##### Table of Contents



Securities and Exchange Commission
 Washington, D.C. 20549
 Form 10-Q
 Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the Quarterly Period Ended September 30, 2006
 Commission file number 000-20699
 DATATRAK International, Inc.
  Ohio
    
    34-1685364(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)6150 Parkland BoulevardMayfield Heights, Ohio
    
    44124(Address of principal executive offices)
    
    (Zip Code)
  
  
  þ o
  o þ o
 o þ




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TABLE OF CONTENTS  Part I. Financial InformationItem 1  Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II. Other InformationItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales of Equity Securities and Use of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Submission of Matters to a Vote of Security HoldersItem 5. Other InformationItem 6. ExhibitsSIGNATURESEX-31.1EX-31.2EX-32.1EX-32.2    Table of Contents  
 Part I. Financial Information
 
 Item 1  Financial Statements
 DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)
    
    
    (Note A)ASSETSCurrent assetsCash and cash equivalents
    
    $
    2,270,464
    
    
    $
    4,407,431Short-term investments
    
    
    2,009,386
    
    
    
    4,955,491Accounts receivable, less allowances
    
    
    3,301,259
    
    
    
    2,853,823Deferred tax asset
    
    
    
    
    
    
    287,000Prepaid expenses and other current assets
    
    
    694,373
    
    
    
    702,075Total current assets
    
    
    8,275,482
    
    
    
    13,205,820Property and equipment, at cost net of accumulated depreciation and amortization
    
    
    5,102,965
    
    
    
    1,878,404Other assetsRestricted cash
    
    
    74,962
    
    
    
    69,976Deferred tax asset
    
    
    1,200,000
    
    
    
    913,000Deposit
    
    
    39,549
    
    
    
    39,549Intangible assets, net of accumulated amortization
    
    
    2,140,040
    
    
    
    Goodwill
    
    
    12,956,842
    
    
    
    Total other assets
    
    
    16,411,393
    
    
    
    1,022,525Total assets
    
    $
    29,789,840
    
    
    $
    16,106,749LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    425,136
    
    
    $
    549,886Notes payable
    
    
    146,210
    
    
    
    Current portion of long-term debt
    
    
    670,038
    
    
    
    Accrued expenses
    
    
    1,707,144
    
    
    
    832,860Deferred revenue
    
    
    977,707
    
    
    
    1,027,015Total current liabilities
    
    
    3,926,235
    
    
    
    2,409,761Long-term liabilitiesLong-term debt
    
    
    3,825,235
    
    
    
    Deferred tax liability
    
    
    2,053,600
    
    
    
    Total long-term liabilities
    
    
    5,878,835
    
    
    
    Total liabilities
    
    
    9,805,070
    
    
    
    2,409,761Shareholders equitySerial preferred shares, without par value, 1,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common share warrants
    
    
    700,176
    
    
    
    711,872Common shares, without par value, authorized 25,000,000 shares; issued 14,706,091
shares as of September 30, 2006 and 13,613,161 shares as of December 31, 2005;
outstanding 11,406,091 shares as of September 30, 2006 and 10,313,161 shares as of
December 31, 2005
    
    
    70,304,643
    
    
    
    61,810,321Treasury shares, 3,300,000 shares at cost
    
    
    (20,188,308
    )
    
    
    (20,188,308
    )Accumulated deficit
    
    
    (30,534,093
    )
    
    
    (28,425,289
    )Foreign currency translation
    
    
    (297,648
    )
    
    
    (211,608
    )Total shareholders equity
    
    
    19,984,770
    
    
    
    13,696,988Total liabilities and shareholders equity
    
    $
    29,789,840
    
    
    $
    16,106,749
 
 Note A:
    
    The condensed consolidated balance sheet at December 31, 2005 has been derived from the
audited consolidated financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted in the United
States for complete financial statements. See notes to condensed consolidated financial statements.
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue
    
    $
    4,374,360
    
    
    $
    4,055,914
    
    
    $
    13,704,673
    
    
    $
    11,415,338Direct costs
    
    
    1,327,173
    
    
    
    899,306
    
    
    
    3,877,047
    
    
    
    2,740,840Gross profit
    
    
    3,047,187
    
    
    
    3,156,608
    
    
    
    9,827,626
    
    
    
    8,674,498Selling, general and administrative expenses
    
    
    3,391,522
    
    
    
    2,603,859
    
    
    
    9,911,092
    
    
    
    7,024,825Severance expense
    
    
    
    
    
    
    
    
    
    
    294,974
    
    
    
    Depreciation and amortization
    
    
    628,648
    
    
    
    198,272
    
    
    
    1,663,692
    
    
    
    574,953(Loss) income from operations
    
    
    (972,983
    )
    
    
    354,477
    
    
    
    (2,042,132
    )
    
    
    1,074,720Other income (expense):Interest income
    
    
    50,047
    
    
    
    62,272
    
    
    
    181,416
    
    
    
    159,430Interest (expense)
    
    
    (106,208
    )
    
    
    
    
    
    
    (248,088
    )
    
    
    (Loss) income before income taxes
    
    
    (1,029,144
    )
    
    
    416,749
    
    
    
    (2,108,804
    )
    
    
    1,234,150Income tax expense
    
    
    297,000
    
    
    
    4,095
    
    
    
    
    
    
    
    28,653Net (loss) income
    
    $
    (1,326,144
    )
    
    $
    412,654
    
    
    $
    (2,108,804
    )
    
    $
    1,205,497Net (loss) income per share:Basic:Net (loss) income per share
    
    $
    (0.12
    )
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.12Weighted-average shares outstanding
    
    
    11,400,675
    
    
    
    10,284,219
    
    
    
    11,205,113
    
    
    
    10,168,126Diluted:Net (loss) income per share
    
    $
    (0.12
    )
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.11Weighted-average shares outstanding
    
    
    11,400,675
    
    
    
    11,457,454
    
    
    
    11,205,113
    
    
    
    11,383,493
 See notes to condensed consolidated financial statements.
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Nine Months EndedSeptember 30,2006
    
    
    2005Operating ActivitiesNet (loss) income
    
    $
    (2,108,804
    )
    
    $
    1,205,497Adjustments to reconcile net (loss) income to net cash provided by operating activities:Depreciation and amortization
    
    
    1,663,692
    
    
    
    574,953Stock based compensation
    
    
    444,373
    
    
    
    79,581Accretion of discount on investments
    
    
    (84,347
    )
    
    
    (120,290
    )Loss from disposal of equipment
    
    
   
    
    
    
    357Changes in operating assets and liabilities:Accounts receivable
    
    
    (301,176
    )
    
    
    (653,333
    )Prepaid expenses and other current assets
    
    
    296,377
    
    
    
    (196,553
    )Accounts payable and accrued expenses
    
    
    470,887
    
    
    
    782Deferred revenue
    
    
    (252,104
    )
    
    
    522,060Net cash provided by operating activities
    
    
    128,898
    
    
    
    1,413,054Investing ActivitiesAcquisition of ClickFind, less cash acquired
    
    
    (4,668,926
    )
    
    
    Purchases of property and equipment
    
    
    (483,276
    )
    
    
    (807,842
    )Maturities of short-term investments
    
    
    6,319,116
    
    
    
    6,500,000Purchases of short-term investments
    
    
    (3,288,664
    )
    
    
    (6,405,314
    )Net cash used in investing activities
    
    
    (2,121,750
    )
    
    
    (713,156
    )Financing ActivitiesProceeds from issuance of common shares and stock option exercises
    
    
    167,094
    
    
    
    1,073,936Gross tax benefits from share based awards
    
    
    8,000
    
    
    
    Share issuance costs
    
    
    
    
    
    
    (103,125
    )Repayment of long-term debt and notes payable
    
    
    (215,614
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (40,520
    )
    
    
    970,811Effect of exchange rate changes on cash
    
    
    (103,595
    )
    
    
    (140,958
    )(Decrease) increase in cash and cash equivalents
    
    
    (2,136,967
    )
    
    
    1,529,751Cash and cash equivalents at beginning of period
    
    
    4,407,431
    
    
    
    2,232,276Cash And Cash Equivalents At End Of Period
    
    $
    2,270,464
    
    
    $
    3,762,027Unpaid Acquisition Costs
    
    $
    52,448
    
    
    $
    
 See notes to condensed consolidated financial statements.
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 1. Basis of Presentation
   2. ClickFind Acquisition
     Cash, accounts receivable and other current assets
    
    $
    254,000Amortizable intangible assets
    
    
    6,040,000Goodwill
    
    
    12,957,000Accounts payable and other current liabilities
    
    
    (408,000
    )Long-term debt
    
    
    (117,000
    )Deferred tax liability
    
    
    (2,054,000
    )Total acquisition cost
    
    $
    16,672,000
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
  
 ,
   Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2006
    
    2005
    
    2006
    
    2005Pro forma revenue
    
    $
    4,374,360
    
    
    $
    4,401,000
    
    
    $
    13,913,071
    
    
    $
    12,417,000Pro forma net (loss) income
    
    $
    (1,326,144
    )
    
    $
    (97,000
    )
    
    $
    (2,386,468
    )
    
    $
    (281,000
    )Pro forma basic (loss) income per share
    
    $
    (0.12
    )
    
    $
    (0.01
    )
    
    $
    (0.21
    )
    
    $
    (0.03
    )Pro forma diluted (loss) income per share
    
    $
    (0.12
    )
    
    $
    (0.01
    )
    
    $
    (0.21
    )
    
    $
    (0.03
    )
 3. Stock Based Compensation
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
       Weighted-average risk free interest rate
    
    
    4.2
    %Weighted-average volatility of the expected market price of the common shares
    
    
    1.01Dividend yield
    
    
    0.0
    %Weighted-average expected life of the options
    
    
    7 yearsWeighted-average fair value per share of options granted
    
    $
    9.90
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
   Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2005
    
    
    September 30, 2005Net income recorded
    
    $
    413,000
    
    
    $
    1,205,000Plus: stock compensation expense recognized
    
    
    16,000
    
    
    
    49,000Less: stock compensation expense that
would have been recognized under SFAS No.
123
    
    
    175,000
    
    
    
    740,000Pro forma net income
    
    $
    254,000
    
    
    $
    514,000Pro forma basic income per share
    
    $
    0.02
    
    
    $
    0.05Pro forma diluted income per share
    
    $
    0.02
    
    
    $
    0.05
   Weighted AverageWeighted Average
    
    
    Aggregate Intrinsic
    
    
    RemainingOptions
    
    
    Exercise Price
    
    
    Value
    
    
    Contractual LifeOutstanding at January 1, 2006
    
    
    1,619,891
    
    
    $
    3.52Granted
    
    
    
    
    
    
    Exercised
    
    
    (44,400
    )
    
    
    3.53Cancelled
    
    
    (48,981
    )
    
    
    6.44Outstanding at September 30, 2006
    
    
    1,526,510
    
    
    $
    3.43
    
    
    $
    3,288,000
    
    
    5.0 YearsVested or expected to vest at September 30, 2006
    
    
    1,523,324
    
    
    $
    3.43
    
    
    $
    3,282,000
    
    
    5.0 YearsExercisable at September 30, 2006
    
    
    1,314,947
    
    
    $
    2.93
    
    
    $
    3,479,000
    
    
    4.5 Years
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 4. Net (Loss) Income Per Share
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net (loss) income used in the calculation of
basic and diluted net (loss) income per share
    
    $
    (1,326,144
    )
    
    $
    412,654
    
    
    $
    (2,108,804
    )
    
    $
    1,205,497Denominator for basic net (loss) income per share 
weighted-average common shares outstanding
    
    
    11,400,675
    
    
    
    10,284,219
    
    
    
    11,205,113
    
    
    
    10,168,126Effect of dilutive common share options and warrants
    
    
    
    
    
    
    1,173,235
    
    
    
    
    
    
    
    1,215,367Denominator for diluted net (loss) income per share
    
    
    11,400,675
    
    
    
    11,457,454
    
    
    
    11,205,113
    
    
    
    11,383,493Basic net (loss) income per share
    
    $
    (0.12
    )
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.12Diluted net (loss) income per share
    
    $
    (0.12
    )
    
    $
    0.04
    
    
    $
    (0.19
    )
    
    $
    0.11Weighted-average common share options and warrants
excluded from the computation of diluted net (loss)
income per share because they would have an
antidilutive effect on net (loss) income per share
    
    
    1,723,437
    
    
    
    9,450
    
    
    
    1,751,664
    
    
    
    12,128
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 5. Comprehensive (Loss) Income
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net (loss) income
    
    $
    (1,326,144
    )
    
    $
    412,654
    
    
    $
    (2,108,804
    )
    
    $
    1,205,497Foreign currency translation
    
    
    (88,282
    )
    
    
    (11,359
    )
    
    
    (86,040
    )
    
    
    (166,183
    )Comprehensive (loss) income
    
    $
    (1,414,426
    )
    
    $
    401,295
    
    
    $
    (2,194,844
    )
    
    $
    1,039,314
 6. Shareholders Equity
   7. Operating Leases
  Twelve Months ended September 30,
    
    Amount2007
    
    $
    883,0002008
    
    
    885,0002009
    
    
    764,0002010
    
    
    584,0002011
    
    
    585,000Subsequent to September 30, 2011
    
    
    640,000$
    4,341,000
 8. Income Taxes
  Nine Months Ended September 30,2006
    
    
    2005Current:Federal
    
    $
    
    
    
    $
    29,000State and local
    
    
    
    
    
    
    
    
    
    
    29,000DeferredFederal
    
    
    
    
    
    
    State and local
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    29,000
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
  Nine Months Ended September 30,2006
    
    
    2005Income tax (benefit) provision at the United States statutory rate
    
    $
    (715,000
    )
    
    $
    420,000Increase (reversal) of valuation allowance
    
    
    615,000
    
    
    
    (391,000
    )Non-deductible permanent differences
    
    
    100,000
    
    
    
    $
    
    
    
    $
    29,000
    9. Notes Payable
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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 10. Long-term Debt
  September 30,
    
    
    December 31,2006
    
    
    2005Notes payable held by certain
former shareholders of ClickFind (the
ClickFind Notes). The notes payable
bear interest at prime plus 1%, and
principal payments are due in
installments of $500,000, $500,000 and
$3,000,000 on February 1, 2007, 2008 and
2009, respectively. Of the $4,000,000,
$2,618,000 is held by an executive
officer of the Company who was the
founder of ClickFind. Of the remaining
$1,382,000 of ClickFind Notes,
$1,017,000 is held by other current
employees of the Company
    
    $
    4,000,0000
    
    
    $
    Financing agreement with Oracle Credit
Corporation (the Oracle Agreement) for
the purchase of certain computer
equipment. The terms of the financing
agreement require DATATRAK to make 36
monthly payments of $9,012, including
accrued interest, beginning in July 2006
through June 2009
    
    
    254,547
    
    
    
    Capital lease agreement with Dell
Financial Services (the Dell
Agreement) for the purchase of certain
computer equipment. The terms of the
lease agreement require DATATRAK to make
36 monthly payments of $7,340, including
accrued interest, beginning in September
2006 through August 2009
    
    
    240,726
    
    
    
    4,495,273
    
    
    
    Less current maturities
    
    
    670,038
    
    
    
    $
    3,825,235
    
    
    $
    
  11. Severance Expense
   12. Restricted Cash
  12




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DATATRAK INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 13. Software Development Costs
   14. Reclassification
  15. Contingencies
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  General
 ®
    
    
    Project management and data management (design, report and export) service revenue is
recognized proportionally over the life of a contract as services are performed, based on
the contractual billing rate per hour for those services.
    
    Data items revenue is recognized based on a price per data unit as data items are entered
into DATATRAKs hosting facility.
    
    Classroom training services revenue is recognized as classroom training is completed, at
rates based on the length of the training program.
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
    
    Internet-based training services revenue is recognized on a per user basis as self-study courses are completed.
    
    Help desk revenue is recognized based on a monthly price per registered user under the contract.
    Critical Accounting Policies
   ,
  15




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Results of Operations
 Three months ended September 30, 2006 compared with three months ended September 30, 2005
       Nine months ended September 30, 2006 compared with nine months ended September 30, 2005
  16




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Liquidity and Capital Resources
    17




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®
  ®
 18




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®
  Inflation
  Information About Forward-Looking Statements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
  19




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Foreign Currency Risk
   
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls
  20




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Part II. Other Information
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1
    
    Section 1350 Certification of Chief Executive Officer32.2
    
    Section 1350 Certification of Chief Financial Officer
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SIGNATURES
  DATATRAK International, Inc.RegistrantDate: November 9, 2006
    /s/ Jeffrey A. GreenJeffrey A. Green,President and Chief Executive Officer and a Director
(Principal Executive Officer)Date: November 9, 2006
    /s/ Terry C. BlackTerry C. Black,Vice President of Finance, Chief Financial Officer,
Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer) 22