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

Overview

We provide point-of-care technology-based clinical and productivity solutions that focus on addressing the needs of physicians, managed care payers and plans.

From our inception in 1986 through 1996, we focused almost exclusively on the sale of prepackaged medications to physicians, in particular those with a high percentage of fee-for-service patients. The advent of managed prescription benefit programs required providers to obtain reimbursement for medications dispensed from managed care organizations rather than directly from their patients. This new reimbursement methodology made it more difficult for our physician customers to dispense medications to their patient base.

In 1997, under the direction of our new executive management team, we focused our efforts on the information aspects of medication management, including the development of technology tools necessary for electronic prescribing, routing of prescription information and submission of medication claims for managed care reimbursement. In January 1998, we introduced the first version of our TouchScript product that fully incorporated these features. At the same time, we redirected our sales and marketing efforts away from our traditional fee-for-service customer base to physicians who have a large percentage of managed care patients. We recognized that there is a larger market opportunity among physicians whose patients are covered by managed care plans because the portion of prescriptions covered by managed care plans is increasing relative to the portion of fee-for-service prescriptions. Further, we believe that our technology can give us a competitive advantage where more patients' prescriptions are covered b y managed care plans because our products streamline the process by which physicians, managed care organizations and patients interact. In addition, we believe that the managed care market provides us with the opportunity to realize higher margins on our software products.

We believe that managed care prescription programs will continue to cover an increasing percentage of patients in the foreseeable future. This trend will have the effect of reducing the dispensing opportunities of our traditional dispensing customers because of their inability to submit claims electronically for reimbursement by managed care payers. This reduction in dispensing opportunities will reduce the revenue that we have historically recognized from these customers. Additionally, managed care programs impose reduced reimbursement rates for the medications dispensed to their plan participants, thus providing us with a dollar margin per prescription dispensed that is lower than we have historically experienced. Because TouchScript enables physicians to submit claims electronically for reimbursement by managed care payers, a large portion of the medications dispensed by our TouchScript customers is dispensed to managed care patients. Accordingly, we expect that the fastest growing portion of our prepa ckaged medication business will provide margins with respect to the sale of prepackaged medications that are lower than we have historically experienced. In addition, we expect that seasonal variances in demand for our products and services will continue. Historically, all other factors aside, our sales of prepackaged medications have been highest in the fall and winter months.

In addition to medication management, we believe that there are other aspects of the physician's daily workflow that can be effectively addressed through technology-focused solutions. We have enhanced and intend to continue to enhance our current offerings by integrating new products and services that address these needs. In furtherance of this strategy, in May 2000, we acquired MasterChart, Inc., a software developer providing dictation, integration and patient record technology, and Medifor, Inc., a provider of electronic patient education. In addition, on January 8, 2001, we acquired Channelhealth Incorporated, a software developer providing modular software for physicians to access medical information and manage clinical workflow.

In July 2001, we announced and began implementation of a restructuring plan to realign our organization, prioritize our initiatives around high-growth areas of our business, focus on profitability, reduce operating expenses, and improve efficiencies in light of the aforementioned acquisitions and the commitment to focus sales and service efforts on larger physician practices, academic medical centers, and integrated delivery networks. The restructuring plan includes workforce and overhead reduction, and the termination of certain strategic agreements and unprofitable customer contracts. As a result of the restructuring plan, we recorded restructuring and other charges of $4,370,000 and $4,266,000, respectively, during the third quarter of 2001. In addition, certain events and changes in circumstances caused us to conduct a review of the carrying value of our goodwill and purchased intangible assets. These events include the restructuring plan, the determination of the business climate, which has gene rated the valuation declines of enterprises in our industry, and the failure of certain assets to generate the cash flows that were projected at the time of acquisition. As a result of this review, we recorded an asset impairment charge of $354,984,000 during the three months ended September 30, 2001. The restucturing and other charges and the asset impairment charge are classified as operating expenses.

We currently derive our revenue from the sale of prepackaged medications and software and related services. Software and related services include revenue from software licenses, computer hardware, electronic information, education products, and related services.

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Our shift in focus to physicians who desire technology-based clinical and productivity solutions is reflected in the composition of our revenue, as depicted in the following table (in thousands):

Software and related services revenue for the fourth quarter of 2000 includes $1,500,000 for services provided to IMS Health Incorporated.

Three Months Ended September 30, 2001 Compared to Three Months Ended September 30, 2000

Total revenue for the three months ended September 30, 2001 increased by 10.6% or $1,577,000 from $14,838,000 in 2000 to $16,415,000 in 2001. Prepackaged medication revenue increased by 4.2% or $467,000 from $11,146,000 in the third quarter of 2000 to $11,613,000 in the third quarter of 2001. Software and related service revenue for the three months ended September 30, 2001 increased by 30.1% or $1,110,000 from $3,692,000 in 2000 to $4,802,000 in 2001. The September 11, 2001 terrorist attacks and the subsequent travel and delivery disruptions affected our ability to close key sales that would have contributed to revenue, postponed our ability to generate revenue from new and ongoing client implementations, and impaired our ability to ship prepackaged medications.

The increase in prepackaged medication revenue reflects an increase in the average selling prices of medications sold, caused primarily by general price inflation, offset by a decrease in the volume of prepackaged medications sold. The increase in software and related services revenue reflects an increase in revenue from the sale of our integrated content and clinical workflow products, offset by a decrease in revenue for our physician education and stand-alone offerings of dictation, document management products provided by our Masterchart acquisition.

Cost of revenue for the three months ended September 30, 2001 increased by 40.3% or $4,698,000 from $11,654,000 in 2000 to $16,352,000 in 2001 due to increased cost of implementation, training, and support for all of our software and related services, increased amortization expense of acquired software, and increased revenue from the sale of prepackaged medications. For the three months ended September 30, 2001, cost of revenue as a percentage of total revenue increased to 99.6% from 78.5% in the same period in 2000.

Selling, general and administrative expenses for the three months ended September 30, 2001 increased by 28.0% or $3,249,000 from $11,624,000 in 2000 to $14,873,000 in 2001 due primarily to incremental expenses related to Channelhealth, which was acquired in January 2001, and additional spending for other general and administrative expenses required to support increased revenue levels, partially offset by a decrease in expenses for the sales, marketing, and support of our stand-alone medication management solutions due to the change in our focus to aim our sales and service efforts at larger physician practices. Selling, general and administrative expenses as a percentage of total revenue increased to 90.6% for the three months ended September 30, 2001 from 78.3% of total revenue in the prior year period.

Amortization of intangibles for the three months ended September 30, 2001 increased $9,458,000 from $9,020,000 in 2000 to $18,478,000 in 2001. The increase in amortization relates to the amortization of goodwill and other intangibles recorded from the Channelhealth acquisition completed in January 2001.

During the three months ended September 30, 2001, we recorded an expense of $8,636,000 related to a restructuring plan initiated during the quarter. In addition, we recorded an asset impairment charge of $354,984,000 related to a reduction in the carrying value of intangible assets and goodwill from our acquisitions.

Interest income for the three months ended September 30, 2001 was $1,073,000 as compared to $2,300,000 for the prior year period. The decrease relates to the use of funds from our public offering in March 2000 for operations, capital expenditures, and acquisitions and a decrease in the average interest rates earned on our investments as compared to the prior year period.

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We have recorded a benefit for income taxes during the three months ended September 30, 2001 of $44,012,000 related to the reversal of deferred tax liabilities established for non-goodwill intangibles in response to the amortization and impairment of these assets during the three months ended September 30, 2001. No other provision or tax benefit for income taxes was computed because we currently anticipate that annual income taxes payable will be minimal or zero, and we have provided a valuation allowance for our net deferred tax assets.

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30, 2000

Total revenue for the nine months ended September 30, 2001 increased by 42.4% or $15,532,000 from $36,601,000 in 2000 to $52,133,000 in 2001. Prepackaged medication revenue increased by 27.7% or $7,995,000 from $28,900,000 in the first nine months of 2000 to $36,895,000 in the first nine months of 2001. Software and related service revenue for the nine months ended September 30, 2001 increased by 97.9% or $7,537,000 from $7,701,000 in 2000 to $15,238,000 in 2001. The September 11, 2001 terrorist attacks and the subsequent travel and delivery disruptions affected our ability to close key sales that would have contributed to revenue, postponed our ability to generate revenue from new and ongoing client implementations, and impaired our ability to ship prepackaged medications.

The increase in prepackaged medication revenue reflects an increase in the dispensing of drugs with higher average selling prices and an increase in the volume of prepackaged medications sold. The increase in software and related services revenue reflects an increase in revenue from the sale of our integrated content and clinical workflow products, offset by a decrease in revenue from our outsourcing business, where we provide the staffing for dispensing medications at the customer's premises.

Cost of revenue for the nine months ended September 30, 2001 increased by 69.6% or $20,011,000 from $28,743,000 in 2000 to $48,754,000 in 2001 due to increased cost of implementation, training, and support for all of our software and related services, increased revenue from the sale of prepackaged medications, and increased amortization expense of acquired software. For the nine months ended September 30, 2001, cost of revenue as a percentage of total revenue increased to 93.5% from 78.5% in the prior year period.

Selling, general and administrative expenses for the nine months ended September 30, 2001 increased by 43.6% or $13,639,000 from $31,317,000 in 2000 to $44,956,000 in 2001, due primarily to incremental expenses related to Channelhealth, which was acquired in January 2001, and MasterChart and Medifor, which were acquired during May 2000, additional spending to support increased revenue levels, and expenses for the development of information-based products and services. Selling, general and administrative expenses as a percentage of total revenue increased to 86.2% for the nine months ended September 30, 2001, from 85.6% of total revenue in the prior year period.

Amortization of intangibles for the nine months ended September 30, 2001 increased $39,857,000 from $15,037,000 in 2000 to $54,894,000 in 2001. The increase in amortization relates to the amortization of goodwill and other intangibles recorded from acquisitions completed in May 2000 and in January 2001.

During the nine months ended September 30, 2001, we recorded an expense of $8,636,000 related to a restructuring plan initiated during the third quarter of 2001. In addition, we recorded an asset impairment charge of $354,984,000 related to a reduction in the carrying value of purchased intangible assets and related goodwill from our acquisitions.

Write-off of acquired in-process research and development of $3,000,000 for the nine months ended September 30, 2001 relates to the Channelhealth acquisition completed in January 2001. For the nine months ended September 30, 2000, we recorded an expense for an immediate write-off of acquired in-process research and development related to the Medifor and Masterchart acquisitions in the amount of $13,729,000.

Interest income for the nine months ended September 30, 2001 was $4,187,000 as compared to $5,824,000 for the prior year period. The decrease relates to the use of funds from our public offering in March 2000 for operations, capital expenditures, and acquisitions and a decrease in the average interest rates earned on our investments as compared to the prior year period.

Other income for the nine months ended September 30, 2001 of $398,000 results primarily from a reduction in the estimated accrual necessary for unredeemed rebate obligations and realized gains on marketable securities.

We have recorded a benefit for income taxes during the nine months ended September 30, 2001 of $48,360,000 related to the reversal of deferred tax liabilities established for non-goodwill intangibles in response to the amortization and impairment of these assets during the three months ended September 30, 2001. No other provision or tax benefit for income taxes was computed because we currently anticipate that annual income taxes payable will be minimal or zero, and we have provided a valuation allowance for our net deferred tax assets.

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Liquidity and Capital Resources

At September 30, 2001, our principal sources of liquidity consisted of $40,576,000 of cash and cash equivalents and $42,672,000 of marketable securities. We issued securities for net cash proceeds totaling $99,738,000 in 2000. We have used these capital resources to fund operating losses, working capital needs, capital expenditures, acquisitions and retirement of debt. At September 30, 2001, we had an accumulated deficit of $529,760,000.

Net cash used in operating activities was $29,321,000 for the nine months ended September 30, 2001. Cash used in operating activities resulted primarily from a loss from operations of $410,385,000, partially offset by a non-cash asset impairment charge of $354,984,000, and depreciation and amortization of $65,169,000 primarily related to amortization expenses as a result of recent acquisitions. A non-cash charge of $3,000,000 was recorded due to the write-off of in-process research and development costs related to the Channelhealth acquisition. In addition, restructuring and other charges, net of cash paid out, were recorded in the amount of $7,775,000. Deferred taxes decreased by $48,360,000 due to a tax benefit recorded as it related to the asset impairment charge on and the amortization of non-goodwill intangibles from acquisitions. Accounts receivable, net of balances acquired in the purchase of Channelhealth, increased by $3,209,000 in the nine months ended September 30, 2001, primarily due to incr eased sales volume. Other receivables, net of acquired balances, decreased by $3,811,000 primarily due to a contract termination payment received. Inventories increased by $1,693,000 in the nine months ended September 30, 2001 primarily due to advance purchases of certain medications and computer equipment where shortages were expected.

Net cash used in investing activities was $6,638,000 for the nine months ended September 30, 2001. Cash used in investing activities resulted primarily from net cash used for acquisitions of $5,305,000, offset by net maturities of marketable securities of $1,400,000. In addition, capital expenditures were $2,733,000 for the nine months ended September 30, 2001 as a result of expenditures for electronic prescribing computer systems and capital outlays to support the future growth of our business. Currently, we have no material commitments for capital expenditures, although we anticipate ongoing capital expenditures in the ordinary course of business.

Net cash provided by financing activities was $22,000 for the nine months ended June 30, 2001 as a result of proceeds from the exercise of common stock options.

We believe that our existing cash, cash equivalents and marketable securities will be sufficient to meet the anticipated cash needs of our current business for at least the next twelve months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. We will, from time to time, consider the acquisition of, or investment in, complementary businesses, products, services and technologies, which might impact our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that financing will be available in the amounts or on terms acceptable to us, if at all.

Recently Issued Accounting Pronouncements

In July 2001, Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Intangible Assets" were issued. In October 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting and prohibits the use of the pooling-of-interests method for such transactions. SFAS No. 141 also requires identified intangible assets acquired in a business combination to be recognized as assets apart from goodwill if they meet certain criteria.

SFAS No. 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill and intangible assets with an indefinite life, including those acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually. Identified intangible assets should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144. Within six months of initial application of the new standard, a transitional impairment test must be performed on all goodwill. Any impairment loss recognized as a result of the transitional impairment test should be reported as a change in accounting principle. In addition to the transitional impairment test, the required annual impairment test should be performed in the year of adoption of SFAS No. 142. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, (although early adoption would be permitted in certain circum stances) and must be adopted as of the beginning of a fiscal year. Retroactive application is not permitted.

As of the date of adoption, we expect to have unamortized goodwill of approximately $732,000 and unamortized identifiable intangible assets of approximately $4,783,000, all of which will be subject to the transition provisions of SFAS No. 141 and SFAS No. 142. Amortization expense related to goodwill was approximately $44,000,000 and $20,400,000 for the nine months ended September 30, 2001 and the twelve months ended December 31, 2000, respectively. During the three months ended September 30, 2001, we recorded an impairment charge of $354,984,000 reducing the carrying value of the acquired intangible assets and related goodwill. The Company is in the process of evaluating the impact that adoption of SFAS No. 142 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time.

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SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was issued in October 2001. While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business. However, it retains the requirement in Opinion 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fi scal years. We are in the process of evaluating the impact that adoption of SFAS No. 144 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time.

Safe Harbor For Forward-Looking Statements

This report, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements," and statements we or our representatives make may contain forward-looking statements that involve risks and uncertainties. We develop forward-looking statements by combining currently available information with our beliefs and assumptions. These statements often contain words like believe, expect, anticipate, intend, contemplate, seek, plan, estimate or similar expressions. Forward-looking statements do not guarantee future performance. Recognize these statements for what they are and do not rely upon them as facts.

Forward-looking statements involve risks, uncertainties and assumptions, including, but not limited to, those discussed in this report as well as risks and uncertainties resulting from or otherwise related to the September 11, 2001 terrorist attacks. We make these statements under the protection afforded them by Section 21E of the Securities Exchange Act of 1934. Because we cannot predict all of the risks and uncertainties that may affect us, or control the ones we do predict, our actual results may be materially different from the results we express in our forward-looking statements. Unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

For a more complete discussion of the risks, uncertainties and assumptions that may affect us, see our Annual Report on Form 10-K for the fiscal year ended December 31, 2000.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2001, we did not own any derivative financial instruments but we were exposed to market risks, primarily changes in U.S. interest rates. As of September 30, 2001, we had cash, cash equivalents and marketable securities in financial instruments of $83,248,000. Maturities range from less than one month to approximately 12 years. Declines in interest rates over time will reduce our interest income from our investments. Based upon our balance of cash, cash equivalents and marketable securities as of September 30, 2001, a decrease in interest rates of 1.0% would cause a corresponding decrease in our annual interest income of approximately $832,000.

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PART II. OTHER INFORMATION

ITEM 6. Exhibits and Reports on Form 8-K

(A) Exhibits -- See Index to Exhibits.

(B) Reports on Form 8-K -- None.

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SIGNATURE

    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.

                                                                         ALLSCRIPTS HEALTHCARE SOLUTIONS, INC.
  (Registrant)

                        By:      /s David B. Mullen
                                      David B. Mullen
                                              President and Chief Financial Officer
                                              (Duly Authorized Officer and
                                               Principal Financial Officer)

Date: November 13, 2001

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INDEX TO EXHIBITS

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