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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_________________

FORM 10-Q

_________________

     [X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
               OF THE SECURITIES EXCHANGE ACT OF 1934.

                   For the quarterly period ended September 30, 2004

OR

     [_]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
               OF THE SECURITIES EXCHANGE ACT OF 1934.

                   For the transition period from__________to_____________

Commission file number 0-26816

_________________

IDX SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

_________________

Vermont                                                                                                                            03-0222230
(State or Other Jurisdiction of                                                                                                (I.R.S. Employer
Incorporation or Organization)                                                                                             Identification No.)

40 IDX Drive
South Burlington, VT 05403
(Address of Principal Executive Offices)

Registrant’s Telephone Number, Including Area Code: (802) 862-1022

_________________

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes X    No ____

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes X     No ____

The number of shares outstanding of the registrant’s common stock as of October 28, 2004 was 30,474,727.

The following trademarks used herein are owned by IDX: Flowcast, Groupcast, Carecast, Imagecast, IDX, LastWord, IDXtend and Web Framework. All other trademarks referenced in this Quarterly Report on Form 10-Q are the property of their respective owners.

IDX SYSTEMS CORPORATION
FORM 10-Q
For the Period Ended September 30, 2004

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

IDX Systems Corporation
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)

See Notes to the Condensed Consolidated Financial Statements (unaudited)

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IDX Systems Corporation
Condensed Consolidated Statements of Income
(in thousands, except for per share data)
(unaudited)

See Notes to the Condensed Consolidated Financial Statements (unaudited)

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IDX Systems Corporation
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See Notes to Condensed Consolidated Financial Statements (unaudited)

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Notes to Condensed Consolidated Financial Statements (unaudited)

Note 1 – Nature of Business and Basis of Presentation

IDX Systems Corporation (“IDX” or the “Company”) provides healthcare information systems and services to large integrated healthcare delivery enterprises located in the United States, the United Kingdom and Canada. Revenues are derived from the licensing of software, hardware sales, and providing maintenance and services related to system sales.

On June 18, 2003, the Company completed the sale of its wholly owned subsidiary EDiX Corporation (“EDiX”) to Spheris, formerly Total eMed, Inc. (“TEM”), a medical transcription company based in Franklin, Tennessee. EDiX was accounted for as a discontinued operation, and therefore, EDiX’s results of operations and cash flows have been removed from the Company’s results of continuing operations and cash flows for all periods presented in this Quarterly Report on Form 10-Q. See Note 3 for further information on the sale of EDiX.

The interim unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) and in accordance with accounting principles generally accepted in the United States. Accordingly, certain information and footnote disclosures normally included in annual financial statements have been omitted or condensed. In the opinion of management, all necessary adjustments (consisting of normal recurring accruals) have been made to provide a fair presentation. The operating results for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes included in the Company’s latest annual report on Form 10-K filed with the SEC on March 15, 2004.

Certain reclassifications of prior period data have been made to conform to the current reporting period.

Note 2 – Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

Significant Estimates and Assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant 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 revenues and expenses during the reporting periods. Significant estimates and assumptions by management affect the Company’s revenue recognition, allowance for doubtful accounts, deferred tax assets, certain accrued expenses, amortization periods, capitalized software and intangible and long-lived assets. Actual results could differ from those estimates.

Revenue Recognition

IDX enters into contracts to license software and sell hardware and related ancillary products to customers through its direct sales force. The majority of the Company’s system sales attributable to software license revenue are earned from software that does not require significant customization or modification. The Company recognizes revenue for the licensing of software in accordance with American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements and SAB No. 104, Revenue Recognition and Emerging Issues Task Force 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”) and, accordingly, the Company recognizes revenue from software licenses, hardware, and related ancillary products when:

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Judgment is required in assessing the probability of collection and the current creditworthiness of each customer. For example, if the financial condition of our customers were to deteriorate, it could affect the timing and the amount of revenue the Company recognizes on a contract to the extent of cash collected. In addition, in certain instances judgment is required in assessing if there are uncertainties in determining the fee. If there are significant uncertainties, the revenue is not recognized until the fee is determinable.

The Company uses the residual method to recognize revenue when a contract includes one or more elements to be delivered at a future date and vendor specific objective evidence (“VSOE”) of the fair value of all undelivered elements (typically maintenance and professional services) exists. Under the residual method, the Company defers revenue recognition of the fair value of the undelivered elements and allocates the remaining portion of the arrangement fee to the delivered elements and recognizes it as revenue, assuming all other conditions for revenue recognition have been satisfied. The Company recognizes substantially all of its product revenue in this manner. If the Company cannot determine the fair value of any undelivered element included in an arrangement, the Company will defer revenue recognition until all elements are delivered, services are performed or until fair value can be objectively determined.

As part of an arrangement, the Company typically sells maintenance contracts as well as professional services to customers. Maintenance services include telephone and web-based support as well as rights to unspecified upgrades and enhancements, when and if the Company makes them generally available. Professional services are deemed to be non-essential and typically are for implementation planning, loading of software, installation of hardware, training, building simple interfaces, running test data, assisting in the development and documentation of process rules, and best practices consulting.

The Company recognizes revenues from maintenance services ratably over the term of the maintenance contract period based on VSOE of fair value. VSOE of fair value is based upon the amount charged for maintenance when purchased separately, which is typically the contract’s renewal rate. Maintenance services are typically stated separately in an arrangement. The allocated fair value of revenues pertaining to contractual maintenance obligations are classified as a current liability, since they are typically for the twelve-month period subsequent to the balance sheet date.

The Company recognizes revenues from professional services based on VSOE of fair value when: (1) a non-cancelable agreement for the services has been signed or a customer’s purchase order has been received; and (2) the professional services have been delivered. VSOE of fair value is based upon the price charged when professional services are sold separately and is typically based on an hourly rate for professional services.

The Company’s arrangements with customers generally include acceptance provisions. However, these acceptance provisions are typically based on our standard acceptance provision, which provides the customer with a right to a refund if the arrangement is terminated because the product did not meet our published specifications. This right generally expires 30 days after installation is completed. The product is deemed accepted unless the customer notifies the Company otherwise. Generally, the Company determines that these acceptance provisions are not substantive and historically have not been exercised, and therefore should be accounted for as a warranty in accordance with Statement of Financial Accounting Standards No. 5. In addition, for IDX Carecast system, IDX specifications include a 99.9% uptime guarantee and subsecond response time. The length of the guarantee typically ranges from one to three years. Historically, the Company has not incurred substantial costs relating to this guarantee and the Company currently accrues for such costs as they are incurred. The Company reviews these costs on a regular basis as actual experience and other information becomes available; and should they become more substantial, the Company would accrue an estimated exposure. The Company has not accrued any costs related to these warranties in the accompanying consolidated financial statements.

At the time the Company enters into an arrangement, the Company assesses the probability of collection of the fee and the terms granted to the customer. The Company’s typical payment terms include a deposit and subsequent payments based on specific milestone events and dates. If the Company considers the payment terms for the arrangement to be extended or if the arrangement includes a substantive acceptance provision, the Company defers revenue not meeting the criterion for recognition under SOP 97-2 and classifies this revenue as deferred revenue, including deferred product revenue. The Company’s payment terms are generally fewer than 90 days and payments from customers are typically due within 30 days of invoice date. If payment terms for an arrangement are considered extended or if the arrangement contains a substantive acceptance provision, the Company defers the recognition of revenue, including product revenue, not meeting the criterion under SOP 97-2. The Company recognizes this

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revenue, assuming all other conditions for revenue recognition have been satisfied, when the payment of the arrangement fee becomes due and/or when the uncertainty regarding acceptance is resolved as generally evidenced by written acceptance or payment of the arrangement fee.

Additionally, the Company enters into certain arrangements for the sale of software that require significant customization. In these instances, the Company accounts for the contract in accordance with Accounting Research Bulletin No. 45, Long-term Construction-Type Contracts and SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company generally recognizes revenue on a percentage of completion basis using labor input measures, which involves the use of estimates. Labor input measures are used because they reasonably measure the stage of completion of the contract. Revisions to cost estimates, which could be material, are recorded to income in the period in which the facts that give rise to the revision become known. The Company also follows the completed-contract method of accounting for one contract. Revenues and costs are included in operations in the year during which they are completed. This contract is expected to be completed during the fourth quarter of 2004 and the Company is currently expecting to realize revenues of approximately $13.5 million and costs that approximate revenues during the fourth quarter of 2004. The Company recognizes losses, if any, on fixed price contracts when the amount of the loss is determined. The complexity of the estimation process and the assumptions inherent in the application of the percentage of completion method of accounting affect the amounts of revenue and related expenses reported in the Company’s consolidated financial statements. The Company records revenues earned in excess of billings on uncompleted contracts as an asset with unbilled receivables and records billings in excess of revenue earned on uncompleted contracts as deferred revenues until revenue recognition criteria are met. Deferred contract costs represent costs incurred for the acquisition of goods or services associated with contracts, including contracts accounted for under the percentage-of-completion method of accounting, and certain pre-contract costs for which revenue has not yet been earned.

The Company also enters into arrangements that involve the delivery or performance of multiple products and services that include the development and customization of software, implementation services, and licensed software and support services. For these contracts, the Company applies the consensus of EITF 00-21 to determine whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes. Accordingly, if the elements qualify as separate units of accounting, and fair value exists for the elements of the contract that are unrelated to the customization services, these elements are accounted for separately, and the related revenue is recognized as the products are delivered or the services are rendered.

The Company also enters into arrangements under which the Company provides a hosted software application. The Company recognizes revenue for these arrangements based on the provisions of Emerging Issues Task Force (“EITF”) Issue No. 00-3, Application of AICPA SOP 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware (“EITF-00-3”), and the provisions of SAB No. 101, as amended by SAB No. 104, when there is persuasive evidence of an arrangement, collection of the resulting receivable is probable, the fee is fixed or determinable and acceptance has occurred. The Company’s revenues related to these arrangements consist of system implementation service fees and software subscription fees. The Company has determined that the system implementation services represent set-up services that do not qualify as separate units of accounting from the software subscriptions as the customer would not purchase these services without the purchase of the software subscription. As a result, the Company recognizes system implementation fees ratably over a period of time from when the system implementation services are completed and accepted by the customer to the end of the contractual life of the customer’s subscription agreement. The Company recognizes software subscription fees, which commence upon completion of the related system implementation, ratably over the applicable subscription period. Amounts billed prior to satisfying the Company’s revenue recognition policy are reflected as deferred revenue.

The application of SOP 97-2 and EITF 00-21 require judgment, including whether a software arrangement includes multiple elements, and if so, whether fair value exists for those elements. Typically the Company’s contracts contain multiple elements, and while the majority of the Company’s contracts contain standard terms and conditions, there are instances where our contracts contain non-standard terms and conditions. As a result, contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes in accordance with SOP 97-2 or EITF 00-21, and if so, the relative fair value that should be allocated to each of the elements and when to recognize revenue for each element. Interpretations would not affect the amount of revenue recognized but could impact the timing of recognition.

The Company records reimbursable out-of-pocket expenses in both maintenance and services revenues and as a direct cost of maintenances and services in accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred (“EITF 01-14”). EITF 01-14 requires reimbursable out-of-pocket expenses incurred to be characterized as revenue in the income statement. For the three months ended September 30, 2004 and 2003,

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reimbursable out-of-pocket expenses were $2.1 million and $1.9 million, respectively. For the nine months ended September 30, 2004 and 2003, reimbursable out-of-pocket expenses were $5.8 million and $5.3 million, respectively.

Accounting for Stock Based Compensation

The Company accounts for its stock-based compensation plan under Accounting Principles Board Opinion No. 25 (“APB No. 25”), Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock-based compensation plans. Accordingly, the Company records expense for employee stock compensation plans equal to the excess of the market price of the underlying IDX shares at the date of grant over the exercise price of the stock-related award, if any (known as the intrinsic value). In general, all employee stock options are issued with the exercise price equal to the market price of the underlying shares at the grant date and therefore, no compensation expense is recorded. In addition, no compensation expense is recorded for purchases under the 1995 Employee Stock Purchase Plan (the “ESPP”), as the plan is non-compensatory under the provisions of APB No. 25. The intrinsic value of restricted stock units and certain other stock-based compensation issued to employees as of the date of grant is amortized to compensation expense over the vesting period.

Statement of Financial Accounting Standards No. 123 (“SFAS 123”) establishes the fair value based method of accounting for stock-based compensation plans. The Company has adopted the disclosure-only alternative for stock options granted to employees and directors and for employee stock purchases under the ESPP under SFAS 123. The table below summarizes the pro forma operating results of the Company had compensation cost been determined in accordance with the fair value based method prescribed by SFAS 123.  

Subsequent to the quarter ended September 30, 2004, the Company entered into Executive Retention Agreements with certain key executives that provide, if certain conditions exist subsequent to a change in control of the Company, that the executives will receive both acceleration of vesting and extension of the exercise period on their stock-based awards. In accordance with APB Opinion No. 25, the Company has measured the intrinsic value of these individuals’ stock awards as of the modification date, which totaled approximately $37.0 million. If the acceleration of vesting and the extension of the exercise period occurs pursuant to the Executive Retention Agreements, this intrinsic value of any outstanding awards as of the date of separation will be recorded as compensation expense in the Company’s Consolidated Statements of Income. If the award vests and is exercised prior to the separation, the intrinsic value as of the date of modification is not recognized.

Foreign Currency Translation

The financial statements of the Company’s foreign subsidiary are translated in accordance with SFAS No. 52, Foreign Currency Translation. The reporting currency for the Company is the U.S. dollar (dollar). The functional currency of the Company’s subsidiary in the United Kingdom is the local currency of that country. Accordingly, the assets and liabilities of the Company’s subsidiary are translated into U.S. dollars using the exchange rate in effect at each balance sheet date. Revenue and expense accounts are generally translated using an average rate of exchange during the period. Foreign currency translation adjustments are accumulated as a component of other comprehensive loss as a separate component of stockholders’ equity. Gains and losses arising from transactions denominated in foreign currencies are primarily related to inter-company accounts that have been determined to be temporary in nature and cash, accounts receivable and accounts payable denominated in non–functional

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currencies. During the three and nine month periods ended September 30, 2004, the Company recorded net foreign currency transaction gains of $83,000 and $101,000, respectively.

New Accounting Standards

In October 2004, the Financial Accounting Standards Board (“FASB”) concluded that the proposed Statement 123R, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value, would be effective for public companies (except small business issuers as defined in SEC Regulation S-B) for interim or annual periods beginning after June 15, 2005. The FASB has tentatively concluded that companies could adopt the new standard using either the modified prospective transition method or the modified retrospective transition method. Under the modified prospective transition method, a company would recognize share-based employee compensation cost from the beginning of the fiscal period in which the recognition provisions are first applied as if the fair-value-based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and to any awards that were not fully vested as of the effective date. Measurement and attribution of compensation cost for awards that are not vested as of the effective date of the proposed Statement would be based on the same estimate of the grant-date fair value and the same attribution method used previously under Statement 123 (either for recognition or pro forma purposes). Under the modified retrospective transition method, a company would recognize employee compensation cost for periods presented prior to the adoption of Statement 123R in accordance with the original provisions of Statement 123; that is, an entity would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with Statement 123. A company would not be permitted to make any changes to those amounts upon adoption of the proposed Statement unless those changes represent a correction of an error (and are disclosed accordingly). For periods after the date of adoption of Statement 123R, the modified prospective transition method described above would be applied. The Company is in the process of determining the impact of this statement on its condensed consolidated financial statements.

Note 3 – Business Combinations and Divestitures

On June 18, 2003, the Company sold its wholly owned subsidiary, EDiX, to TEM resulting in a net gain on the sale of discontinued operations of $27.2 million. The Company received approximately $64.0 million in cash from TEM in exchange for all the capital stock of EDiX. The Company transferred approximately $8.2 million of cash to TEM as part of the sale of EDiX, resulting in a net cash inflow related to the EDiX sale of $53.6 million, net of transaction costs. EDiX represented the Company’s medical transcription services segment (See Note 7).

Summarized operating results for discontinued operations is as follows (in thousands):

The provision for income taxes on loss from discontinued operations was significantly higher than statutory provision primarily due to certain state tax payments.

The gain on the disposal of EDiX resulted in an income tax benefit of $2.2 million. The Company’s tax basis in the stock of EDiX exceeded the net proceeds from the sale, resulting in a capital loss on the sale for tax purposes. A tax benefit arises from this deductible temporary difference, which more likely than not will reverse in the foreseeable future and be realized.

Note 4 – Investments

On January 8, 2001, the Company sold certain of the net assets and operations of its majority owned subsidiary, ChannelHealth Incorporated (“ChannelHealth”), to Allscripts Healthcare Solutions, Inc. (“Allscripts”), a public company providing point-of-care

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e-prescribing and productivity solutions for physicians. In exchange for the Company’s 87% ownership of ChannelHealth, the Company received approximately 7.5 million shares (with restrictions as to resale as discussed below) of Allscripts common stock, which represented approximately a 20% ownership interest in Allscripts. In addition to the sale, the Company entered into a ten-year strategic alliance (the “Alliance Agreement”) whereby Allscripts is the exclusive provider of point-of-care clinical applications sold by IDX to physician practices.

Previously, the Company accounted for its investment in Allscripts under the equity method of accounting. Under the equity method of accounting, the Company recognized its pro-rata share of Allscripts losses during the 2001 fiscal year resulting in the elimination of the carrying value of this investment. Through September 30, 2004, the Company has sold approximately 168,000 shares of Allscripts common stock and at September 30, 2004, the Company owned approximately 19.1% of the outstanding shares of common stock of Allscripts. Due to the fact that the Company’s equity interest in Allscripts has fallen below 20% and that the Company no longer significantly influences the financial or operating policies of Allscripts, the equity method was discontinued during the third quarter of 2004. The Company accounts for its investment in Allscripts as available-for-sale securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, available-for-sale investments, which have readily determinable fair values, are reported at fair value with unrealized gains and losses, net of taxes, reported in Other Comprehensive Income as part of shareholders’ equity. The fair market value of this stock is affected by the Company’s contractual restriction that it is allowed to sell only 25% of its initial Allscripts shares in any one year. Restricted stock does not meet the readily determinable fair value criterion under SFAS 115; however, any portion of the security holding that can be reasonably expected to qualify for sale within one year is not considered restricted.

At September 30, 2004, the estimated market value of the Company’s investment in Allscripts is approximately $66.0 million, based on the last reported sales price per share of Allscripts common stock on the NASDAQ National Market on that date. Of this amount, $25.3 million is reported in Marketable Securities, which represents the fair value at September 30, 2004 of Allscripts shares that can be sold within one year.

Certain information relative to the Company’s marketable securities at September 30, 2004 and December 31, 2003 is as follows (in thousands):

Note 5 – Derivative Financial Instruments and Hedging Agreements

From time to time, the Company enters into forward foreign exchange contracts to hedge, on a net basis, the foreign currency exposure of a portion of the Company’s assets and liabilities denominated in the British pound sterling, including inter-company accounts. Inter-company transactions are denominated in the functional currency of our foreign subsidiary in order to centralize foreign exchange risk in the parent company in the United States. Increases or decreases in our foreign currency exposures are partially offset by gains and losses on the forward contracts, so as to mitigate foreign currency transaction gains and losses. The terms of these forward contracts are generally for one month. The Company does not use forward contracts for trading or speculative purposes. The forward contracts are not designated as cash flow or fair value hedges under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended. All outstanding forward contracts are marked to market at the end of the period and recorded on the balance sheet at fair value in other current assets and other current liabilities. The changes in fair value from these contracts and from the underlying hedged exposures are generally offsetting and are recorded in other income, net in the accompanying Consolidated Statement of Income.

During the three months ended September 30, 2004, the Company settled its 3.6 million outstanding forward foreign exchange contracts outstanding to exchange British pounds for US dollars outstanding as of June 30, 2004 for a nominal loss. At September 30, 2004, the Company had no forward foreign exchange contracts outstanding.

Note 6 – Restructuring Costs and Other Charges

Restructuring costs

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On September 28, 2001, the Company announced its plan to restructure and realign its large physician group practice businesses. The Company implemented a workforce reduction and restructuring program affecting approximately four percent of the Company’s employees. The restructuring program resulted in a charge to earnings of approximately $19.5 million during the fourth quarter of 2001, in connection with costs associated with employee severance arrangements of approximately $5.5 million, lease payment costs of approximately $5.2 million, equipment and leasehold improvement write-offs related to the leased facilities of $8.6 million and other restructuring costs, primarily related to professional and consulting fees related to the restructuring. Workforce related accruals, consisting principally of employee severance costs, were based on specific identification of employees to be terminated, along with their job classification and functions, and their location. Approximately 200 employees were terminated primarily in the Flowcast operating unit and certain corporate services functions. Substantially all workforce related actions were completed during the fourth quarter of 2001, with the exception of a minimal number of staff assigned to transition teams. As of December 31, 2003, the Company had an accrual balance of $1.4 million related to lease payments through the end of the lease term in 2006.

On June 1, 2004, the Company entered into an agreement to terminate its contractual commitments under the remaining lease. Such termination was in part, related to the restructuring. The Company paid $1.5 million to terminate the lease, which was approximately $387,000 higher than the amount accrued at the date of termination.

Lease abandonment charges

In 1999, the Company entered into a lease commitment for new office space in Seattle, Washington under a lease that commenced in 2003. The Company continued to utilize its existing space and an active search for a sublessee was initiated and has been ongoing. In 2002, the Company made the decision to consolidate its Seattle operations into the new office space. Due to the depressed Seattle real estate market and the inability to obtain a sublessee, the Company recorded a lease abandonment charge of $9.2 million in the fourth quarter of 2002. The lease abandonment charge is related to lease payments of approximately $7.9 million through the end of the lease term in 2005 and non-cash write-offs of certain leasehold improvements of approximately $1.3 million. As of December 31, 2003, the Company had an accrued liability of $5.1 million. During the first nine months of 2004, lease payments of $1.9 million were made. Of the $3.2 million accrual remaining at September 30, 2004, approximately $600,000 will be paid during the remainder of 2004 and approximately $2.6 million thereafter. In the event that the Company is able to secure a sub-lessee to assume its prior lease in a future reporting period or is able to negotiate lease terminations with the landlord, the present value of the savings generated from the future sub-lease income or lease terminations would be recorded as a reduction in lease abandonment expense in the period in which the sub-lease or termination agreements are signed.

Note 7 – Segment and Geographic Information

Segment Information

Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), establishes standards for reporting information about operating segments. SFAS 131 also establishes standards for related disclosures about major customers, products and services, and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions how to allocate resources and assess performance. The Company internally identifies operating segments by the type of products produced and markets served, and in accordance with SFAS 131, the Company has aggregated similar operating segments into one segment: Information Systems and Services.

Information Systems and Services consist of IDX’s healthcare information solutions that include software, hardware and related services. IDX solutions are designed to enable healthcare organizations to redesign patient care and other workflow processes in order to improve efficiency and quality. The principal markets for this segment include physician groups, management service organizations, hospitals and integrated delivery networks primarily located in the United States, United Kingdom and Canada.

Through the first quarter of 2003, the Company reported results of an additional segment, Medical Transcription Services (EDiX), which provided medical transcription outsourcing services for hospitals and large physician group practices primarily located in the United States. This segment was reported as discontinued operations (see Note 3) effective the second quarter of 2003 due to the sale of EDiX to TEM. Accordingly, because the Company currently operates under one business segment, segment information is no longer being disclosed separately. Operating results for the discontinued Medical Transcription Services segment have been reclassified to exclude general corporate overhead previously allocated to the segment and interest charged on certain inter-company loans, net of income taxes.

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Geographic Information

Revenues are attributed to countries based on the location of the client. The following table represents percentage of total revenues of principal geographic areas:

No significant revenues were generated from customers in foreign countries outside the US and Canada for the comparable periods in 2003.

During the three months ended September 30, 2004 there was one customer who accounted for approximately 14.3% of consolidated revenues from continuing operations. During the nine months ended September 30, 2004, there were no customers who accounted for more than 10% of our consolidated revenues from continuing operations. No single customer accounted for more than 10% of our consolidated revenues from continuing operations for comparable periods in 2003.

Note 8 – Accounts Payable, Accrued Expenses and Other Liabilities

Accounts payable, accrued expenses and other liabilities consist of the following (in thousands):

During the three months ended September 30, 2004, the Company decreased its accrual related to performance-based incentives by $950,000 based upon a review of current and forecasted metrics compared to the Company’s plan. In addition, during the three months ended September 30, 2004, the Company decreased its allowance of doubtful accounts by $780,000 as a result of a reduction in specifically identified collection risks combined with improved collection experience.

Note 9 – Deferred Revenues

Deferred revenues consists of the following (in thousands):

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Note 10 – Income Taxes

The Company’s 2004 and 2003 effective tax rate for continuing operations was lower than the Company’s statutory rate of 40.0%. For 2004, the lower effective tax rate of 38.0% is due to the utilization of research and experimentation credits to offset income taxes. For 2003, the lower effective tax rate of 9.3% was due to the utilization of previously reserved net operating losses and research and experimentation credits to offset income taxes and a decline in the deferred tax asset valuation allowance of approximately $4.4 million during the three months ended September 30, 2003. The Company currently expects to realize net recorded deferred tax assets as of September 30, 2004 of approximately $4.5 million. Management’s conclusion that such assets will be recovered is based upon its expectation that future earnings of the Company combined with tax planning strategies available to the Company will provide sufficient taxable income to realize recorded tax assets. Such tax strategies include estimates and involve judgment relating to unrealized gains on the Company’s investment in publicly traded common stock. While the realization of the Company’s net recorded deferred tax assets cannot be assured, to the extent that future taxable income against which these tax assets may be applied is not sufficient, some or all of the Company’s net recorded deferred tax assets would not be realizable.

Note 11– Earnings Per Share

The following sets forth the computation of basic and diluted earnings per share:

Options to acquire 909,713 and 1,051,398 shares for the three months ended September 30, 2004 and 2003, respectively, were excluded from the calculation of diluted earnings per share, as the effect would not have been dilutive. Options to acquire 473,347 and 1,875,278 shares for the nine months ended September 30, 2004 and 2003, respectively, were excluded from the calculation of diluted earnings per share, as the effect would not have been dilutive.

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Note 12 — Comprehensive Income

Components of other comprehensive income consisted of unrealized gains (losses) on marketable securities and foreign currency translation adjustments as follows:

Note 13 – Commitments and Contingencies

Leases:

At September 30, 2004, minimum lease payments for certain facilities and equipment under noncancelable leases commitments are as follows (in thousands):

Of the $138.7 million in non-cancelable operating lease obligations, approximately $3.0 million is included in accrued expenses at September 30, 2004 relating to a lease abandonment charge. See Notes 6 and 8.

Richard E. Tarrant, Chairman of the Company’s Board of Directors, is the President and a director of LBJ Real Estate Inc., a Vermont corporation (“LBJ Real Estate”). Certain executive officers of LBJ Real Estate are also directors or executive officers of the Company, including Robert H. Hoehl, a director of the Company, and John A. Kane, the Company’s Chief Financial Officer, who also serves as a director of LBJ Real Estate. The stockholders of LBJ Real Estate include Messrs. Tarrant and Hoehl and an independent individual. LBJ Real Estate holds a 1% general partnership interest in LBJ Limited Partnership, a Vermont limited partnership and an affiliate of the Company (“LBJ”), and Messrs. Hoehl, Tarrant, Kane and Robert F. Galin, President of IDX Global Business Development and Executive Vice President of the Company, and two other employees of the Company hold in the aggregate a 72.95% limited partnership interest. Through September 30, 2003, the Company leased an office building from LBJ. On September 30, 2003, LBJ sold the real estate leased by the Company to an unrelated third party. The Company is continuing to lease the real estate from the new owners under a new lease agreement, which has been approved by certain independent members of the Board of Directors of the Company who have no financial interest in the transaction.

Total rent expense from continuing operations amounted to $3.9 million and $2.9 million during the three months ended September 30, 2004 and 2003, respectively. Total rent expense from continuing operations amounted to $11.8 million and $9.0 million during the nine months ended September 30, 2004 and 2003, respectively. Total rent paid to LBJ was approximately $138,000 and $414,000 during the three and nine-month periods ended September 30, 2003, respectively.

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The Company leases office space to Allscripts in Burlington, Vermont. Total rent received from Allscripts was approximately $51,000 for each of the three month periods ended September 30, 2004 and 2003 and $152,000 and $173,000 for the nine months ended September 30, 2004 and 2003, respectively.

Contingencies:

Federal regulations issued in accordance with the Health Insurance Portability and Accountability Act of 1996, (“HIPAA”), impose national health data standards on health care providers that conduct electronic health transactions, health care clearinghouses that convert health data between HIPAA-compliant and non-compliant formats, and health plans. Collectively, these groups, including most of IDX’s customers and IDX’s eCommerce Services clearinghouse business, are known as covered entities. These HIPAA standards include:

All covered entities were required to comply with the TCS Standards by October 16, 2003. The Privacy Standards imposed by HIPAA have been in effect for most covered entities since April 14, 2003, while the compliance deadline for the Security Standards is April 21, 2005.

Many covered entities, including some of IDX’s customers, IDX’s eCommerce Services clearinghouse business, and trading partners of IDX’s clearinghouse business, were not fully compliant with the TCS Standards as of October 16, 2003. However, IDX has deployed contingency plans to accept non-standard transactions. Because the entire healthcare system, including IDX’s eCommerce Services clearinghouse business and the business of IDX’s customers who use our information systems to generate claims data, has not operated at full capacity using the newly-mandated standard transactions, it is possible that currently undetected errors may cause rejection of claims, extended payment cycles, system implementation delays and cash flow reduction, with the attendant risk of liability and claims against IDX.

The Privacy Standards place on covered entities specific limitations on the use and disclosure of individually identifiable health information. IDX has made certain changes in products and services to comply with the Privacy Standards. The effect of the Privacy Standards on IDX’s business is difficult to predict and there can be no assurances that IDX will adequately address the risks created by the Privacy Standards and their implementation or that IDX will be able to take advantage of any resulting opportunities.

Failure to comply with these standards under HIPAA may subject IDX to civil monetary penalties and, in certain circumstances, criminal penalties. Under HIPAA, covered entities may be subject to civil monetary penalties in the amount of $100 per violation, capped at a maximum of $25,000 per year for violation of any particular standard. Also, the U.S. Department of Justice (“DOJ’), may seek to impose criminal penalties for certain violations of HIPAA. Criminal penalties under the statute vary depending upon the nature of the violation but could include fines of not more than $250,000 and/or imprisonment.

The effect of HIPAA on IDX’s business is difficult to predict and there can be no assurances that IDX will adequately address the business risks created by HIPAA and its implementation, or that IDX will be able to take advantage of any resulting business opportunities. Furthermore, IDX is unable to predict what changes to HIPAA, or the regulations issued pursuant to HIPAA, might be made in the future or how those changes could affect IDX’s business or the costs of compliance with HIPAA.

Indemnifications:

IDX includes indemnification provisions in software license agreements with its customers. These indemnification provisions include provisions indemnifying the customer against losses, expenses, and liabilities from damages that could be awarded against the customer in the event that IDX’s software is found to infringe upon a patent or copyright of a third party. The scope of remedies available under these indemnification obligations is limited by the software license agreements. IDX believes that its internal business practices and policies and the ownership of information, works and rights agreements signed by all employees, limits IDX’s risk in paying out any claims under these indemnification provisions. To date IDX has not been subject to any litigation and has not had to reimburse any customers for any losses associated with these indemnification provisions.

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Note 14 – Legal Proceedings

In late 2001, the Company finalized a “Cooperative Agreement” with a non-regulatory federal agency within the U.S. Commerce Department’s Technology Administration, NIST, whereby the Company agreed to lead a $9.2 million, multi-year project awarded by NIST to a joint venture composed of the Company and four other joint venture partners (the “SAGE Project”). The project entails research and development to be conducted by the Company and its partners in the grant. Subsequently, an employee of the Company made allegations that the Company had illegally submitted claims for labor expenses and license fees to NIST and that the Company never had a serious interest in researching the technological solutions described in the proposal to NIST.

On March 31, 2004, IDX submitted certain information to NIST, which NIST requested in conjunction with a proposed amendment to the Cooperative Agreement. As a result of the Amendment, payment on the award is discontinued until IDX demonstrates regulatory compliance relating to certain aspects of its grant accounting and reporting procedures and relating to an in-kind contribution of software IDX made to the project. In issuing the Amendment, NIST made no finding of regulatory noncompliance by IDX in connection with the award. In connection with NIST’s Amendment, the U.S. Commerce Department, Office of Inspector General (“OIG”), is presently conducting an audit of the SAGE Project. IDX is cooperating with OIG auditors, and continues to be in discussions to resolve the issues raised by the Amendment. IDX has developed a plan with its joint venture partners to continue to conduct certain research on the SAGE project during the audit period and while funding is suspended.

The Company believes the employee has likely filed an action under the Federal False Claims Act under seal in the Federal District Court for the Western District of Washington with respect to his claims, sometimes referred to as a “qui tam” complaint. The Company has no information regarding the specific allegations in the qui tam complaint. Further, the Company has no information concerning the actual amount of money at issue in the qui tam complaint. The Company has not yet been served with legal process detailing the allegations. Prompted by the employee’s allegations, the Civil Division of the U.S. Attorney’s office in Seattle, Washington, in conjunction with the U.S. Commerce Department, OIG, is investigating whether the Company made false statements in connection with the application for the project award from NIST. The Company is cooperating in the government’s ongoing investigation.

In April 2003, the Company filed a complaint against the employee with the United States District Court for the Western District of Washington, entitled IDX Systems Corporation v. Mauricio Leon (case no. C03-972R). The Company’s lawsuit asks the Court to grant a declaratory judgment stating that, should the Company terminate the employee’s employment, such action would not constitute retaliation for alleged whistle-blowing activities in violation of the Federal False Claims Act or the Sarbanes-Oxley Act and would not constitute a violation of the employee’s rights under other laws. On June 10, 2004, the Company terminated the employee based upon, among other things, information obtained during the litigation and, as a result, the Company dismissed the aforementioned declaratory relief action.

In May 2003, the employee filed a complaint against the Company with the Federal District Court for the Western District of Washington, entitled Mauricio A. Leon, M.D. v. IDX Systems Corporation (case no. CV03-1158P) asserting that the Company had knowledge that the employee engaged in “protected activity” and retaliated against the employee in violation of the False Claims Act. In addition, the employee alleges that the Company violated the Americans with Disabilities Act and its Washington State counterpart in part through retaliation against the employee for exercising the employee’s rights under the federal and state discrimination laws. The employee also asserts other causes of action including (a) wrongful termination in violation of public policy (which has since been dismissed), (b) fraudulent inducement to enter into an employment contract with the Company (which has since been dismissed), and (c) negligent and intentional infliction of emotional distress (as to which the employee did not oppose the dismissal). The employee requests relief including, but not limited to, an injunction against the Company enjoining and restraining the Company from the alleged harassment and discrimination, wages, damages, attorneys’ fees, interest and costs. In addition, the employee’s complaint alleges that the Company submitted false statements to the government to obtain the grant and to obtain reimbursement from the government for project costs.

On September 30, 2004, the U.S. District Court issued an order dismissing all of the employee’s claims. The dismissal was based on the Court’s finding that the employee acted in bad faith in destroying evidence that he had a duty to preserve. The Court also awarded the Company $65,000 as sanctions, reflecting the cost of investigating and litigating the destruction of evidence. The Company has received notice that the employee has appealed the dismissal. The Company intends to vigorously argue in support of the District Court’s ruling.

In May 2003, the employee filed a complaint against the Company with the U.S. Department of Labor, pursuant to Section 1514A of the Sarbanes-Oxley Act of 2002. The employee’s complaint asserts that, notwithstanding alleged notice to the Company of the employee’s allegations, Company management conspired to continue to defraud the government by allowing fraudulent activities to continue uncorrected and by concealing and avoiding its obligations to report any and all fraudulent activities to the proper

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authorities. In addition, the employee’s complaint alleges that the Company acted to retaliate, harass and intimidate the employee in contravention of the Sarbanes-Oxley Act’s whistleblower provisions. The employee’s complaint requests relief including, but not limited to, reinstatement, back-pay, with interest, compensation for any damages sustained by the employee as a result of the alleged discrimination, and attorney’s fees. The Occupational Health and Safety Administration (“OSHA”) is investigating the employee’s complaint on behalf of the U.S. Department of Labor, and the Company intends to cooperate in the investigation. On October 14, 2004, the Company requested the U.S. District Court that dismissed the employee’s retaliation claims under the False Claims Act, as noted above, to enter an order enjoining the employee and OSHA from further processing the employee’s retaliation claim filed with the Department of Labor based on the doctrine of resjudicata. OSHA has opposed the motion. The Court has not yet ruled on this motion.

The Company intends to continue to vigorously defend against all of the employee’s claims, which the Company continues to maintain are without merit. However, the outcome or the impact these claims may have on the Company’s operations cannot currently be predicted.

From time to time, the Company is a party to or may be threatened with other litigation in the ordinary course of its business. The Company regularly analyzes current information, including, as applicable, the Company’s defenses and insurance coverage and, as necessary, provides accruals for probable and estimable liabilities for the eventual disposition of these matters. The ultimate outcome of these matters is not expected to materially affect the Company’s business, financial condition or results of operations.

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

You should read the following discussion together with the condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. This Item contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 that involve risks and uncertainties. Actual results may differ materially from those included in such forward-looking statements. Factors which could cause actual results to differ materially include those set forth under “Forward-Looking Information and Factors Affecting Future Performance” commencing on page 35, as well as those otherwise discussed in this section and elsewhere in this Quarterly Report on Form 10-Q. Unless otherwise specified or the context requires otherwise, the terms “we”, “us”, “our” and the “Company” refer to IDX Systems Corporation and its subsidiaries. There are a number of important factors that could cause results to differ materially from those indicated by these forward-looking statements, including among others, statements regarding the health care industry, statements regarding our products, product development and information technology, statements regarding future revenue or other financial trends, statements regarding future acquisitions, strategic alliances, or other agreement, including our agreements in the UK and statements regarding our intellectual property. If any risk or uncertainty identified in the following factors actually occurs, our business, financial condition and operating results would likely suffer. In that event, the market price of our common stock could decline.

We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial condition or business over time.

Because of these and other factors, past financial performance should not be considered an indicator of future performance. Investors should not use historical trends to anticipate future results.

INTRODUCTION

Founded in 1969, IDX Systems Corporation provides information technology (software and services) solutions designed to maximize value in the delivery of healthcare by improving the quality of patient service and reducing the costs of care. We offer business performance and clinical software solutions. Healthcare providers purchase IDX systems to improve their patients’ experience through simpler access, safer care delivery and more streamlined accounting.

We generate revenues from system sales and from maintenance and service fees for the implementation and support of system sales. Our system sales are comprised of a combination of IDX software licensed under the IDX^® Flowcast™, IDX^® Groupcast™, IDX^® Carecast™ System, and IDX^® Imagecast™ brands to primarily end-user customers, as well as bundled third party hardware and software. IDX patient access, financial and business intelligence products for hospitals, integrated delivery networks and group practices are packaged under Flowcast and Groupcast. Clinical solutions are generally packaged as the Carecast Clinical Enterprise System, which require more configurations and have a longer install period than our business performance solutions. Specialty care products, which include IDX’s radiology and imaging products, are marketed under Imagecast. Our maintenance

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and service fees consist of software maintenance fees, installation fees, development fees, professional and technical service fees, consulting fees and other miscellaneous fees. Maintenance and service fees also include outsourcing services and our IDX eCommerce Services business, which offers web-based electronic data interchange (“EDI”) claims, remittance and statement services. Costs relating to system sales consist primarily of external costs for bundled third party hardware and software purchases. Costs relating to maintenance and service fees consist primarily of employee costs and related infrastructure costs incurred in providing installation services, post-installation support and training and consulting services.

Our revenue growth is driven by demand for new healthcare information technology systems and services as well as installation, maintenance and service to our existing customers. Our ability to increase earnings is driven primarily by IDX software sales, which yield significantly higher gross profit margins than our hardware and services revenue components. Our ability to maintain or increase our services revenue in the future depends primarily on our ability to increase our installed customer base, to resubscribe existing customers to maintenance agreements and to maintain or increase current levels of our professional services business.

Matters Affecting Analysis

In June 2003, we completed the disposition of our wholly owned subsidiary, EDiX, to TEM, a medical transcription company based in Franklin, Tennessee. With the sale of EDiX, we no longer provide medical transcription outsourcing services. Our condensed consolidated financial statements have been reclassified to reflect EDiX as a discontinued operation for all periods presented in this Quarterly Report on Form 10-Q. As a result, we no longer discuss EDiX as a separate segment. For purposes of this Quarterly Report on Form 10-Q, the discussion will relate to our only segment, Information Systems and Services, which is discussed under the Results from Continuing Operations section below. The results of EDiX are discussed under the Results of Discontinued Operations section below.

Overview

During the first quarter of 2004, we finalized our subcontract agreement with British Telecommunications PLC (“BT”) to provide our clinical information technology systems to BT. BT is the local service provider for the London region contract awarded by the United Kingdom National Health Service (“NHS”). In December 2003, we reached a binding agreement in principle with Fujitsu Services, which is the local service provider for the Southern region contract awarded by the NHS. We continue to work on finalizing our definitive subcontract agreement to provide our clinical information technology systems to Fujitsu Services.

On March 31, 2004, we released Flowcast 3.0. Flowcast 3.0 represents a next-generation, revenue cycle management solution for hospitals, integrated delivery networks and large physician organizations and was the culmination of a two-year development effort.

During the second quarter of this year, we launched Flowcast Business Services Outsourcing (“BSO”). Flowcast BSO provides a revenue cycle management outsourcing solution for large physician organizations, hospitals and integrated delivery networks. The Flowcast BSO solution provides the technology, services, human resources and best practices for key processes in the revenue cycle.

Total revenues increased 34.2% to $136.1 million during the three months ended September 30, 2004 from $101.4 million for the same period in 2003. System sales and maintenance and service fees increased by 2.8% and 50.9%, respectively, driven largely from revenues generated from our subcontract arrangement with BT. Total operating expenses increased 30.1% resulting in operating income of $14.6 million or an operating margin of 10.8% for the three months ended September 30, 2004 as compared to an operating margin of 8.0% for the same period in 2003. For the three months ended September 30, 2004, we reported income from continuing operations of $9.8 million, or $0.31 diluted earnings per share, and at September 30, 2004, cash and marketable securities totaled $153.2 million.

A more detailed discussion of our results is presented in the Results from Continuing Operations section below.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates and judgments on our experience, our current knowledge, including terms of existing contracts, and our beliefs of what could occur in the future, based on our observation of trends in the industry, information provided by our customers and information available from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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The following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements and could potentially create materially different results under different assumptions and conditions.

This is not a comprehensive list of all of IDX’s accounting policies. For a detailed discussion on the application of these and other accounting policies, see Note 1 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Revenue Recognition – We enter into contracts to license software and sell hardware and related ancillary products to customers through our direct sales force. The majority of our system sales attributable to software license revenue are earned from software that does not require significant customization or modification. We recognize revenue for the licensing of software in accordance with American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements and SAB No. 104, Revenue Recognition and Emerging Issues Task Force 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”) and, accordingly, we recognize revenue from software licenses, hardware, and related ancillary products when:

We must exercise our judgment when we assess the probability of collection and the current creditworthiness of each customer. For example, if the financial condition of our customers were to deteriorate, it could affect the timing and the amount of revenue we recognize on a contract to the extent of cash collected. In addition, in certain instances judgment is required in assessing if there are uncertainties in determining the fee. If there are significant uncertainties, the revenue is not recognized until the fee is determinable.

We use the residual method to recognize revenue when a contract includes one or more elements to be delivered at a future date and vendor specific objective evidence (“VSOE”) of the fair value of all undelivered elements (typically maintenance and professional services) exists. Under the residual method, we defer revenue recognition of the fair value of the undelivered elements and we allocate the remaining portion of the arrangement fee to the delivered elements and recognize it as revenue, assuming all other conditions for revenue recognition have been satisfied. We recognize substantially all of our product revenue in this manner. If we cannot determine the fair value of any undelivered element included in an arrangement, we will defer revenue recognition until all elements are delivered, services are performed or until fair value can be objectively determined.

As part of an arrangement, we typically sell maintenance contracts as well as professional services to customers. Maintenance services include telephone and web-based support as well as rights to unspecified upgrades and enhancements, when and if we make them generally available. Professional services are deemed to be non-essential and typically are for implementation planning, loading of software, installation of hardware, training, building simple interfaces, running test data, assisting in the development and documentation of process rules, and best practices consulting.

We recognize revenues from maintenance services ratably over the term of the maintenance contract period based on VSOE of fair value. VSOE of fair value is based upon the amount charged for maintenance when purchased separately, which is typically the contract’s renewal rate. Maintenance services are typically stated separately in an arrangement. We classify the allocated fair value of revenues pertaining to contractual maintenance obligations as a current liability, since they are typically for the twelve-month period subsequent to the balance sheet date.

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We recognize revenues from professional services based on VSOE of fair value when: (1) a non-cancelable agreement for the services has been signed or a customer’s purchase order has been received; and (2) the professional services have been delivered. VSOE of fair value is based upon the price charged when professional services are sold separately and is typically based on an hourly rate for professional services.

Our arrangements with customers generally include acceptance provisions. However, these acceptance provisions are typically based on our standard acceptance provision, which provides the customer with a right to a refund if the arrangement is terminated because the product did not meet our published specifications. This right generally expires 30 days after installation is completed. The product is deemed accepted unless the customer notifies us otherwise. Generally, we determine that these acceptance provisions are not substantive and historically have not been exercised, and therefore should be accounted for as a warranty in accordance with Statement of Financial Accounting Standards No. 5. In addition, for our Carecast system, our specifications include a 99.9% uptime guarantee and subsecond response time. The length of the guarantee typically ranges from one to three years. Historically, we have not incurred substantial costs relating to this guarantee and we currently accrue for such costs as they are incurred. We review these costs on a regular basis as actual experience and other information becomes available; and should they become more substantial, we would accrue an estimated exposure. We have not accrued any costs related to these warranties in our consolidated financial statements.

At the time we enter into an arrangement, we assess the probability of collection of the fee and the terms granted to the customer. Our typical payment terms include a deposit and subsequent payments based on specific milestone events and dates. If we consider the payment terms for the arrangement to be extended or if the arrangement includes a substantive acceptance provision, we defer revenue not meeting the criterion for recognition under SOP 97-2 and classify this revenue as deferred revenue, including deferred product revenue. Our payment terms are generally fewer than 90 days and payments from customers are typically due within 30 days of invoice date. If payment terms for an arrangement are considered extended or if the arrangement contains a substantive acceptance provision, we defer the recognition of revenue, including product revenue, not meeting the criterion under SOP 97-2. We recognize this revenue, assuming all other conditions for revenue recognition have been satisfied, when the payment of the arrangement fee becomes due and/or when the uncertainty regarding acceptance is resolved as generally evidenced by written acceptance or payment of the arrangement fee.

Additionally, we enter into certain arrangements for the sale of software that require significant customization. In these instances, we account for the contract in accordance with Accounting Research Bulletin No. 45, Long-term Construction-Type Contracts and SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. In those situations, we generally recognize revenue on a percentage of completion basis using labor input measures, which involves the use of estimates. Labor input measures are used because they reasonably measure the stage of completion of the contract. Revisions to cost estimates, which could be material, are recorded to income in the period in which the facts that give rise to the revision become known. We also follow the completed-contract method of accounting for one contract. Revenues and costs are included in operations in the year during which they are completed. We recognize losses, if any, on fixed price contracts when the amount of the loss is determined. This contract is expected to be completed during the fourth quarter of 2004 and the Company is currently expecting to realize revenues of approximately $13.5 million and costs that approximate revenues during the fourth quarter of 2004. The complexity of the estimation process and the assumptions inherent in the application of the percentage of completion method of accounting affect the amounts of revenue and related expenses reported in our consolidated financial statements. We record revenue earned in excess of billings on uncompleted contracts as an asset with unbilled receivables. We record billings in excess of revenue earned on uncompleted contracts as deferred revenue until revenue recognition criteria are met. Deferred contract costs represent costs incurred for the acquisition of goods or services associated with contracts, including contracts accounted for under the percentage-of-completion method of accounting, and certain pre-contract costs for which revenue has not yet been earned.

We also enter into arrangements that involve the delivery or performance of multiple products and services that include the development and customization of software, implementation services, and licensed software and support services. For these contracts, we apply the consensus of EITF 00-21 to determine whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes. Accordingly, if the elements qualify as separate units of accounting, and fair value exists for the elements of the contract that are unrelated to the customization services, these elements are accounted for separately, and the related revenue is recognized as the products are delivered or the services are rendered.

We also enter into arrangements under which we provide hosted software applications. We recognize revenue for these arrangements based on the provisions of Emerging Issues Task Force Issue No. 00-3, Application of AICPA SOP 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware (“EITF-00-3”), and the provisions of Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, when there is

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persuasive evidence of an arrangement, collection of the resulting receivable is probable, the fee is fixed or determinable and acceptance has occurred. Our revenues related to these arrangements consist of system implementation service fees and software subscription fees. We have determined that the system implementation services represent set-up services that do not qualify as separate units of accounting from the software subscriptions as the customer would not purchase these services without the purchase of the software subscription. As a result, we recognize system implementation fees ratably over a period of time from when the system implementation services are completed and accepted by the customer to the end of the contractual life of the customer’s subscription agreement. We recognize software subscription fees, which commence upon completion of the related system implementation, ratably over the applicable subscription period. Amounts billed prior to satisfying our revenue recognition policy are reflected as deferred revenue.

The application of SOP 97-2 and EITF 00-21 require judgment, including whether a software arrangement includes multiple elements, and if so, whether fair value exists for those elements. Typically our contracts contain multiple elements, and while the majority of our contracts contain standard terms and conditions, there are instances where our contracts contain non-standard terms and conditions. As a result, contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes in accordance with SOP 97-2 or EITF 00-21, and if so, the relative fair value that should be allocated to each of the elements and when to recognize revenue for each element. Interpretations would not affect the amount of revenue recognized but could impact the timing of recognition.

We record reimbursable out-of-pocket expenses in both maintenance and services revenues and as a direct cost of maintenances and services in accordance with EITF Issue No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred (“EITF 01-14”). EITF 01-14 requires reimbursable out-of-pocket expenses incurred to be characterized as revenue in the income statement.

Allowance for Doubtful Accounts and Credits – We maintain an allowance for doubtful accounts to reflect estimated losses resulting from the inability of customers to make required payments. We record an allowance for receivables based on a percentage of revenues. We review individual overdue accounts and record an additional allowance when we determine it necessary to state the specific receivable at realizable value. We base our allowance on estimates after consideration of factors such as the composition of the accounts receivable aging, bad debt experience and our evaluation of the financial condition of the customers. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances and bad debt expense may be required. We typically do not require collateral from our customers. Historically, our estimates have been adequate to cover accounts receivable exposures.

We also record a provision for estimated credits on product and service related sales in the same period the related revenues are recorded. These estimates are based on an analysis of historical credits issued and other known factors. If the historical data we use to calculate these estimates does not properly reflect the future credits, then a change in the credit reserve would be made in the period in which such a determination is made and revenues in that period would be affected.

Capitalization of Software Development Costs – We expense all costs incurred in the research, design and development of software for sale to others until technological feasibility is established. Technological feasibility is established when planning, designing, coding and testing activities have been completed so that the working model is consistent with the product design as confirmed by testing. Thereafter, we capitalize and amortize software development costs to software development expense on a straight-line basis over the lesser of 18 months or the estimated lives of the respective products, beginning when the products are offered for sale. We capitalize software acquired if the related software under development has reached technological feasibility or if there are alternative future uses for the software. We evaluate the recoverability of capitalized software based on estimated future gross revenues reduced by the estimated cost of completing the products and of performing maintenance and customer support. If our gross revenues were to be significantly less than our estimates, the net realizable value of our capitalized software intended for sale would be impaired.

While we believe that our current estimates and the underlying assumptions regarding capitalized software development costs are appropriate, future events could necessitate adjustments to these estimates, resulting in additional software development expense in the period of adjustment.

We expense costs incurred in the development of software for internal use until we have completed the conceptual formulation, design, and testing of possible project alternatives, including the process of vendor selection for purchased software, if any. We capitalize and amortize certain costs; principally external direct costs and payroll and payroll related costs directly associated with the internal-use computer software project, incurred subsequent to the preliminary project stage, to operating expense on a

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straight-line basis over the lesser of seven years or the estimated economic life of the software.

Income Taxes – We account for income taxes under the liability method. We determine deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities, measured using the enacted tax rates that will be in effect when these differences are expected to reverse. We have typically had net deferred tax assets at our reporting dates. In assessing the realization of our net deferred tax assets, we evaluated certain relevant criteria, including future taxable income, and tax planning strategies designed to generate future taxable income. We currently believe that future earnings and current tax planning strategies will be sufficient to recover substantially all of our net recorded deferred tax assets. These strategies include estimates and involve judgments relating to certain unrealized gains in our investment in common stock of an equity investee. To the extent that facts and circumstances change – for example, if there is a decline in the fair value of the equity method investment – this tax-planning strategy may no longer be sufficient to support certain deferred tax assets and we may be required to increase the valuation allowance. Furthermore, to the extent that future taxable income against which these tax assets may be applied is not sufficient, some portion or all of our recorded deferred tax assets would not be realizable.

Accounting for Contingencies – We are currently involved in certain legal proceedings, which, if unfavorably determined, could have a material adverse effect on our operating results and financial condition. In connection with our assessment of these legal proceedings, we must determine if an unfavorable outcome is probable and evaluate the costs for resolution of these matters, if reasonably estimable. We have developed these determinations and related estimates in consultation with outside counsel handling our defense in these matters, and through an analysis of potential results assuming a combination of litigation and defense strategies. See Part II, Item 1, “Legal Proceedings” and Note 14 of Notes to Consolidated Financial Statements included in this Quarterly Report on 10-Q.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003 which contain accounting policies and other disclosures required by generally accepted accounting principles.

NEW ACCOUNTING STANDARDS

In October 2004, the Financial Accounting Standards Board (“FASB”) concluded that the proposed Statement 123R, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value, would be effective for public companies (except small business issuers as defined in SEC Regulation S-B) for interim or annual periods beginning after June 15, 2005. The FASB has tentatively concluded that companies could adopt the new standard using either the modified prospective transition method or the modified retrospective transition method. Under the modified prospective transition method, a company would recognize share-based employee compensation cost from the beginning of the fiscal period in which the recognition provisions are first applied as if the fair-value-based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and to any awards that were not fully vested as of the effective date. Measurement and attribution of compensation cost for awards that are not vested as of the effective date of the proposed Statement would be based on the same estimate of the grant-date fair value and the same attribution method used previously under Statement 123 (either for recognition or pro forma purposes). Under the modified retrospective transition method, a company would recognize employee compensation cost for periods presented prior to the adoption of Statement 123R in accordance with the original provisions of Statement 123; that is, an entity would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with Statement 123. A company would not be permitted to make any changes to those amounts upon adoption of the proposed Statement unless those changes represent a correction of an error (and are disclosed accordingly). For periods after the date of adoption of Statement 123R, the modified prospective transition method described above would be applied. We are in the process of determining the impact of this statement on our condensed consolidated financial statements.

RESULTS OF CONTINUING OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2004 AS COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2003

The following table indicates the percentage of total revenues and the dollar and percentage of period over period change represented by line items in our condensed consolidated statements of income from continuing operations:

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_________________

+ Does not total due to rounding.
* Not meaningful.

Total Revenues

Total revenues consist of system sales and maintenance and service fees. Our system sales consist of our software licensed to primarily end-user customers, along with third party hardware and software. Maintenance and service fees represent services to implement and support our system sales. More specifically, our maintenance and service fees consist of software maintenance fees, installation fees, professional and technical service fees, training fees, outsourcing services, and other miscellaneous fees.

Our eCommerce Services revenues have been historically classified with system sales. These revenues are now included with maintenance and service fees, since a large component of these revenues are service driven. In addition, royalty revenues, which historically have been classified with maintenance and service fees, are now included with system sales, since typically royalties are associated with related system sales. Prior period data have been reclassified to conform to the current reporting period.

During the three months ended September 30, 2004 as compared to the same period in 2003, total revenues increased 34.2% driven principally from maintenance and service fees, which increased 50.9% due primarily to our development efforts in the UK. This resulted in maintenance and service fees representing a larger portion of our total revenues. We currently anticipate this trend to continue with our development work in the UK and as we market more comprehensive clinical systems the time and effort required to implement these systems is typically more extensive.

System Sales

Software license and subscription revenues and hardware and third party software sales increased minimally during the three months ended September 30, 2004 as compared to the same period last year. The overall increase in system sales was primarily attributable to increases of $1.1 in royalty revenue. Under certain royalty and revenue-sharing arrangements, we recognize royalty revenue from sales by third parties that incorporate technology licensed from IDX, or we share in revenues received by third parties from IDX customers. The increase in royalty and revenue sharing income was primarily due to the increased level of third party sales.

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Maintenance and Service Fees

The following table indicates the percentage of total revenues and the dollar and percentage of period over period change by line items comprising maintenance and service fees as represented in our condensed consolidated statements of income from continuing operations:

_________________

+ Does not total due to rounding.

The increase in maintenance and service fees was driven largely from our efforts in the UK. The increases in development services, which represent revenues for our development efforts associated with the production and customization of certain product functionalities required under our UK contracts, and installation fees were both primarily related to work performed for our UK customers. The increase in maintenance fees for software and hardware support was primarily due to an increase in our installed base of $3.8 million combined with annual maintenance price increases of approximately $1.2 million. Consulting, professional and other fees increased 24.0% primarily attributable to growth in our services, principally eCommerce, mailing services and business outsourcing. The growth in our eCommerce revenues was primarily from our medical and physician group practice customers as a result of HIPAA regulation requirements. Increases in our revenues from mailing services typically follow increases in our eCommerce revenues. BSO is a new offering that was launched during the second quarter of 2004.

Cost of Sales 

The following table indicates the total cost of system sales and maintenance and service fees as a percentage of total revenues and the cost of system sales and maintenance and service fees as a percentage of their respective revenues:

The cost components of our total revenues vary based on the type of products and services we provide, namely system sales and maintenance and service fees. Our cost of system sales consists primarily of external costs relating to third party hardware and

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software purchases, while the costs of maintenance and service fees are employee-driven and consist primarily of employee and related infrastructure costs incurred in providing maintenance and installation services, post-installation support and training and consulting services. These costs as a percentage of total revenues typically have varied as the mix of revenue (software, bundled third party software, hardware, maintenance and service fees) components carry different margin rates from period to period. In addition, fluctuations in our cost of system sales typically result from the revenue mix of our software license revenue, which has a lower cost percentage and higher margins, and third party hardware and software sales, which have higher cost percentages and lower margins.

Cost of System Sales

For the three months ended September 30, 2004 as compared to the same period in 2003, our cost of system sales as a percentage of system sales decreased principally as a result of the change in the product mix between our software license revenue and third party hardware and software sales. IDX software sales, which carry a lower cost of revenue percentage, represented a larger portion of system sales during the nine months ended September 30, 2004 as compared to the same period in 2003. The shift in product mix was attributable to the increase in our royalty and revenue sharing income as described under system sales above combined with a decrease in royalties paid due to the restructuring of certain of our royalty arrangements.

Cost of Maintenance and Service Fees

The cost of maintenance and service fees increased $20.3 million or 47.6% during the three months ended September 30, 2004 as compared to the same period in 2003 to support the growth in our installed base of software applications and is in line with the increase of 50.9% in maintenance and service fees revenue. The increase was primarily attributable to increases of $9.1 million in subcontractor consulting expenses, $6.1 million in employee compensation and benefit costs, $1.3 million in third party maintenance contract costs and $1.1 million in professional fees. Subcontractor consulting expenses, professional fees and employee compensation and benefit costs increased primarily to support the growth in our revenues from our operations in the UK. A portion of our research and development costs, principally employee compensation and benefit costs, were allocated to the cost of maintenance and services that relate to the development work in the UK. Certain third party maintenance contract costs increased as customers upgraded to new systems, which have a higher support cost per user. The cost of maintenance and service fees as a percentage of maintenance and service fee revenue for the three months ended September 30, 2004 as compared to the same period in 2003 decreased to 63.1% from 64.5% due to operational efficiencies achieved in employee and infrastructure costs.

As the demand for services from new and existing customers for installation, maintenance and consulting services increases in future periods, we anticipate that our cost of services will also increase. In addition, we expect the cost of maintenance and service fees to increase in future periods, primarily due to classification of development costs related to services provided in the UK as costs of maintenance and service fees. The use of specialized professional outside services may increase as well, further increasing cost of services, which may reduce our overall margin.

Selling, General and Administrative Expenses

The increase of $6.6 million in selling, general and administrative expenses was principally due to increases of $3.1 million in employee compensation and benefit costs, $2.0 million in outside professional fees, $1.5 million in occupancy related expenses, $1.2 million in travel related expenses and $800,000 in depreciation charges offset with a decrease in bad debt expense of $1.1 million and in performance driven incentives of $950,000.

The increase in employee compensation and benefit costs was due primarily to expansion in our operations in the UK. Professional fees increased principally due to litigation matters as described in Note 14 of Notes to Condensed Consolidated Financial Statements, audit and accounting fees incurred in conjunction with the enhanced testing and the general expansion of our UK operations, and consulting fees incurred in conjunction with the Sarbanes-Oxley Act of 2002. Occupancy related expenses and travel increased primarily as a result of the expansion of our UK operations. The increase in depreciation charges was primarily attributable to the Enterprise Resource Planning (“ERP”) system, of which a significant portion went live in fourth quarter 2003. Bad debt expense decreased by $1.1 million this quarter primarily as a result of a reduction in specifically identified collection risks combined with improved collection experience.

We expect our selling, general and administrative expenses to increase in future periods as we increase our administrative and accounting staff to support our growth. In addition, we anticipate that we will continue to incur higher professional fees in 2004 in conjunction with current litigation matters and increased use of outside professional accounting and consulting firms and outside legal counsel to assist us in our continued compliance efforts with the requirements of the Sarbanes-Oxley Act of 2002.

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Software Development Costs

Software development costs consist primarily of costs related to our software developers, associated infrastructure costs required to fund product development initiatives and amortization of such costs. As described in Note 1 to the Notes to Consolidated Financial Statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003, which contain accounting policies and other disclosures required by generally accepted accounting principles, software development costs incurred subsequent to the establishment of technological feasibility until general release of the related products are capitalized. Technological feasibility is established upon the completion of a working model or detail program design. Historically, costs incurred after establishment of technological feasibility have not been significant; however, as we develop products that use more complex technologies as well as more comprehensive clinical systems, the time and effort required to complete testing after technological feasibility has been established may become significantly more extensive. Consequently, we anticipate that as we continue to focus our development efforts on enhancing functionality and developing new applications for our current product suites, capitalized software development costs may become more significant in future reporting periods. Approximately $889,000 and $811,000 of software development costs were capitalized during the three months ended September 30, 2004 and 2003, respectively. Amortization of software development costs was approximately $770,000 and $298,000 during the three months ended September 30, 2004 and 2003, respectively.

The following table indicates software development costs as a percentage of system sales:

The $1.6 million increase in software development costs was due primarily to increases of $1.2 million in employee compensation and benefit cost and subcontractor consulting costs and $500,000 in capitalized software development costs amortization primarily attributable to costs previously capitalized during the three months ended March 31, 2004 for Flowcast 3.0, which was released on March 31, 2004.

Total Other Income (Expense), Net

The following table sets forth the components of total other income, net:

Interest Income

The increase in interest income was due to higher domestic interest rates for the three months ended September 30, 2004 as compared to the same period in 2003 and higher average invested balances in the UK, which yield higher interest rates than domestic balances.

Gain on Sale of Equity Investment

During the three months ended September 30, 2004, we realized a gain of approximately $248,000 on the sale of 29,000 shares of our equity investment in Allscripts common stock.

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Foreign Currency Transaction Gains (Losses), net

Revenues generated from our operations in the UK are primarily denominated in pounds sterling, the local foreign currency. In addition, certain expenses to service our UK contracts are incurred in pounds sterling. As such, we are exposed to foreign exchange rate fluctuations from these transactions. For the three months ended September 30, 2004, we incurred a net foreign currency transaction gain of $83,000.

Income Tax Provision

Our effective income tax rate was 38.0% for the three months ended September 30, 2004 resulting in an income tax provision of $5.9 million. Our effective income tax rate for 2004 was lower than our historical tax rate of 40.0% primarily due to our use of research and development credits to offset income taxes. We recorded an income tax benefit of approximately $1.9 million during the three months ended September 30, 2003, resulting in an effective tax rate from continuing operations for the quarter of (23.0%). This is lower than our historical tax rate of 40.0% due to the utilization of previously reserved net operating losses and research and experimentation credits to offset income taxes and a decline in the deferred tax asset valuation allowance. The valuation allowance declined $4.4 million during the three months ended September 30, 2003 as a result of management expectations that the Company will more likely than not realize future tax benefits through tax planning strategies related to unrealized gains on the Company’s investment in publicly traded common stock that the Company, at that time, accounted for using the equity method of accounting.

NINE MONTHS ENDED SEPTEMBER 30, 2004 AS COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2003

The following table indicates the percentage of total revenues and the dollar and percentage of period over period change represented by line items in our condensed consolidated statements of income from continuing operations:

_________________

+ Does not total due to rounding.
* Not meaningful.

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System Sales

The increase in system sales during the nine months ended September 30, 2004 as compared to the same period in 2003 was attributable to increases of $7.9 million in software license and subscription revenues and $1.4 million in hardware and third party software sales. The increases were primarily attributable to system sales relating to Imagecast radiology contracts.

Maintenance and Service Fees

The following table indicates the percentage of total revenues and the dollar and percentage of period over period change by line items comprising maintenance and service fees as represented in our condensed consolidated statements of income from continuing operations: