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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

OR

FOR THE TRANSITION PERIOD FROM              TO             

Commission file number 0-26816

IDX SYSTEMS CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

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 May 4, 2004 was 30,132,748.

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.

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IDX SYSTEMS CORPORATION

FORM 10-Q

For the Period Ended March 31, 2004

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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

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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

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IDX Systems Corporation

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

See Notes to Condensed Consolidated Financial Statements

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Notes to Condensed Consolidated Financial Statements

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 Securities and Exchange Commission 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 months ended March 31, 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 Securities and Exchange Commission on March 15, 2004.

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

Accounting for Stock Based Compensation

The Company accounts for its stock-based compensation plan under Accounting Principles Board (“APB”) 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 (“SFAS”) No. 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

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granted to employees and directors and for employee stock purchases under the ESPP under SFAS No. 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 No. 123.

Note 2 – New Accounting Standards

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Prior to FIN 46, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that guidance by requiring a variable interest entity, as defined in FIN 46, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosure about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. On October 8, 2003, the Financial Accounting Standards Board deferred the effective date of FIN 46 for variable interest entities created before February 1, 2003 to periods ending after December 15, 2003. A public entity need not apply the provisions of FIN 46 to an interest held in a variable interest entity (“VIE”) until the end of the first interim or annual period ending after December 15, 2003, if both of the following apply:

Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of FIN 46 had no impact on the Company’s financial position, results of operations or cash flows.

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 $26.5 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 6).

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Summarized selected financial information for the discontinued operations for the three months ended March 31, 2003 is as follows (in thousands):

Note 4 – Investments in Affiliates, at Equity

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 e-prescribing and productivity solutions for physicians. 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.

At March 31, 2004, the Company owned approximately 19.0% of the outstanding shares of common stock of Allscripts and accounts 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. In accordance with the equity method of accounting, the Company has not recorded its share of losses since then, which share amounts to $68.5 million through December 31, 2003. At March 31, 2004, the estimated market value of the Company’s investment in Allscripts is approximately $72.6 million, based on the last reported sales price per share of Allscripts common stock on the NASDAQ National Market on that date. The fair market value of this stock would be affected by the Company’s contractual restriction that it is allowed to sell only 25% of its initial Allscripts shares in any one year.

Through March 31, 2004, the Company has sold approximately 14,000 shares of Allscripts common stock, which sale has not materially changed its ownership interest in Allscripts.

Note 5 – Restructuring costs and other charges

Restructuring costs

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. Of the $1.3 million accrual remaining at March 31, 2004, approximately $500,000 will be paid during the remainder of 2004 and approximately $800,000 thereafter. The table below sets forth the activity in the workforce reduction and restructuring program (in thousands):

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Lease abandonment charges

In 1999, the Company entered into a lease commitment for new office space in Seattle under a lease that commenced in 2003. The Company continued to utilize its existing space and an active search for a sublessor 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 sublessor, 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. Of the $4.4 million accrual remaining at March 31, 2004, approximately $1.8 million 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-tenant 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. The table below sets forth the activity in the lease abandonment charge (in thousands):

Note 6 – Segment and Geographic 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 had 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 discontinued effective as of the second quarter of 2003 with the sale of EDiX to TEM and is reflected in discontinued operations (see Note 3). 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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Note 7 – Accounts Payable, Accrued Expenses and Other Liabilities

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

Note 8 – Income Taxes

The Company’s 2004 and 2003 effective tax rate for continuing operations was 38.0% and 30.0%, respectively, which is lower than the Company’s statutory rate of 40.0% due to the utilization of research and experimentation credits. The Company currently expects to realize net recorded deferred tax assets as of March 31, 2004 of approximately $19.6 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 of an equity investee. 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 9 – Stockholders’ Equity

Earnings Per Share:

The following sets forth the computation of basic and diluted earnings per share (in thousands, except for per share data):

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Options to acquire 177,009 and 4,529,862 shares for the three months ended March 31, 2004 and 2003, respectively, were excluded from the calculation of diluted earnings per share, as the effect would not have been dilutive.

Comprehensive Income:

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

Note 10 – Financing Arrangements

The Company has a revolving line of credit agreement (the “Line”) allowing the Company to borrow up to $40.0 million subject to certain restrictions. The Line is secured by deposit accounts, accounts receivable and other assets and bears interest at the bank’s base rate plus .25%, resulting in a rate of 4.25% as of March 31, 2004. The Line expires on June 27, 2005. At December 31 2003 and March 31, 2004, no amounts were outstanding under the Line.

Note 11 – Commitments and Contingencies

Leases:

At March 31, 2004, minimum lease payments, net of sublease proceeds, for certain facilities and equipment under noncancelable leases are as follows (in thousands):

Of the $147.7 million in non-cancelable operating lease obligations, approximately $5.8 million is included in accrued expenses at March 31, 2004 relating to a lease abandonment charge and restructuring costs. See Notes 5 and 7.

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 Ltd. Partnership, a Vermont limited partnership and an affiliate of the Company (“LBJ”), and Messrs. Hoehl, Tarrant, and Kane and Mr. Robert F. Galin, the Company’s Senior Vice President of Sales, 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.

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Total rent expense from continuing operations amounted to $3.8 million and $2.9 million during the three months ended March 31, 2004 and 2003, respectively. Total rent paid to LBJ was approximately $138,000 during the three months ended March 31, 2003.

The Company leases office space to Allscripts in Burlington, Vermont. Total rent received from Allscripts was approximately $51,000 and $71,000 for the three months ended March 31, 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 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, or 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 12 – 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 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.

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 or in any action the employee has brought claiming damages for alleged retaliatory actions by the Company. 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 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 U.S. Attorney’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.

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 wrongful termination in violation of public policy, fraudulent inducement to enter into an employment contract with the Company, and negligent and intentional infliction of emotional distress. 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 falsified unspecified documents submitted to the Government and made unspecified false statements to the Government.

Following a hearing on October 21, 2003, the Court on October 22, 2003, issued a series of orders regarding alignment of the IDX v. Leon and Leon v. IDX cases. Pursuant to the orders, the claims asserted by the parties will proceed under the case of Leon v. IDX, case number CV03-1158. IDX realigned its declaratory judgment claims as affirmative defenses and/or counterclaims in that case. The employee filed a motion for an injunction to reinstate his pay and benefits pending conclusion of the action. The motion was denied on December 12, 2003. Trial of the consolidated cases is presently scheduled for November 2004. The Company intends to vigorously defend itself and to vigorously pursue relief through prosecution of its own claims in the consolidated lawsuits. Although the Company believes that these actions are without merit, the Company currently cannot predict the outcome or the impact these matters may have upon the Company’s operations.

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 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, and compensation for any damages sustained by the employee as a result of the alleged discrimination. The Department of Occupational Health and Safety is investigating the employee’s complaint on

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behalf of the U.S. Department of Labor, and the Company intends to cooperate in the investigation. The Company intends to vigorously defend against the employee’s claims, however, the outcome or the impact these claims may have on the Company’s operations cannot currently be predicted.

There are additional claims made by the employee against the Company, including a charge with the U.S. Equal Employment Opportunity Commission, claiming that the employee was discriminated against in violation of the Americans with Disabilities Act, the processing of which the EEOC has subsequently terminated through a Notice of Right to Sue. The Company intends to vigorously defend against the employee’s claims, 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.

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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 27, 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.

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 System, which require more configuration 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 IDX eCommerce Services business offers web-based electronic data interchange (“EDI”) claims, remittance and statement services and is designed to improve data quality and streamline business processes by linking physician practices to sophisticated mailing services and other businesses. Our maintenance and service fees consist of software maintenance fees, installation fees, professional and technical service fees, consulting fees and other miscellaneous fees. 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 subcontract to provide our clinical information technology systems to Fujitsu Services.

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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.

Total revenues increased 10.9% to $102.6 million during the three months ended March 31, 2004 from $92.4 million for the same period in 2003. System sales and maintenance and service fees increased by 10.5% and 11.1%, respectively, which we currently believe reflects our ability to generate new sales as well as sales to our existing customers. We did not recognize any revenues during the three months ended March 31, 2004 under our subcontract arrangements with BT and Fujitsu. Total operating expenses increased 14.7% resulting in operating income of $2.4 million or operating margin of 2.4% for the three months ended March 31, 2004 as compared to an operating margin of 5.6% for the same period in 2003. This decrease in operating margin was largely attributed to start-up costs for our UK operations. For the three months ended March 31, 2004, we reported income from continuing operations of $1.6 million, or $0.05 diluted earnings per share, and at March 31, 2004, cash and marketable securities totaled $105.3 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.

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 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. If the financial condition of our customers were to deteriorate, it may affect the timing and the

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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.

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. The product is deemed accepted unless the customer notifies the Company 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 with an annual renewal option. 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.

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 not meeting the criterion under SOP 97-2, including product revenue. 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 are recorded to income in the period in which the facts that give rise to the revision become known. We recognize losses, if any, on fixed price

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contracts when the loss is determined. We record revenue in excess of billings on long-term service contracts as unbilled receivables. We record billings in excess of revenue recognized on service contracts as deferred income until revenue recognition criteria are met.

Allowance for Doubtful Accounts and Credits – IDX maintains 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. Additionally, 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. 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 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. Given our cumulative pre-tax income from continuing operations for the three year period ended December 31, 2003 along with our current tax planning strategies, we currently believe that future earnings 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

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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 12 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 January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Prior to FIN 46, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that guidance by requiring a variable interest entity, as defined in FIN 46, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosure about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. On October 8, 2003, the Financial Accounting Standards Board deferred the effective date of FIN 46 for variable interest entities created before February 1, 2003 to periods ending after December 15, 2003. A public entity need not apply the provisions of FIN 46 to an interest held in a variable interest entity (“VIE”) until the end of the first interim or annual period ending after December 15, 2003, if both of the following apply:

Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of FIN 46 had no impact on our financial position, results of operations or cash flows.

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RESULTS OF CONTINUING OPERATIONS

THREE MONTHS ENDED MARCH 31, 2004 AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 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:

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, which includes our eCommerce services business, along with bundled 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, and other miscellaneous fees.

System Sales

Software license and subscription revenues increased $3.5 million and eCommerce Services revenues increased $2.0 million during the three months ended March 31, 2004 as compared to the same period in 2003. The increase in software license revenues was primarily attributable to system sales of approximately $3.3 million from several Imagecast PACS contracts that were in backlog at the end of 2003. Our eCommerce Services are designed to enable customer HIPAA compliance with EDI formats for eligibility, referrals, claims, remittances and claims status. HIPAA regulations resulted in an increase in demand for our eCommerce Services primarily from our medical and physician group practice customers.

Revenues from third party software sales decreased by $1.9 million during the three months ended March 31, 2004 as compared to the same period in 2003 due to the timing of certain of our clinical solutions contracts. Our clinical solutions contracts typically represent large contracts, include bundled third party software and have a longer installation period with revenue recognized over a longer period in time. As such, third party software sales are dependant on the timing of the contract 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:

The increase in maintenance fees for software and hardware support was primarily due to an increase in our installed base of $1.9 million combined with annual maintenance price increases of approximately $1.2 million. Installation fees increased 30.8% during the three months ended March 31, 2004 and represented 15.0% of total revenues as compared to 12.7% of total revenues for the same period in 2003. This growth was primarily driven from our clinical solutions packaged under Carecast, which represented approximately $4.2 million of the increase in installation fees. We currently expect our installation fees to increase in future periods as we commence installation work related to our subcontract arrangements with BT and Fujitsu to provide our clinical solutions in the UK.

Cost of Sales

The following table indicates total cost of system sales and maintenance and service fees as a percentage of total revenues and the cost of system sales and the cost of maintenance and service fees as a percentage of their respective revenues (in thousands, except percentages):

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 software purchases, while cost of maintenance and service fees are employee-driven and

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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 and 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 a higher cost percentage and lower margins.

Cost of System Sales

The decrease in the cost of system sales as a percentage of system sales resulted principally from 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 three months ended March 31, 2004 as compared to the same period in 2003.

Cost of Maintenance and Service Fees

The cost of maintenance and service fees increased $4.9 million to support the growth in our installed base of software applications. The increase was primarily attributable to increases of $3.1 million in subcontractor consulting services, $1.4 million in consulting and $600,000 in employee compensation and benefit costs, offset by a decrease in third party royalty expense of $600,000. Subcontractor consulting services and consulting costs typically have a higher cost of revenue percentage as opposed to internal labor, which resulted in the increase in the cost of maintenance and service fees as a percentage of maintenance and service fees for the three months ended March 31, 2004 as compared to the same period in 2003. We re-negotiated certain of our royalty arrangements, which accounted for the decrease in third party royalty expense.

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 cost of maintenance and service fees. We expect that the use of specialized professional outside services will increase as well, further increasing cost of services, which may reduce our overall margin.

Selling, General and Administrative Expenses

The increase of $8.0 million in selling, general and administrative expenses was principally due to increases of $4.0 million in employee compensation and benefit costs, $1.8 million in outside professional fees, $900,000 in occupancy expenses and $900,000 in depreciation charges.

The increase in employee compensation and benefit costs was primarily due to the start-up efforts of our UK operations. Professional fees increased principally due to litigation matters as described in Note 12 of Notes to Condensed Consolidated Financial Statements, audit and accounting fees incurred in conjunction with the enhanced testing and analysis surrounding our 2003 year-end audit and consulting fees incurred in conjunction with the Sarbanes-Oxley Act of 2002. Our occupancy expense increase was primarily related to our Seattle location. In April 2003, we consolidated our Seattle operations into new expanded facilities increasing our space by approximately 50%, resulting in an increase in our occupancy costs. The increase in depreciation charges was primarily attributable to the enterprise resource planning (“ERP”) system.

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, our occupancy expenses will include approximately $895,000 per year due to our new sublease of office facilities for our UK operations, which commenced in April 2004. 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.

Software Development Costs

Software development costs consist primarily of costs primarily related to our software developers and the associated infrastructure costs required to fund product development initiatives. As described in Note 1 to the Notes

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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. 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 $1.6 million and $114,000 of software development costs were capitalized during the three months ended March 31, 2004 and 2003, respectively. Amortization of software development costs was approximately $406,000 and $580,000 during the three months ended March 31, 2004 and 2003, respectively.

The following table indicates software development costs as a percentage of system sales (in thousands, except percentages):

The $500,000 increase in software development costs was due to increases in personnel costs and outside consulting fees of approximately $1.1 million and associated infrastructure costs of approximately $900,000, offset with an increase in capitalized software development costs, net of amortization, of $1.6 million. Associated infrastructure costs increased primarily due to the increase in our occupancy expenses associated with our Seattle facilities, which also supports software development efforts. The increase in capitalized software development costs was primarily related to costs capitalized relating to Flowcast 3.0.

Total Other Income, Net

The following table sets forth the components of total other income, net (in thousands):

Interest Income

The increase in interest income for the three months ended March 31, 2004 as compared to the same period in 2003 was due to higher average invested balances due to the proceeds received from the sale of EDiX.

Foreign Currency Transaction Gains (Losses), net

Our revenues generated from UK customers are primarily denominated in the local foreign currency, pounds sterling. We are exposed to foreign exchange rate fluctuations from these transactions and from certain inter-company transactions with our UK subsidiary, which are denominated in British pounds sterling. For the three months ended March 31, 2004, we incurred a net foreign currency transaction loss of $189,000, primarily due to the re-measurement of our foreign currency denominated accounts receivable at March 31, 2004 into US dollars.

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Income Tax Provision

Our effective income tax rate was 38.0% for the three months ended March 31, 2004 and 30.0% for the three months ended March 31, 2003 resulting in an income tax provision of $967,000 and $1.6 million for the three months ended March 31, 2004 and 2003, respectively. Our effective income tax rates for 2004 and 2003 are lower than our historical tax rate of 40.0% primarily due to our use of research and development credits to offset income taxes.

RESULTS OF DISCONTINUED OPERATIONS

The following is a summary of the results of discontinued operations for the three months ended March 31, 2003 (in thousands):

EDiX’s effective tax rate for the three months ended March 31, 2003 of 30.0% was lower than its historical tax rate of 40.0% primarily due to its use of previously reserved net operating losses to offset income taxes.

LIQUIDITY AND CAPITAL RESOURCES

We primarily generate cash from the sale of our software, maintenance fees, which are typically paid on a monthly basis, implementation services and providing professional and consulting services. We primarily use cash to pay employees’ salaries, commissions, and benefits, pay rent for office facilities, procure insurance, pay taxes and pay vendors for services and supplies. We also use cash to procure capital assets to support our business. We principally have funded our operations, working capital needs and capital expenditures from operations and short-term borrowings under revolving secured bank lines of credit. At March 31, 2004, we had no debt, $18.8 million in cash and cash equivalents and $86.4 million in short-term investments, consisting principally of investments in interest-bearing demand deposit accounts, money market funds and highly liquid debt securities of corporations and municipalities, and $155.8 million of working capital.

Net cash provided by or used in continuing operations is principally comprised of net income or loss and is primarily affected by the net change in accounts and unbilled receivables, prepaid cost of sales, accounts payable, accrued expenses and non-cash items relating to depreciation and amortization, deferred taxes, and certain components of lease abandonment and restructuring charges. Due to the nature of our business, accounts and unbilled receivables, prepaid cost of sales, deferred revenue, and accounts payable can fluctuate considerably due to, among other things, the length of installation efforts, which is dependent upon the size of the transaction, the changing business plans of the customer, the effectiveness of customers’ management and general economic conditions. Accounts receivable, including unbilled receivables, increased $24.5 million during the three months ended March 31, 2004. This increase was primarily due to pre-billings under certain of our UK contracts at quarter end. Correspondingly, deferred revenue increased $21.9 million due to the deferral of billings in excess of revenue recognized on these contracts, which are deferred until revenue recognition criteria are met. This resulted in an increase in our Days Sales Outstanding (“DSO”), which represents the average number of days sales in accounts receivable. DSO increased to 104 days during the three months ended March 31, 2004 from 83 days during the same period in 2003 and from 86 days for the year ended December 31, 2003. Management continues to focus efforts on reducing the average time to collect payment on sales and currently expects DSO to return to approximate historical levels once we begin routine billing and recognition of our UK generated revenues. The increase in accounts payable and accrued expenses of $5.5 million was attributable to costs associated with the start-up of our UK operations, which was offset by an increase in prepaid expenses relating to prepayment of cost of maintenance and service fees incurred on revenues that have been deferred.

Cash flows related to investing activities have historically been related to the purchase of computer and office equipment, leasehold improvements and the purchase and sale of investment grade marketable securities. We invested approximately $20.1 million through December 31, 2003 on the acquisition and implementation of an enterprise resource planning system and have invested an additional $1.2 million in the ERP system during the three months ended March 31, 2004. We anticipate investing an additional $6.6 million in 2004 and an additional

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$5.2 million in 2005 related to this system implementation. Of the $6.6 million we anticipate investing in the ERP system in 2004, approximately $4.1 million relates to systems implementation for our UK operations. In April 2004, we entered into a new operating sublease for office space in the UK for a period of ten years and currently plan to invest approximately $1.8 million in 2004 for leasehold improvements.

In addition, investing activities may also include purchases of, interests in, loans to and acquisitions of businesses for access to complementary products and technologies. We expect these activities to continue, but there can be no assurance that we will be able to successfully complete any such purchases or acquisitions in the future.

In April 2002, we acquired a minority interest in Stentor, Inc. (“Stentor”), one of our strategic partners, by exercising a warrant to purchase 562,069 shares of preferred stock of Stentor for $7.5 million. Each preferred share is convertible, at any time at our option, into one share of common stock of Stentor, subject to certain adjustments. In addition, the preferred shares are not entitled to dividends but are entitled to a liquidation preference equal to the amount we paid to purchase such shares.

Cash flows from financing activities historically relate to the issuance of shares of our common stock through the exercise of employee stock options and in connection with the employee stock purchase plan and to the proceeds from line of credit. We currently have a revolving line of credit agreement allowing us to borrow up to $40.0 million based on certain restrictions. This line of credit is secured by deposit accounts, accounts and unbilled receivables and other assets and bears interest at the bank’s base rate plus .25%, which was approximately 4.25% as of March 31, 2004. This line of credit is subject to certain terms and conditions and will expire on June 27, 2005. At March 31, 2004 no amounts were outstanding under the line of credit.

In addition to existing financing arrangements, we own, through a wholly owned subsidiary, approximately 7.5 million shares of common stock of Allscripts Healthcare Solutions, Inc., a public company listed on the NASDAQ National Market under the symbol MDRX. This investment had a quoted market value of approximately $72.6 million as of March 31, 2004, and is subject to certain sale restrictions that may significantly impact the market value. See Note 4 of Notes to Condensed Consolidated Financial Statements.

We expect that our requirements for office facilities and other office equipment will grow as staffing requirements dictate. Our operating lease commitments consist primarily of office leases for our operating facilities. We plan to increase our professional staff during 2004 as needed to meet anticipated sales volume and support research and development efforts for certain products. We also plan to hire additional accounting personnel in our finance department. To the extent necessary to support increases in staffing, we may obtain additional office space. We do not have any present intention to pay cash dividends on our capital stock.

Contractual Obligations