Medecision 10-Q 2007 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2007

OR

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

For the transition period from                            to                           

Commission File Number 001-33191

MEDecision, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania	23-2530889
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)
601 Lee Road
Chesterbrook Corporate Center
Wayne, Pennsylvania	19087
(Address of Principal Executive	(Zip Code)
Offices)

Registrant’s telephone number, including area code: (610) 540-0202

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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, or a non-accelerated filer. See definition of “accelerated filed and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o                Accelerated filer o                Non-accelerated filer x

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

As of May 11, 2007, 15,310,146 shares of the registrant’s common stock, no par value per share, were outstanding.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION	1
Item 1.  Financial Statements	1
Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006	1
Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006	2
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006	3
Notes to Consolidated Financial Statements	4
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.  Controls and Procedures	20
PART II – OTHER INFORMATION	20
Item 1A. Risk Factors	20
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 5.  Other Information	23
Item 6.  Exhibits	24
SIGNATURES	25

PART I – FINANCIAL INFORMATION

Item 1.    Financial Statements

MEDECISION, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	March 31,			December 31,
	2007			2006
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$	14,866		$	17,408
Accounts receivable, net of allowance for doubtful accounts of $48 and $52, respectively	8,675			9,975
Prepaid expenses	1,403			1,085
Other current assets	143			116
Total current assets	25,087			28,584
Property and equipment
Computer equipment and software	7,626			7,384
Leasehold improvements	3,351			3,324
Office equipment and furniture	1,899			1,887
	12,876			12,595
Less accumulated depreciation and amortization	(4,782		)	(4,116		)
Net property and equipment	8,094			8,479
Capitalized software, net of accumulated amortization of $7,193 and $6,909, respectively	4,432			3,857
Other assets	455			460
Total assets	$	38,068		$	41,380
Liabilities and Stockholders’ Equity
Current liabilities
Current portion of capital lease obligations	$	1,742		$	1,773
Note payable and current portion of long-term note payable	260			388
Accounts payable	2,352			2,554
Accrued payroll and related costs	884			1,111
Other accrued expenses	1,645			1,799
Deferred license and maintenance revenue	7,061			7,482
Deferred professional services revenue	2,571			2,180
Total current liabilities	16,515			17,287
Long-term liabilities
Capital lease obligations	2,140			2,557
Deferred rent	2,412			2,380
Deferred license and maintenance revenue	565			691
Total long-term liabilities	5,117			5,628
Commitments and contingencies	—			—
Stockholders’ equity
Common stock, no par value; authorized 100,000,000 shares; issued and outstanding 15,242,771 and 14,886,073 at March 31, 2007 and December 31, 2006, respectively	104,571			104,099
Accumulated deficit	(88,135		)	(85,634		)
Total stockholders’ equity	16,436			18,465
Total liabilities and stockholders’ equity	$	38,068		$	41,380

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

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MEDECISION, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(unaudited)

	Three Months Ended
	March 31,
	2007			2006
Revenue
Subscription, maintenance and transaction fees	$	5,711		$	5,308
Term licenses	1,567			415
Professional services	2,539			3,103
Total revenue	9,817			8,826
Cost of revenue
Subscription, maintenance and transaction fees	2,365			1,722
Term licenses	601			212
Professional services	1,478			1,621
Total cost of revenue	4,444			3,555
Gross margin	5,373			5,271
Operating expenses
Sales and marketing	2,241			2,205
Research and development	1,728			1,561
General and administrative	3,949			2,475
Total operating expenses	7,918			6,241
Loss from operations	(2,545		)	(970		)
Gain on change in fair value of redeemable convertible preferred stock conversion options	—			285
Interest income (expense), net	44			(60		)
Loss before benefit for income taxes	(2,501		)	(745		)
Benefit for income taxes	—			416
Net loss	$	(2,501	)	$	(329	)
Accretion of convertible preferred shares and redeemable convertible preferred shares	—			(684		)
Loss available to common shareholders	$	(2,501	)	$	(1,013	)
Loss per share available to common shareholders, basic and diluted	$	(0.16	)	$	(0.31	)
Weighted average shares used to compute loss available to common shareholders per common share, basic and diluted	15,183,004			3,274,850

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

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MEDECISION, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	March 31,
	2007			2006
Cash flows from operating activities
Net loss	$	(2,501	)	$	(329	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	666			446
Gain on change in fair value of redeemable convertible preferred stock conversion options	—			(285		)
Amortization of capitalized software	284			77
Stock compensation expense	212			108
Amortization of deferred financing cost	23			5
Recovery of doubtful accounts	(4		)	(27		)
Deferred income tax benefit	—			(416		)
Decrease (increase) in assets:
Accounts receivable	1,304			3,398
Prepaid expenses and other assets	(363		)	(1,155		)
Increase (decrease) in liabilities:
Accounts payable	(202		)	104
Accrued payroll and related costs	(227		)	(69		)
Other accrued expenses	(122		)	(536		)
Deferred revenue	(156		)	1,610
Net cash (used in) provided by operating activities	(1,086		)	2,931
Cash flows from investing activities
Capitalized software	(859		)	(350		)
Purchase of property and equipment	(281		)	(129		)
Net cash used in investing activities	(1,140		)	(479		)
Cash flows from financing activities
Proceeds from exercise of common stock options	260			—
Repayment of capital lease obligations	(448		)	(262		)
Repayment of insurance note payable	(103		)
Repayment on equipment note payable, bank	(25		)	(25		)
Net cash used in financing activities	(316		)	(287		)
Net (decrease) increase in cash and cash equivalents	(2,542		)	2,165
Cash and cash equivalents, beginning of period	17,408			2,447
Cash and cash equivalents, end of period	$	14,866		$	4,612
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	133		$	55
Supplemental disclosures of noncash investing and financing activities:
Property and equipment acquired under capital leases	$	—		$	426
Tenant improvement allowance received under operating lease	$	—		$	—

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

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MEDECISION, INC.

Notes to Consolidated Financial Statements

(in thousands, except share and per share data)

(unaudited)

(1)Basis of Presentation

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.

It is suggested that these interim financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest shareholders’ Annual Report on Form 10-K.

All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. Such adjustments are of a normal, recurring nature.

On October 18, 2006, the Company’s Board of Directors approved a 1-for-2 reverse stock split with an effective date of December 13, 2006. All share and per share amounts in the accompanying consolidated financial statements have been retroactively adjusted for all periods presented to give effect to the reverse stock split.

(2)Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurement. This new standard provides guidance for using fair value to measure assets and liabilities. The statement clarifies that for items that are not actively traded, fair value should reflect the price in a transaction with a market participant, including an adjustment for risk, and establishes a fair value hierarchy that prioritizes the information used to develop the assumptions market participants would use when pricing the asset or liability. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect to record any material adjustments upon the adoption of this statement.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115. Under this statement, entities will be permitted to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). By electing the fair value measurement attribute for certain assets and liabilities, entities will be able to mitigate potential “mismatches” that arise under the current mixed measurement attribute model. Entities will also be able to offset changes in the fair values of a derivative instrument and its related hedged item by selecting the fair value option for the hedged item. SFAS No. 159 will become effective for fiscal years beginning after November 15, 2007. We are currently evaluating the effect that the adoption of this statement will have on our financial statements.

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(3)Stock-Based Compensation

The Company accounts for share based payments in accordance with SFAS No. 123R, Share Based Payment: An Amendment of FASB Statements No. 123 and 95. Effective January 1, 2006, the Company adopted the calculated value recognition provisions of SFAS No. 123R utilizing the prospective-transition method, as permitted by SFAS No. 123R.

In October 2006, the Company’s shareholders approved the 2006 Equity Incentive Plan, which became effective upon the Company’s initial public offering. The 2006 Plan provides for the award of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards and other stock-based awards.  Employees, directors, consultants, and other individuals who provide services to the Company are eligible to be granted awards under the 2006 Plan; however, only employees are eligible to be granted incentive stock options, and not beyond 10 years from the adoption of the 2006 Plan. The exercise price of any option granted under the plan will not be less than 100% of the fair market value of the common stock on the date of grant (110% for incentive stock options issued to a more than 10% shareholder). No incentive stock option award may be awarded in an amount that would vest more than $100 of fair value in any calendar year. The maximum term of any award is 10 years from the grant date (5 years for more than 10% shareholder). The board of directors may determine the vesting period for each award under the 2006 Plan.

During the three months ended March 31, 2007 and 2006, respectively, ten-year options to purchase 99,650 and 57,500 shares of common stock, at a weighted average exercise price of $6.86 and $2.50, were granted to employees. For the three months ended March 31, 2007 and 2006, the Company recognized stock-based compensation expense of $212 ($0.01 per share) and $108 ($0.02 per share), respectively, of which $98 and $98, respectively, pertained to the intrinsic value of options issued below fair market value in 2005 and 2004.

The Company used a Black-Scholes model to determine the fair value of options issued in 2006 and 2007. The weighted average calculated value of options at date of grant and the assumptions utilized to determine such values are indicated in the following table:

	Three Months Ended
	March 31,
	2007			2006
Weighted average fair value at date of grant for options granted during the period	$	6.86		$	4.52
Weighted average risk-free interest rates	4.8		%	4.0		%
Weighted average expected life of option (in years)	6.4			6.6
Expected stock price volatility	72.5		%	87.9		%
Expected dividend yield	—			—

The Company determined its volatility factor through an analysis of peer companies in terms of market capitalization and total assets. The Company cannot compute expected volatility due to its lack of historical stock prices. The Company uses historical data to estimate option exercise and employee termination within the valuation model. Separate groups of employees and non-employees that have similar historical exercise behavior are considered separately for valuation purposes. The Company calculated the expected term by analyzing for each group cumulative share exercise and expiration data and post-vesting employment termination behavior as of the grant date. The weighted average life as of each grant date was then calculated and used in determining the fair value at each grant date. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected dividend yield is zero

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based on the Company’s historical experience. For the three months ended March 31, 2006, the fair value of the common stock at the date of grant was based on an independent appraisal of the common stock’s value at January 1, 2006.

As of March 31, 2007, there was $2,287 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under existing stock option plans, which will be recognized over the weighted average period of 2.56 years. At March 31, 2007, there were 1,448,473 shares available for grant under the 2006 Plan.

Stock option activity for the three months ended March 31, 2007 is as follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
	Number of		Exercise		Contractual	Intrinsic
	Shares		Price		Term (Years)	Value
Balance at December 31, 2006	2,937,082		$	4.27
Granted	99,650		6.86
Exercised	(361,750	)	0.82
Canceled	(48,123	)	11.77
Balance at March 31, 2007	2,626,859		$	4.70	6.40	$	11,855
Exerciseable at March 31, 2007	1,555,207		$	0.99	5.32	$	8,669

The total intrinsic value of options exercised during the three months ended March 31, 2007 was $1,925. During the three months ended March 31, 2007, the Company received $260 in cash payments related to option exercises.

(4)Earnings Per Share

Basic earnings per share is calculated by dividing net income or loss by the weighted average numbers of shares outstanding. The Company had a net loss available to common shareholders for the three months ended March 31, 2007 and 2006. As a result, the common stock equivalents of stock options, warrants and convertible securities issued and outstanding at those dates were not included in the computation of diluted earnings per share for the periods then ended as they were antidilutive. The Company has reflected on a retroactive basis the effect on historical basic and diluted earnings per share of the 1-for-2 reverse stock split of its common stock effective as of December 13, 2006.

Net loss per share is computed as follows:

	Three Months Ended
	March 31,
	2007			2006
Numerator:
Loss available to common shareholders	$	(2,501	)	$	(1,013	)
Accretion of convertible preferred shares and redeemable convertible preferred shares	—			(684		)
Net loss	$	(2,501	)	$	(329	)
Denominator:
Weighted average shares used to compute loss available to common shareholders per common share, basic and diluted	15,183,004			3,274,850
Loss per share available to common shareholders, basic and diluted	$	(0.16	)	$	(0.31	)

For the three months ended March 31, 2007 and 2006, weighted average shares of common stock issuable in connection with stock options and warrants of 576,738 and 38,650 shares, respectively, were not included in the diluted earnings per share calculation because doing so would have been antidilutive.

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(5)Income Taxes

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, under the asset-and-liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any change in the enacted tax rate and its effect on deferred assets and liabilities is recognized in the period that includes the enactment date. A valuation allowance is recorded against deferred tax assets if it is more likely than not that such assets will not be realized.

We adopted the Financial Accounting Standard Board’s Interpretation No. 48, Accounting for Income Tax Uncertainties (“FIN 48”), on January 1, 2007.  FIN 48 clarifies the accounting for uncertain income tax positions recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority.  As of January 1, 2007, we had $15.7 million of unrecognized tax benefits which, if recognized, would favorably impact our effective tax rate.  The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of audits and the expiration of the statute of limitations within the next 12 months. Our policy is to recognize interest and penalties on unrecognized tax benefits in provision for income taxes in the consolidated statements of operations.  As of March 31, 2007, we have no accrued interest or penalties related to uncertain tax positions. Tax years beginning in 2003 are subject to examination by taxing authorities, although net operating loss and credit carryforwards from all years are subject to examinations and adjustments for at least three years following the year in which the attributes are used.

(6)Leases

The Company is obligated under capital leases covering office furniture and computer hardware and software that expire at various dates through August 2011. At March 31, 2007 and December 31, 2006, the gross amount of property and equipment and related accumulated amortization recorded under capital leases were as follows:

	March 31,			December 31,
	2007			2006
Computer equipment and software	$	4,959		$	5,570
Leasehold improvements	15			15
Office equipment and furniture	1,743			1,797
	6,717			7,382
Less: accumulated amortization	(2,863		)	(3,110		)
	$	3,854		$	4,272

Amortization of assets held under capital leases is included with depreciation and amortization expense in the accompanying statements of operations.

The Company leases office space, equipment and a vehicle under various cancelable and noncancelable operating lease agreements that expire on various dates through August 2016. The Company’s operating lease for office space allows the Company to terminate the lease after seven years, provided 12 months’ written notice is provided. Upon such termination, the Company must pay a penalty of $1,800, reduced by $30 each month subsequent to the 84th month of the lease. Rental expense for operating leases was approximately $556 and $314 for the three months ended March 31, 2007 and 2006, respectively.

Future minimum lease payments under noncancelable operating leases and future minimum capital lease payments as of March 31, 2007 are:

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Year ending December 31,	Capital Leases			Operating Leases
2007 (April 1 through December 31)	$	1,597		$	1,458
2008	1,808			1,838
2009	766			1,878
2010	202			1,931
2011	59			1,999
Thereafter through 2016	—			10,258
Total minimum lease payments	4,432			$	19,362
Less: amount representing interest (at rates ranging from 2.0% to 18.9%)	(550		)
Present value of net minimum capital lease payments	3,882
Less: current installments of obligations under capital leases	1,742
Obligations under capital leases, excluding current installments	$	2,140

(7)Industry and Geographic Segment Information

The Company derived all of its revenue from the healthcare industry in the three months ended March 31, 2007 and 2006. All of the Company’s revenue in those periods was derived from United States customers and all of its assets during these periods were in the United States.

(8)Commitments and Contingencies

The Company’s contracts with its customers provide that customers are responsible for payment of sales and use taxes on the Company’s licensing and maintenance fees, and where applicable, professional services. Prior to 2006, the Company did not collect sales taxes. During the year ended December 31, 2006, the Company began to collect and remit sales taxes from its customers. In the event that a customer has not paid use tax where and when due, or is otherwise unable to pay, the Company may have a contingent liability for unpaid taxes, interest and penalties. A liability of $202 and $229 has been accrued at March 31, 2007 and December 31, 2006, respectively, against such contingencies.

The Company, in the normal course of business, may be party to various claims. Management believes that the ultimate resolution of any such claims would not have a material impact on the Company’s financial position or operating results.

(9)Concentration of Credit Risk

Sales to three customers for the three months ended March 31, 2007 were 44% and sales to two customers for the three months ended March 31, 2006 were 43%. Trade receivables related to three customers were 49% of total net accounts receivable as of March 31, 2007. Trade receivables related to two customers were 42% of total net accounts receivable as of March 31, 2006.

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

This Quarterly Report on Form 10-Q, including the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. Such statements are based on current expectations of future events that involve a number of risks and uncertainties that may cause the actual events to differ materially from those discussed herein. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward-looking terminology such as “believes,” “expects,” “may,” “could,” “will,” “should,” “seeks,” “pro forma,” “potential,” “anticipates,” “predicts,” “plans,” “estimates,” or “intends,” or the negative of any thereof, or other variations thereon or comparable terminology, or by discussions of strategy or intentions.  Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.  Forward-looking statements should be considered in light of various important factors, including those set forth under the caption “Risk Factors” in this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission. All forward-looking statements, and reasons why results may differ, that are included in this report are made as of the date of this report, and except as required by law, we disclaim any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein or reasons why results might differ to reflect future events or developments.  References herein to “MEDecision,” “we,” “our,” and “us” collectively refer to MEDecision, Inc., a Pennsylvania corporation, and all of its subsidiaries.

Overview

We are a provider of software, services and clinical content to healthcare payers that allow them to improve the quality and affordability of healthcare provided to their members and increase their administrative efficiency. Our Collaborative Care Management suite analyzes data, automates payer workflow processes and electronically connects payers, healthcare providers and patients, providing them with a common view of the patient’s health that helps to foster better clinical decision making. Our solution is built around a suite of modular and easily configurable software applications and utilizes the Internet to link our payer customers to their members and their members’ chosen healthcare providers.

Our Collaborative Care Management suite is comprised of four related product modules: (i) Data Gathering and Analytics; (ii) Clinical Rules and Processes; (iii) Advanced Medical Management; and (iv) Collaborative Data Exchange. Data Gathering and Analytics is a data engine with an analytics component that enables a payer to process, summarize and evaluate information from both internal and external sources. Clinical Rules and Processes is a clinical content and process management solution featuring embedded, state-of-the-art clinical best practices that have been validated by evidence-based medicine. Advanced Medical Management is a care management solution consisting of workflow and decision support tools that address the continuum of care management processes, such as specialized case and disease management, admission and outpatient certification, referral management, concurrent review and discharge planning. Collaborative Data Exchange is a communication service that facilitates the transmission of information between the various stakeholders in the healthcare process. Collaborative Data Exchange addresses the entire spectrum of clinical data exchange: from basic service requests (referrals, authorizations and extensions) to simple clinical information transfer (questionnaire fulfillment), to complex electronic health record-based transactions. The Collaborative Data Exchange module allows our customers to securely transmit health records containing critical patient information in an easily understood format to patients and providers at the time they are making treatment decisions. We refer to these health records as Patient Clinical Summaries and believe that they are a critical first step to developing Electronic Health Records. In the future, we expect our Patient Clinical Summaries to integrate additional information provided by patients and a broad range of providers, thereby increasing their value to all constituents.

Since 1999, we have focused on broadening our solution portfolio in order to respond to the evolving needs of our customers. In 1999, we began offering our Data Gathering and Analytics module; in 2001, we began offering our Collaborative Data Exchange module; in 2003, we began offering OptiCareCert; in 2004, we began offering OptiCarePath; and in 2005, we began offering our customers the ability to electronically transmit Patient Clinical Summaries via our Collaborative Data Exchange module.

We operate in a relatively small market, where we have 55 of approximately 350 potential customers. This presents our management with the challenge of expanding our revenue within a limited potential customer base, and the attendant risk of our inability to grow revenue if we are unable to do so. Our strategy is to develop new customers, sell additional solutions to existing customers, and introduce new products such as MEDeWeaver and MEDePathway. However, not every potential customer is in the market for software at all times. Because of the cost, time and effort involved in implementing a software

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solution like the products we sell, once a potential customer chooses a solution from a competitor over MEDecision’s Collaborative Care Management solutions, they may not be in the market to buy a complete software solution for a number of years. There may be, however, opportunities to provide them with specific modules from our Collaborative Care Management suite to address particular needs they may have.

In the past, our non-recurring revenue, which primarily consists of term license fees for our software products and professional service fees associated with implementation of these software products, has constituted a significant portion of our revenue. This non-recurring revenue is generally paid in lump sums, thereby decreasing the predictability of our revenue. As a result of these risks and challenges, we will continue to focus on the growth of our business, expanding existing customer relationships, developing innovative new solutions, expanding our customer base within our market and continuing to build recurring and predictable revenue through new products like our Patient Clinical Summary. While we anticipate funding our growth primarily from operating cash flow, we may utilize a portion of the net proceeds from our initial public offering which closed on December 18, 2006 for one or more of the components of our growth strategy.

Prior to 2006, we experienced our fastest growth in term licenses and professional services revenue, thereby increasing those items as a percentage of our revenue. Consequently, we realized a decreasing percentage of subscription, maintenance and transaction fee revenue even though that revenue grew as well. For the three months ended March 31, 2007, subscription, maintenance and transaction fee revenue increased as a percentage of total revenue due to increased sales of our Data Gathering and Analytics and Collaborative Data Exchange modules. In the future, we anticipate the market will have an increased focus on Electronic Health Records and what we refer to as our Patient Clinical Summary. For these solutions, our customers pay an annual subscription fee and pay a transaction fee each time they utilize the solution. In addition, once adopted by a customer, there are less sales and administrative efforts required to increase the transaction volume with a customer as compared to the efforts required to sell a new term license for one of our other solutions. We anticipate that the growth of this portion of our business will continue to outpace our traditional software licenses and, as a result, subscription and transaction revenue will become a larger portion of our overall revenue. We anticipate that this strategy will continue to lead to more recurring and predictable overall revenue. In addition, given the lower administrative and sales costs associated with this revenue, we anticipate that this will increase our margins, especially as transaction volume with a given customer increases.

We evaluate and monitor our business based on our results from operations, including our percentage of revenue growth, our revenue by category, operating expenses as a percent of total revenue and our overall financial position. In doing so, we monitor margins for our existing business and evaluate the potential margin contributions for each type of revenue that we generate. In addition, we monitor our Earnings Before Interest, Depreciation and Amortization, or EBITDA, as a measure of operating performance in addition to net income and the other measures included in our financial statements. We operate in one reportable segment.

We license our solutions primarily to large regional healthcare insurance companies. As of March 31, 2007, our customers included approximately 55 regional and national managed care organizations, including the largest organizations in more than 27 regional markets. Our revenue has increased at a compound annual growth rate of 28.1% since 2002, to $44.2 million for the year ended December 31, 2006. Our overall increase in revenue is attributable to increased emphasis by our customers on active management of their total insured population and the expansion of our solutions to meet their evolving needs.

Recent Events

On December 18, 2006, we raised approximately $26.4 million from our initial public offering, net of fees and expenses. In connection with the closing of our initial public offering, all of our outstanding shares of Series A preferred stock, Series B preferred stock and Series C preferred stock were converted into common stock under the terms of each of the respective preferred stock designations. All dividends on the Series A preferred stock that were accrued but unpaid as of the date of the offering were converted into common stock pursuant to an election of each holder of such shares as provided under the terms of the Series A preferred stock designation. All dividends on the Series B preferred stock and Series C preferred stock that were accrued but unpaid as of the date of the offering (approximately $9.5 million) were paid in cash from the proceeds of the offering. We currently have no shares of preferred stock outstanding.

Sources of Revenue

We derive revenue from the following sources: (i) subscription, maintenance and transaction fees; (ii) term license fees for our solutions; and (iii) fees for discrete professional services.

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Subscription, Maintenance and Transaction Fees

Our customers pay an annual subscription fee to process data through MEDecision’s service bureau and access reports using our Data Gathering and Analytics module and to transmit clinical data and decisions through our Collaborative Data Exchange module. Customers also pay a fee for each transaction transmitted over our network. We recognize subscription fees ratably over the term of the subscription agreement and include this in the subscription, maintenance and transaction fee revenue on our consolidated statements of operations. We also offer our customers a hosted solution and receive monthly fees for those services. We recognize hosting revenue ratably over the term of the related agreement, which is typically five years in duration. Hosting revenue is included in subscription, maintenance and transaction fee revenue on our consolidated statements of operations.

Our customers pay an annual maintenance and support fee equal to approximately 22% of the Advanced Medical Management license fee, which entitles our customers to unspecified software updates and upgrades and basic product support. For clinical content, our customers pay an additional 13% (for a total of 35%) of the license fee for maintenance and support. We recognize maintenance and support fees ratably over the term of the maintenance and support agreement.

Our customers pay transaction fees for member eligibility verification, for clinical adjudication of treatment requests and for access to on-demand member health information, including Patient Clinical Summaries. We recognize transaction fees at the time of the transaction.

Term Licenses

Our customers pay a term license fee to utilize our Advanced Medical Management and Clinical Rules and Processes modules, typically for five years. We recognize revenue for term license fees upon delivery of the software.

Professional Services

In conjunction with our solutions, we provide services to assist our customers in the installation and implementation of the software and the integration of our solutions with other systems within the healthcare insurance company. We sell these services on either a fixed price or a time-and-materials basis and recognize revenue when the services are performed. Services revenue also includes reimbursable billable travel, lodging and other out-of-pocket expenses incurred as part of delivering services to our customers.

Each of our license models provides us with a recurring revenue stream. Historically, a substantial portion of our clients have renewed their licenses each year. During the year ended December 31, 2006, our clients renewed 89% of the contracts which were to expire during that period. The combination of recurring revenue and high renewal rates provide us with substantial annual revenue predictability. Although in general our revenue is consistent throughout the year, sales of certain modules that have an initial term license can cause revenue volatility from quarter to quarter. The sales cycle for our Advanced Medical Management module is typically eight months or longer. As a result, it is difficult for us to predict the quarter in which a particular sale may occur. In addition, in a small portion of our sales, the license fee is material relative to our total revenue during the quarter. Accordingly, our revenue may vary significantly from quarter to quarter depending on the quarter during which a large sale occurs.

Strategy for Growth

Our strategy for revenue growth is to (1) increase recurring and transaction-based revenue streams as a percentage of total revenue, primarily through Patient Clinical Summary transactions; (2) expand our customer base into additional managed care organizations in the United States that could benefit from our entire Collaborative Care Management suite or its related product modules; (3) expand relationships with our existing customers; and (4) develop the next generation of our Collaborative Care Management suite.

Historically, we derived most of our revenue from our Advanced Medical Management module, for which our customers purchase five-year term licenses and which we recognize as revenue at the time we enter into the contract. In 1999, we began licensing modules that provide transaction or annual recurring revenue that are recorded ratably over the contract term. In 2005, we began to deliver a Patient Clinical Summary, and continue to do so today for eight managed care organizations. We intend to emphasize modules with transaction oriented and annual recurring revenue, as these streams provide us with greater revenue visibility and higher gross margins and operating margins. We have developed a scalable network infrastructure to deliver a high volume of transactions (such as authorizations, referrals and Patient Clinical Summaries) to providers and patients. An increase in transaction volume will require some additional technology infrastructure, but we believe the cost of network expansion will be substantially lower than the increase in revenue. In addition, we expect some investment initially in sales and marketing to educate and assist in the initial deployment of transaction-based modules, but less, as a percentage of revenue, than the increase in revenue.

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Prior to 2003, we licensed our software modules separately to payer organizations. Beginning in 2003, we began marketing and licensing our modules as an integrated solution, providing the payer an ability to license the entire Collaborative Care Management suite, or certain components initially, based upon the payer’s business needs at that time. We believe there are at least 350 additional managed care organizations in the United States, plus a substantial number of self-insured companies and Medicare and Medicaid organizations that could benefit from licensing and deploying our entire Collaborative Care Management suite, or selected modules. We license our solutions to new customers through our direct sales force, and our marketing initiatives generally have included conferences, trade shows, healthcare industry events and direct mail campaigns. We will continue to invest in additional sales personnel and marketing programs to increase awareness of our integrated solution, but not at the same rate of our revenue growth.

Through our customer sales operation, we have expanded our penetration within our customer base by including more members and by increasing the number of modules licensed by our customers. We intend to develop additional cross-selling programs to aid our customer relationship staff to continue to increase the number of modules utilized by our customers in the provision of care to their membership. The largest cross-selling opportunity is based on the adoption of the Patient Clinical Summary transactions, which benefit the payer, patient and provider. This adoption will require some investment in marketing, but we expect it to be less than the direct sales costs associated with the sales of our historical software solutions.

Trends in Sales of our Solutions

Our Collaborative Care Management suite consists of four related product modules: (i) Data Gathering and Analytics; (ii) Clinical Rules and Processes; (iii) Advanced Medical Management; and (iv) Collaborative Data Exchange. As discussed above, prior to 2003, we marketed and sold these modules individually rather than as a suite of products. Since that time, we have marketed these modules as the Collaborative Care Management suite, although we continue to license the modules individually in order to offer our customers an individualized solution. In general, customers license the Advanced Medical Management module as the core of their solution. Prior to 2004, our customers generally initiated their relationships with us by licensing just that one module. However, since 2004, we believe that our customers have focused more on implementing integrated multi-functional systems and have looked for products that offer more than a claims management system. As a result, a significant number of our new customers now license one or two modules in addition to our Advanced Medical Management module. We anticipate that this will remain the case for the foreseeable future.

As a result of the shift in market focus to more integrated software solutions, we anticipate that new customers will license an increasing number of modules and existing customers will continue to expand their product suites by licensing additional modules. However, given that most of our customers initially license our Advanced Medical Management module, revenue related to that module is a significant portion of our overall revenue. We anticipate that this significance will diminish as customers license additional modules and our transaction fee revenue increases as a percentage of overall revenue.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates.

We believe that our critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 contains a discussion of these critical accounting policies. There have been no significant changes in our critical accounting policies since December 31, 2006. See also Note 2 to our unaudited consolidated financial statements for the three month period ending March 31, 2007 as set forth herein.

Significant Customer Contracts

Two of our customers, Health Care Service Corporation, or HCSC, and Horizon Blue Cross Blue Shield, or Horizon, accounted for 24% and 10%, respectively, of our revenue for the three months ended March 31, 2007. HCSC accounted for 31% of our revenue for the three months ended March 31, 2006. Each of these contracts contains a term license component, an annual subscription and maintenance fee component. As is the case generally with all of our term license arrangements, a significant amount of the revenue of the contract is recognized in the initial year of the contract, with the remaining year revenue composed predominantly of annual subscription and maintenance fees and services relating primarily to implementation. As a

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result, while these two contracts represent a material portion of our revenue for the three months ended March 31, 2007, we can not determine at this time whether these contracts will represent a material portion of our revenue in the future.

HCSC Agreement

On November 15, 2005, we entered into a Master Product Agreement with HCSC. This agreement, which we refer to as the HCSC Agreement, is a software license and support agreement pursuant to which we license certain software products to HCSC and provide software support and hosting services to HCSC in connection with these software products. The initial term of the license under the HCSC Agreement is for three years, with a yearly option for HCSC to renew for two additional years until expiration in November 15, 2010. The HCSC Agreement may only be terminated by either party for a breach of the agreement, but the support services may be terminated by HCSC at any time with proper notice to us. Annual support fees and annual ASP hosting fees will not increase during the initial three year term, but may increase each year thereafter by no more than a fixed pre-negotiated rate. The agreement sets forth the support services to be provided, including technical support, business support and product upgrades.

The implementation for the project began in late 2005 and continued through the first quarter of 2007. As a result, the revenue in connection with the implementation of the project combined with the recognition of annual license and support payments resulted in the HCSC Agreement accounting for a significant portion of our revenue for the three months ended March 31, 2007 and 2006. Given that services are provided on an as requested basis, we cannot determine at this time whether the HCSC Agreement will account for a material portion of our revenue in the future.

Horizon Agreement

On June 30, 2005, we entered into a Master Product and Services Agreement with Horizon. This agreement, which we refer to as the Horizon Agreement, is a software license and support agreement pursuant to which we license certain software products to Horizon and provide software support services to Horizon in connection with these software products. The initial term of the license under the Horizon Agreement is for five years. The Horizon Agreement may be terminated for convenience by Horizon under certain circumstances or for breach of the agreement by either party. Horizon may choose to terminate the support services on a yearly basis by choosing not to renew these services. The Horizon Agreement sets forth the support services to be provided, including technical support, business support and product upgrades. These support services have specific performance targets, metrics and escalation levels for each of our support services.

The Horizon Agreement accounted for less than 10% of our revenue for the three months ended March 31, 2006. The Horizon Agreement accounted for a significant portion of our revenue for the three months ended March 31, 2007 as a result of the fees from maintenance and support contracts and discrete professional services contracts that were recognized in that period. Given that services are provided on an as requested basis, we cannot determine at this time whether the Horizon Agreement will account for a material portion of our revenue in the future.

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Consolidated Results of Operations

Comparison of Three Months Ended March 31, 2007 and 2006

The following table sets forth key components of our results of operations for the periods indicated as a percentage of total revenue:

	Three Months Ended
	March 31,
	2007		2006
Revenue
Subscription, maintenance and transaction fees	58	%	60	%
Term licenses	16		5
Professional services	26		35
Total revenue	100		100
Cost of revenue
Subscription, maintenance and transaction fees	24		20
Term licenses	6		2
Professional services	15		18
Total cost of revenue	45		40
Gross margin	55		60
Operating expenses
Sales and marketing	23		25
Research and development	18		18
General and administrative	40		28
Total operating expenses	81		71
Loss from operations	(26	)	(11	)
Gain on change in fair value of redeemable convertible preferred stock conversion options	—		3
Interest income (expense), net	1		(1	)
Loss before benefit for income taxes	(25	)	(9	)
Benefit for income taxes	—		5
Net loss	(25	)	(4	)
Accretion of convertible preferred shares and redeemable convertible preferred shares	—		(8	)
Loss available to common shareholders	(25	)%	(12	)%

Revenue

Consolidated revenue increased $1.0 million, or 11% percent, to $9.8 million for the three months ended March 31, 2007 compared to $8.8 million for the three months ended March 31, 2006. The increase is attributable to an increase in subscription, maintenance and transaction revenue and in term licenses partially offset by a decline in professional services revenue.

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Revenue by source is as follows:

	Three Months Ended
	March 31,								Change
	2007				2006				$			%
Subscription, maintenance and transaction fees	$	5,711	58	%	$	5,308	60	%	$	403		8	%
Term licenses	1,567		16	%	415		5	%	1,152			278	%
Professional services	2,539		26	%	3,103		35	%	(564		)	-18	%
Total revenue	$	9,817	100	%	$	8,826	100	%	$	991		11	%

For the three months ended March 31, 2007, we entered into a total of six contracts compared to six contracts for the three months ended March 31, 2006. The six contracts executed during the three months ending March 31, 2007 were with existing customers that have already implemented our Advanced Medical Management module and were adding an additional module or renewing their existing license agreement. During the three months ended March 31, 2006, we entered into a total of six contracts, all of which were with existing customers who had already licensed our Advanced Medical Management module and were adding an additional module or renewing their existing license agreement.

The increase in subscription, maintenance and transaction fees revenue for the three months ended March 31, 2007 is due to increased maintenance and support revenue attributable to contracts that closed after March 31, 2006.

The increase in term licenses for the three months ended March 31, 2007 was attributable to an overall increase in the size of the contracts that closed during the three months ending March 31, 2007 as compared to the same period in 2006.

The decline in professional services revenue for the three months ended March 31, 2007 was due to deals not closing in the fourth quarter of 2006 that would have resulted in implementation revenues in the first quarter on 2007. Additionally, during the comparable 2006 period, there was implementation revenue from the initial ramp-up of the Health Care Service Corporation, or HCSC, contract which concluded later that year.

Cost of Revenue

Cost of revenue increased 25% to $4.4 million for the three months ended March 31, 2007 from $3.6 million for the three ended March 31, 2006.

Cost of revenue by revenue source is as follows:

	Three Months Ended
	March 31,								Change
	2007				2006				$			%
Subscription, maintenance and transaction fees	$	2,365	41	%	$	1,722	32	%	$	643		37	%
Term licenses	601		38	%	212		51	%	389			183	%
Professional services	1,478		58	%	1,621		52	%	(143		)	-9	%
Total cost of revenue	$	4,444	45	%	$	3,555	40	%	$	889		25	%

The increase in the cost of subscription, maintenance and transaction fees is primarily due to an increase in personnel and personnel related costs of $0.4 million resulting from personnel additions in our customer support and ASP and hosting operations in order to support an increase in our customer base, as well as personnel increases related to the creation of our Center for Collaborative Health to focus on provider adoption of the Patient Clinical Summary.

The increase in cost of term licenses is principally due to an increase in the amortization of capitalized software costs of $0.2 million due to the amortization of products and enhancements developed in 2005 and 2006 which were made available to our customers after March 31, 2006 as well as an increase of $0.2 million for third party software costs as a result of the increase in third party software contracts during the three months ending March 31, 2007 as compared the same period in 2006.

The decrease in the cost of professional services of is primarily due to decreased use of consultants of $0.1 million due to lower professional services revenue during the three months ending March 31, 2007 as compared to the same period in 2006.

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Gross Margin

Gross margin in dollars increased 2% to $5.4 million for the three months ended March 31, 2007 from $5.3 million for the three months ended March 31, 2006. As a percentage of revenue, gross margin decreased to 55% for the three months ended March 31, 2007 from 60% for the three months ended March 31, 2006.

Gross margin by revenue source is as follows:

	Three Months Ended
	March 31,								Change
	2007				2006				$			%
Subscription, maintenance and transaction fees	$	3,346	59	%	$	3,586	68	%	$	(240	)	-7	%
Term licenses	966		62	%	203		49	%	763			376	%
Professional services	1,061		42	%	1,482		48	%	(421		)	-28	%
Total gross margin	$	5,373	55	%	$	5,271	60	%	$	102		2	%

The decrease in gross margin from subscription, maintenance and transaction fee revenue is due to personnel increases in our solution support operations, our solutions hosting and ASP operations, both of which were designed to support an increase in customer base. The decrease in gross margin from subscription, maintenance and transaction fee as a percentage from subscription, maintenance and transaction fee was the result of higher personnel costs as a result of anticipated growth in revenue derived from subscription, maintenance and transaction contracts.

The increase in gross margin from term licenses is due to higher average contractual values of contracts executed during the three months ending March 31, 2007 as compared to contracts executed in the same period for 2006. The increase in gross margin from term licenses as a percentage of term license fee revenue for the three months ended March 31, 2007 from the three months ended March 31, 2006 is attributable to higher term licenses from contracts closed during the three months ending March 31, 2007 as compared to the same period in 2006, for which a significant portion of the costs relate to the straight line amortization of capitalized software costs which are incurred at the same rate regardless of revenue in the period.

The decrease in gross margin from professional services revenue is due to the lower volume of professional services revenue. The costs related to professional services revenue are relatively fixed in nature as they primarily consist of salaries and benefits paid to full-time employees in our Client Operations department. Current levels of service resources were maintained for the expected one quarter decline in services revenue for the three months ended March 31, 2007.

Sales and Marketing

	Three Months Ended
	March 31,						Change
	2007			2006			$		%
Sales and marketing	$	2,241		$	2,205		$	36	2	%
As a percentage of revenue	23		%	25		%

Sales and marketing expenses remained relatively flat during the three months ending March 31, 2007 were comparable to the same period in 2006. Sales and marketing expense decreased as a percentage of revenue due to the increased level of revenue.

Research and Development

	Three Months Ended
	March 31,						Change
	2007			2006			$		%
Research and development	$	1,728		$	1,561		$	167	11	%
As a percentage of revenue	18		%	18		%

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The increase in research and development expenses reflects increased personnel and personnel-related costs of $0.7 million partially offset by a decrease in independent contractor costs of $0.1 million. The increased costs relate to planned product development designed to expand the capabilities of core products and to prepare for the next phase of delivering richer Patient Clinical Summaries. For the three months ended March 31, 2007, we capitalized $0.9 million of software development costs, an increase of 200% from $0.4 million capitalized in the comparable period in 2006. With the $0.5 million increase in capitalized costs, the net increase in research and development expenses in the 2007 period compared to the 2006 period was $0.2 million.

Total research and development expenditures increased 37% to $2.6 million (including capitalized software development costs of $0.9 million) for the three months ended March 31, 2007 from $1.9 million (including capitalized software development costs of $0.4 million) for the three months ended March 31, 2006.

As a percentage of revenue, research and development expenses remained constant.

General and Administrative

	Three Months Ended
	March 31,						Change
	2007			2006			$		%
General and administrative	$	3,949		$	2,475		$	1,474	60	%
As a percentage of revenue	40		%	28		%

General and administrative expenses increased due to an increase of $0.1 million in personnel and personnel related costs within the corporate operations, increased depreciation expense of $0.2 million, an increase in professional and consultant fees of $0.5 million, an increase in insurance costs of $0.1 million and a $0.3 million increase in facility costs resulting from the additional space leased during the three months ending March 31, 2007 as compared to same period in 2006. The increases in personnel costs, professional and consultant fees and insurance are primarily associated with the additional requirements of being a public company. The increase in depreciation expense is related to the additional leasehold improvements, office furniture and equipment associated with the additional leased office space. In addition, stock compensation expense under SFAS No. 123R increased by $0.1 million during the three months ending March 31, 2007 compared to the same period in 2006. General and administrative expenses increased as a percentage of revenue for the same reasons.

Gain on Change in Fair Value of Previously Outstanding Redeemable Convertible Preferred Stock Conversion Options

The gain on change in fair value of our previously outstanding conversion options was $0.3 million for the three months ended March 31, 2006. All of the outstanding redeemable convertible preferred stock was converted into common stock on December 18, 2006 in connection with the initial public offering of the Company’s common stock.

Interest Income (Expense), Net

We recorded interest income, net, of $44,000 for the three months ended March 31, 2007 compared to interest expense, net, of $60,000 for the three months ended March 31, 2006. This is attributable to earnings on increased average balances of cash, cash equivalents and short-term investments generated from the initial public offering of the Company’s common stock completed on December 18, 2006.

Benefit for Income Taxes

We recorded no income tax provision for the three months ended March 31, 2007 as compared to a benefit of $0.4 million for the three months ended March 31, 2006. The change resulted from management’s evaluation of our positive and negative evidence bearing upon the ability to realize our deferred tax assets. Management’s assessment at March 31, 2007 was that the weight of the negative evidence outweighed the positive evidence that any portion of the deferred tax assets would be realized, and accordingly, the valuation allowance was increased, to offset the increase in the deferred tax assets relating to the operating loss for the three months ended March 31, 2007.

Net Loss

We recorded a net loss of $2.5 million for the three months ended March 31, 2007 compared to a net loss of $0.3 million for the three months ended March 31, 2006. Gross margin increased by $0.1 million but declined as a percentage of revenue to 55% for the three months ended March 31, 2007 from 60% for the comparable period in 2006. This decline combined with increases in expenses for the three months ended March 31, 2007 of $1.7 million over the comparable period in 2006 resulted in

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a $2.5 million loss from operations for the three months ended March 31, 2007 compared to a $1.0 million loss from operations for the three months ended March 31, 2006. Interest income, net of $44,000 for the three months ended March 31, 2007 compared to interest expense, net of $60,000 for the three months ended March 31, 2006 combined with no provision or benefit for income taxes for the three months ended March 31, 2007 compared to an income tax benefit for the three months ended March 31, 2006, resulted in a net loss of $2.5 million for the three months ended March 31, 2007 compared to a net loss of $0.3 million the three months ended March 31, 2006.

Accretion of Previously Outstanding Convertible Preferred Shares and Redeemable Preferred Shares

The accretion of our previously outstanding convertible and redeemable convertible preferred shares for the three months ended March 31, 2006 was $0.7 million. Under accounting rules, this accretion of value to the preferred stock reduces the net income available to common shareholders. All of the outstanding convertible and redeemable convertible preferred stock was converted into common stock on December 18, 2006 in connection with the initial public offering of the Company’s common stock.

Loss Available to Common Shareholders

For the reasons described above, the loss available to common shareholders was $2.5 million for the three months ended March 31, 2007 compared to a loss available to common shareholders of $1.0 million for the three months ended March 31, 2006. This resulted from a net loss of $2.5 million for the three months ended March 31, 2007 compared to a net loss of $0.3 million for the three months ended March 31, 2006 and from the $0.7 million in the accretion to the preferred shares which reduced net income available to common shareholders for the three months ended March 31, 2006. All of the outstanding convertible and redeemable convertible preferred stock was converted into common stock on December 18, 2006 in connection with the initial public offering of the Company’s common stock.

Liquidity and Capital Resources

Since our inception and until our initial public offering which closed on December 18, 2006, we financed our operations primarily through internally generated cash flows, borrowings from banks and the issuance of preferred stock. On December 18, 2006, we raised approximately $26.4 million, net of fees and expenses, through the closing of our initial public offering. As of March 31, 2007 and December 31, 2006, we had cash of $14.9 million and $17.4 million, respectively, and receivables of $8.7 million and $10.0 million, respectively. As of March 31, 2007 and December 31, 2006, we had no borrowings under our bank working capital facility. As of March 31, 2007 and December 31, 2006, we had $3.9 million and $4.4 million, respectively, in total capital equipment financing, primarily capital leases, outstanding. As of March 31, 2007 and December 31, 2006, we had $0.2 million and $0.3 million, respectively, of insurance premium financing outstanding.

In connection with the closing of our initial public offering on December 18, 2006, all of our outstanding shares of Series A preferred stock, Series B preferred stock and Series C preferred stock converted into common stock under the terms of each of the respective preferred stock designations. All dividends on the Series A preferred stock that were accrued but unpaid as of the date of the offering were converted into common stock pursuant to an election of each holder of such shares as provided under the terms of the Series A preferred stock designation. All dividends on the Series B preferred stock and Series C preferred stock that were accrued but unpaid as of the date of the offering (approximately $9.5 million) were paid in cash from the proceeds of the offering. Thus, as of December 31, 2006, we had no accumulated dividends on our preferred stock.

We have a working capital facility with Silicon Valley Bank that is collateralized by all our assets. Our borrowings under this facility can be no more than the lesser of $8.0 million or 80% of eligible receivables, as such term is defined in the bank agreement, minus the total amounts then undrawn on all outstanding letters of credit, or any other accommodations issued or incurred by Silicon Valley Bank for our benefit. The working capital facility terminates on September 29, 2007. As of March 31, 2007, we had no borrowings outstanding under the working capital facility and have remaining availability of $2.6 million. We also have a $1.0 million equipment line of credit with Silicon Valley Bank that is collateralized by our assets. As of March 31, 2007, we have approximately $0.1 million outstanding under this equipment line. Additional borrowings under this facility will convert to a 30-month term note as of the first day of the subsequent calendar quarter.

As of December 31, 2006, we were out of compliance with one of the financial covenants under the revolving line of credit agreement with Silicon Valley Bank requiring us to maintain a minimum amount of net income for the quarter ended December 31, 2006. On March 26, 2007, we executed an amendment and waiver to the underlying loan and security agreement to (i) waive the existing default; (ii) increase the amount to be borrowed under the equipment line of credit to $1.75 million; (iii) extend the equipment line maturity date to the earlier of the date 30 months after the calendar quarter subsequent to each equipment advance but no later than December 1, 2009; and (iv) replace the financial covenants requiring us to maintain a minimum amount of  liquidity and net income that were set forth under the underlying loan security agreement with financial covenants

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requiring us to maintain a minimum ratio of liquidity and a minimum amount of tangible net worth. As of March 31, 2007, the Company is in compliance with the financial covenants set forth under the loan and security agreement, as amended, with Silicon Valley Bank.

Operating Activities

Net cash used in operating activities was $1.1 million for the three months ended March 31, 2007 compared to net cash provided by operating activities of $2.9 million for the three months ended March 31, 2006. Net cash used in operating activities for the three months ended March 31, 2007 consisted of a net loss of $2.5 million, partially offset by non-cash depreciation and amortization of $1.0 million, non-cash stock compensation expense of $0.2 million, and a decrease in accounts receivable of $1.3 million primarily attributable to the billing and collection during the three months ended March 31, 2007 of unbilled receivables as of December 31, 2006. Other changes in working capital, primarily a reduction in current liabilities, used an additional $1.0 million in cash.

Net cash provided by operating activities for the three months ended March 31, 2006 consisted of a net loss of $0.3 million, offset by non-cash depreciation and amortization of $0.4 million, an increase in deferred revenue of $1.6 million and a decrease in accounts receivable of $3.4 million primarily associated with the collection of fees associated with the HCSC contract closed in 2005.  Other changes in working capital, primarily an increase in prepaid commissions and prepaid software maintenance, used an additional $1.5 million in cash. Deferred revenue increased $1.6 million to $11.2 million at March 31, 2006 from $9.6 million at December 31, 2005. Deferred revenue consists of (i) annual maintenance and subscription fees for the software solutions that are paid in advance and recorded over the service period, and (ii) advance billings for professional services projects that are recorded using the proportional performance method based upon labor hours expended compared to estimated labor hours to complete the project. The increase was attributable to an increase in advance payments for professional services projects partially offset by the amortization of prepaid annual maintenance and subscription fees.

Investing Activities

Net cash used in investing activities was $1.1 million and $0.5 million for the three months ended March 31, 2007 and 2006, respectively. The net change in investing activities resulted from a larger investment in product development designed to expand the capabilities of core products and to prepare for the next phase of delivering richer Patient Clinical Summaries. Net cash used in investing activities for the three months ended March 31, 2007 consisted of the capitalization of product development costs of $0.8 million and the purchase of office equipment and computer equipment of $0.3 million. Net cash used in investing activities for the three months ended March 31, 2006 related to development activities to enhance our product offering and the capitalization of the costs associated with those projects of $0.4 million and the purchase of office equipment and computer equipment of $0.1 million.

Financing Activities

Net cash used financing activities was $0.3 million for the three months ended March 31, 2007 compared to net cash used in financing activities of $0.3 million for the three months ended March 31, 2006. Net cash used in financing activities for the three months ended March 31, 2007 consisted of repayments against our capital leases outstanding of $0.5 million and repayments against our equipment line of credit and insurance premium financing of $0.1 million, partially offset by proceeds from the exercise of stock options of $0.3 million. Net cash used in financing activities for the three months ended March 31, 2006 consisted of repayments against our equipment line of credit of $0.1 million and repayments against our capital leases outstanding of $0.2 million.

We believe that our cash balances, cash flows from operations and available borrowings under our working capital line of credit, equipment line of credit and capital leases will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next 12 months. We used approximately $9.5 million of the $26.4 million net proceeds from our initial public offering which closed on December 18, 2006 to pay the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock upon the automatic conversion of such shares into common stock upon the consummation of the offering. We intend to use the balance of the net proceeds of the offering for general corporate purposes, including working capital needs. We believe opportunities may exist to expand our current business through strategic acquisitions and investments in technology, and we may use a portion of the proceeds for these purposes. Changes in our operating plans, lower than anticipated revenue, increased expenses or other events, including those described in “Risk Factors” may cause us to seek additional debt or equity financing on an accelerated basis. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans, our financial condition and results of operations. Additional equity financing would be dilutive to the holders of common stock, and debt financing, if available, may involve significant cash payment obligations and covenants or financial ratio requirements that restrict our ability to operate our business. We do not, however, have any current plans to issue additional equity, including preferred stock, in the near future.

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates. We do not hold financial instruments for trading purposes.

Interest Rate Risk

The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we may invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, government and non-government debt securities, certificates of deposit and money market funds. Money market funds are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. However, a decline in interest rates would result in reduced future investment income to us.

Our interest expense, generally, is not sensitive to changes in prevailing interest rates since the majority of our borrowings that are outstanding and our capital leases are at a fixed interest rate. Borrowings under our working capital and equipment lines of credit are subject to adjustments in prevailing interest rates. Future increases in prevailing interest rates will increase future interest expense payable by us. However, we do not believe a 10% increase in prevailing interest rates will have a material effect on our interest expense.

Item 4.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of March 31, 2007, our management, including the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on such evaluation, our management concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

There have not been any changes in our internal control over financial reporting during the quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

This quarterly report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.

PART II – OTHER INFORMATION

Item 1A. Risk Factors

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 which could materially affect our business, financial condition or future results of operations.  The risks described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 are not the only risks that we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and future results of operations.  Other than as set forth below, there have been no material changes from the risk factors previously disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

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We operate in a market with limited potential clients, derive a significant portion of our revenue from a limited number of customers, and if we are unable to maintain these customer relationships or attract additional customers, our revenue will be adversely affected.

Our sales to Health Care Service Corporation and Horizon Blue Cross Blue Shield accounted for approximately 24% and 10%, respectively, of our revenue for the three months ended March 31, 2007. Our sales to Health Care Service Corporation and Blue Cross Blue Shield of Massachusetts accounted for approximately 31% and 12%, respectively, of our revenue for the three months ended March 31, 2006. Collectively, our top five customers accounted for approximately 57% and 59% of our revenue for the three months ended March 31, 2007 and 2006, respectively. Although we are seeking to broaden our customer base, we anticipate that a small number of customers will continue to account for a large percentage of our revenue. The loss of one or more of our key customers, or fewer or smaller orders from them, would adversely affect our revenue.

In addition, the number of potential customers in the electronic healthcare information market is limited, and therefore, our total customer base is limited. We believe that there are approximately 300 additional potential customers in our market. As of March 31, 2007, we had contracts with 44 entities that represented approximately 55 regional and national managed care organizations. If we lose one contract, we may lose more than one entity as a customer. Our contracts with our customers are typically five-year agreements. We do, however, enter into contracts with our customers that do not require long-term commitments, such as annual maintenance contracts or contracts for our transactional solutions. If we are not able to attract additional customers, license new solutions to our existing customers or obtain contract renewals from our customers, our revenue could decline.

We have a history of losses and cannot assure you that we will remain profitable, and as a result, we may have to cease operations and liquidate our business.

Our expenses have exceeded our revenue in four of the last five years, and no net income has been available to common shareholders in four of the last five years. As of March 31, 2007, our shareholders’ equity was $16.4 million which amount takes into consideration our net proceeds from our initial public offering which closed on December 18, 2006. Our future profitability depends on revenue exceeding expenses, but we cannot ensure that this will continue. If it does not continue, we could be forced to curtail operations and sell or liquidate our business, and you could lose some or all of your investment.

Our failure to license and effectively integrate third-party technologies could adversely affect our ability to sell our solutions and lead to a decline in revenue and the future growth of our business.

For some of the technology that is used in our solutions and in providing our services, we depend upon licenses from third-party vendors. For example, we license a database module that is material to our Advanced Medical Management module from InterSystems Corporation. We must continue licensing these technologies to operate and license our solutions and to service our customers. These technologies might not continue to be available to us on commercially reasonable terms, if at all. Most of these licenses are for a limited duration and can be renewed only by mutual consent, including the InterSystems license the expiration of which was originally December 31, 2006 but has been extended to June 15, 2007 while the parties negotiate its renewal. In addition, most of these licenses, including the InterSystems license, may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. Our inability to obtain any of these licenses could delay development of new solutions and services or cause us to cease operating one or more solutions or services until equivalent replacement technology can be identified, licensed and integrated. There is no assurance that we would be able to find an equivalent replacement technology, and if we did, the resources required to obtain and implement an equivalent replacement technology could be significant and could harm our business, financial condition and results of operations.

Most of the technology that we license from third-parties is licensed pursuant to agreements that are non-exclusive. Therefore, our competitors may obtain the right to use the technology covered by such licenses and use the technology to compete directly with us. Our use of third-party technologies exposes us to increased risks, including, but not limited to, risks associated with the integration of such technology into our solutions and services, the diversion of our resources from the development of our own proprietary technology and our inability to generate revenue from such licensed third-party technology sufficient to offset associated acquisition and maintenance costs. In addition, if our vendors choose to cease providing any of our licensed third-party technology or discontinue support of the licensed third-party technology in the future, we might not be able to offer our related modules and services. Furthermore, if these third-parties are unsuccessful in their continued research and development efforts or we are unsuccessful in our internal technology development efforts, we might not be able to modify or adapt our own solutions to effectively compete in our industry.

We may not generate sufficient future taxable income to allow us to realize our deferred tax assets.

We have a significant amount of tax loss carryforwards that will be available to reduce the taxes we would otherwise owe in the future. We have not recognized any portion of these future tax deductions in our consolidated balance sheet as of March 31, 2007 and December 31, 2006. The realization of our deferred tax assets is dependent upon our generation of future taxable income during the periods in which we are permitted, by law, to use those assets. We exercise judgment in evaluating our ability to realize the recorded value of these assets, and consider a variety of factors, including the scheduled reversal of deferred tax

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liabilities, projected future taxable income and tax planning strategies in making this assessment. Our evaluation of the realizability of deferred tax assets must consider both positive and negative evidence, and the weight given to the potential effects of positive and negative evidence is based on the extent to which the evidence can be verified objectively. We cannot assure you that we will have profitable operations in the future that will allow us to realize our deferred tax assets.

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

Use of Proceeds from Initial Public Offering

Our registration statement on Form S-1 (Commission File No. 333-136532) covering the initial public offering of 4,700,000 shares of our common stock, including 1,400,000 sold by certain selling shareholders, was declared effective by the SEC on December 13, 2006. The offering closed on December 18, 2006 and did not terminate before any securities were sold. As of the date of the filing of this report, the offering has terminated and all of the securities registered pursuant to the registration statement have been sold.

The offering was managed by Cowen and Company, LLC and CIBC World Markets Corp. Cowen and Company, LLC, CIBC World Markets Corp. and Pacific Growth Equities, LLC were representatives of the underwriters with respect to our initial public offering.

The aggregate proceeds to us from the sale of all 3,300,000 shares of common stock registered for sale by us based on the initial public offering price of $10.00 per share (prior to underwriting commissions) was $33 million. The aggregate proceeds to the selling shareholders named in the registration statement from the sale of all 1,400,000 shares of common stock registered for sale by them based on the initial public offering price of $10.00 per share (prior to underwriting commissions) was $14 million.

Through March 31, 2007, we incurred the following expenses in connection with our initial public offering in the following amounts (as approximated, in thousands):

Underwriting discounts and commissions	$	2,310
Finders’ fees	—
Expenses paid to or for our underwriters	—
Other expenses	$	4,282
Total expenses	$	6,592

No expenses related to our initial public offering were incurred after December 31, 2006.

No payments for any of the foregoing expenses were made directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities or (iii) any of our affiliates.

Net proceeds from the sale of all 3,300,000 shares of common stock registered for sale by us based on the initial public offering price of $9.30 per share (net of underwriting commissions) and estimated offering expenses of approximately $4.3 million payable by us, were approximately $26.4 million.

Between December 13, 2006 and March 31, 2007, the net proceeds have been used for the following purposes in the following amounts (as approximated, in thousands):

Construction of plant, building and facilities	$	—
Purchase and installation of machinery and equipment	$	1,140
Purchase of real estate	—
Acquisition of other business	—
Repayment of indebtedness	$	1,148
Working capital	$	12,431
Temporary investments	—
Other purposes (total) (for which at least $100 has been used)	$	9,505
(1) Payment of accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock - $9,500
Total	$	24,224

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As disclosed in the table immediately above, we have used approximately $9.5 million of the net proceeds to pay the accrued and unpaid dividends to the former holders of our Series B and Series C preferred stock whose shares automatically converted into common stock upon the consummation of our initial public offering. Of this amount, approximately $7.7 million of accrued and unpaid dividends were directly or indirectly paid to certain of our directors and officers and to certain persons beneficially owning 10% or more of any class of our equity securities on account of their previous record or beneficial ownership of shares of our Series B and Series C preferred stock.

We intend to use the balance of the net proceeds from our initial public offering for general corporate purposes, including working capital needs.

Item 5.    Other Information

On May 14, 2007, the Company and InterSystems Corporation agreed to extend the termination date of their license agreement until June 15, 2007 while the parties negotiate the renewal of such agreement.

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Item 6.    Exhibits

The following exhibits are filed as part of this quarterly report on Form 10-Q:

Exhibit
Number	Description of Document
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
32.1	Certification Furnished pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

	MEDECISION, INC.
May 14, 2007	By:	/s/ DAVID ST.CLAIR
		David St.Clair
		Chairman of the Board of Directors and Chief Executive Officer
May 14, 2007	By:	/s/ CARL E. SMITH
		Carl E. Smith
		Chief Financial Officer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit
Number	Description of Document
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
32.1	Certification Furnished pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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