 31, 2005. This included an evaluation of disclosure controls and procedures applicable to the period covered by and existing through the filing of this periodic report. Based on that review, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are not effective to provide reasonable assurance that information the Company is required to disclose in its reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported accurately. As noted below, we have identified material weaknesses in our internal controls that existed during periods prior to and as of March 31, 2005.

Internal Controls over Financial Reporting

      In our Amendment No. 1 to our Annual Report on Form 10-K/A, we disclosed material weaknesses in internal controls as of December 31, 2004. The deficiencies were reported to the audit committee as constituting, individually or in the aggregate, “material weaknesses,” meaning that in those areas our internal controls either individually or in the aggregate result in more than a remote likelihood that a material misstatement of our annual or interim financial statements will not be prevented or detected. These material weaknesses included:

      No additional material weaknesses were identified at March 31, 2005. We believe the changes in internal controls discussed below have remedied two of these weaknesses; analysis and capitalized software and impairment, and capitalization and amortization of software. However, we cannot conclude that these weaknesses have been fully eliminated until we perform our 2005 internal controls testing.

      As of March 31, 2005, we have implemented the following changes to address the internal control weaknesses identified at year end:

      Enhancements were made to the analysis of capitalized software and impairment.

      Enhancements were made to the control of capitalization and amortization of software.

      Except for the improvements described above, there have been no other changes in our internal control over financial reporting during the quarter ended March 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

      We plan to take additional steps to strengthen our internal controls including improved communication, additional processes and additional training for software revenue recognition and expansion of controls, procedures and reviews and reviews for calculation and recording of accrued liabilities. We also plan additional financial reporting review levels and accounting staffing enhancements. We have created a plan to implement these additional internal controls over financial reporting during the second and third quarters of 2005.

PART II OTHER INFORMATION

      On November 14, 2001, a shareholder class action complaint was filed in the United States District Court, Southern District of New York. On April 19, 2002, plaintiffs filed an amended complaint. The amended complaint asserts that the prospectus from the Company’s February 10, 2000 initial public offering (“IPO”) failed to disclose certain alleged improper actions by various underwriters for the offering in the allocation of the IPO shares. The amended complaint alleges claims against certain underwriters, the Company and certain officers and directors under the Securities Act of 1933 and the Securities Exchange Act of 1934 (Bartula v. XCare.net, Inc., et al., Case No. 01-CV-10075). Similar complaints have been filed concerning more than 300 other IPO’s; all of these cases have been coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92. In a negotiated agreement, individual defendants, including all of the individuals named in the complaint filed against the Company, were dismissed without prejudice, subject to a tolling agreement. Issuer and underwriter defendants in these cases filed motions to dismiss and, on February 19, 2003, the Court issued an opinion and order on those motions that dismissed selected claims against certain defendants, including the Rule 10b-5 fraud claims against the Company, leaving only the Section 11 strict liability claims under the Securities Act of 1933 against the Company. A committee of our Board of Directors has approved a settlement proposal made by the plaintiffs On February 15, 2005, the Court issued an order granting conditional preliminary approval of the settlement. If the settlement is not achieved, the Company will continue to aggressively defend the claims. We do not believe that the outcome of this action will have a material adverse effect on our financial position, results of operations or liquidity; however, litigation is inherently uncertain and we can make no assurance as to the ultimate outcome or effect.

      On March 18, 2004, a purported class action complaint was filed in the United States District Court for District of Colorado, entitled Smith v. Quovadx, Inc. et al, Case No. 04-M-0509, against Quovadx, Inc., its now-former Chief Executive Officer and its now-former Chief Financial Officer. The complaint alleged violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended, purportedly on behalf of all persons who purchased Quovadx common stock from October 22, 2003 through March 15, 2004. The claims are based upon allegations the Company (i) purportedly overstated its net income and earnings per share during the class period, (ii) purportedly recognized revenue from contracts between the Company and Infotech Networks Group prematurely, and (iii) purportedly lacked adequate internal controls and was therefore unable to ascertain the financial condition of the Company. Eight additional, nearly identical class action complaints were filed in the same Court based on the same facts and allegations. The actions seek damages against the defendants in an unspecified amount. On May 17 and 18, 2004, the Company filed motions to dismiss each of the complaints. Since then, all but one of the actions, entitled Heller v. Quovadx, Inc., et al., Case No. 04-M-0665 (OES) (D. Colo.), have been dismissed. Thereafter, the plaintiff in Heller filed a first amended complaint, which asserts the same claims as those asserted in the original complaint, and includes allegations regarding the Company’s accounting for certain additional transactions. On September 8, 2004, the Court approved the appointment of David Heller as lead

plaintiff. On September 29, 2004, the Court denied defendants’ motions to dismiss the first amended complaint and approved the appointment of Mr. Heller’s counsel as lead plaintiff’s counsel. On October 14, 2004, the Company and the other defendants filed answers to the first amended complaint, denying allegations of wrongdoing and asserting various affirmative defenses. On January 13, 2005, the Court approved a scheduling order that, inter alia, requires fact discovery, which has commenced, to conclude eight months after the Court issues an order certifying a class. The Court issued its order certifying the class action on April 12, 2005. The deadline for completing fact discovery is December 12, 2005. The class action is still in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On March 22, 2004, a shareholder derivative action was filed in the District Court of Colorado, County of Arapahoe, entitled Marcoux v. Brown et al, against the members of the Board of Directors and certain now-former officers of Quovadx alleging breach of fiduciary duty and other violations of state law. The Company is named solely as a nominal defendant against which no recovery is sought. This complaint generally is based on the same facts and circumstances as alleged in the class action complaints discussed above, alleging that the defendants misrepresented Quovadx financial projections and that one of the defendants violated state laws relating to insider trading. The action seeks damages in an unspecified amount against the individual defendants, disgorgement of improper profits and attorney’s fees, among other forms of relief. On or about April 21, 2004, a second, nearly identical shareholder derivative complaint, seeking the same relief, was filed in the United States District Court for the District of Colorado, entitled Thornton v. Brown et al. The plaintiffs in both of the shareholder derivative actions are represented by the same local counsel. On or about May 20, 2004, a third, nearly identical shareholder derivative complaint, seeking the same relief, was filed in the District Court of Colorado, County of Arapahoe, entitled Jaroslawicz v. Brown, et al. The three shareholder derivative actions are now all pending in the Colorado state court. The Court has consolidated the three actions into a single consolidated action and set February 1, 2005 as the deadline for the filing of a consolidated amended complaint, subsequently extended to May 2, 2005. The parties requested, and the court approved, a further extension to August 1, 2005. The shareholder derivative action is still in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On May 17, 2004, a purported class action complaint was filed in the United States District Court for the District of Colorado, entitled Henderson v. Quovadx, Inc. et al, Case No. 04-M-1006 (OES), against Quovadx, Inc., its now-former Chief Executive Officer, its now-former Chief Financial Officer and its Board of Directors. The complaint alleged violations of Section 11 and Section 15 of the Securities Act of 1933, as amended, purportedly on behalf of all former shareholders of Rogue Wave Software, Inc. who acquired Quovadx common stock in connection with the Company’s exchange offer effective December 19, 2003. The claims are based upon the same theories and allegations as asserted in the Section 10(b) class actions described above. The Court denied plaintiff’s motion to consolidate this Section 11 action with the Section 10(b) cases and authorized the two competing lead plaintiff candidates to take discovery of each other in advance of a hearing on the appointment of lead plaintiff. On July 14, 2004, the Company and outside director defendants filed an answer to the complaint, denying allegations of wrongdoing and asserting various affirmative defenses. On September 8, 2004, the Court directed the plaintiff to publish new notice of pendency of this action inviting potential class members to submit motions for appointment as lead plaintiff. Two putative class members filed competing motions for appointment as lead plaintiff, and their motions are scheduled for a hearing on June 24, 2005. The Court stayed all discovery related to the merits of the litigation pending the appointment of a lead plaintiff. On October 4, 2004, the Company’s former CEO and CFO filed an answer to the complaint, denying allegations of wrongdoing and asserting various affirmative defenses. This class action also is in the preliminary stages, and it is not possible for us to quantify the extent of potential liability, if any.

      On April 12, 2004, the Company announced that the Securities and Exchange Commission (“SEC”) had notified the Company that it’s previously announced informal inquiry has become a formal investigation pursuant to an “Order Directing Private Investigation and Designating Officers to Take Testimony.” The SEC is investigating transactions entered into during the third quarter of 2002 and transactions entered into during 2003 including two distributor contracts totaling approximately $1 million and transactions between Quovadx

and Infotech Network Group. The investigation is continuing, and the Company continues to provide documents and information to the SEC.

      The Company is engaged from time to time in routine litigation that arises in the ordinary course of our business.

      (a) Exhibits

      The exhibits listed in the accompanying Exhibit Index to this quarterly report on Form 10-Q are filed, furnished or incorporated by reference as part of this quarterly report.

SIGNATURES

      In accordance with 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 thereto duly authorized, on the 4^th day of May 2005.

EXHIBIT INDEX