UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

| | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
| | ----------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006.

or

| | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
| | ----------------------------------------------------------------------------------------

For the transitional period from __________________ to __________________

Commission file number 0-29100

eResearchTechnology, Inc.

(Exact name of registrant as specified in its charter)



| | Delaware(State or other jurisdiction of incorporation or organization) |  | 22-3264604(I.R.S. Employer Identification No.) | 
| | ---------------------------------------------------------------------- |  | ---------------------------------------------- | 

| |  |  |  | 
| |  |  |  | 

| | 30 South 17th StreetPhiladelphia, PA(Address of principal executive offices) |  | 19103(Zip code) | 
| | ---------------------------------------------------------------------------- |  | --------------- | 

215-972-0420

(Registrants telephone number, including area code)



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. YesNo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filerAccelerated filerNon-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesNo

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.

The number of shares of Common Stock, $.01 par value, outstanding as of October 31, 2006, was 49,895,399.






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eResearchTechnology,
  Inc. and Subsidiaries

INDEX



PagePart
          I. Financial InformationItem
          1.
      
      Financial
          StatementsConsolidated
          Balance Sheets-December 31, 2005 and September 30, 2006 (unaudited)
      3Consolidated
          Statements of Operations (unaudited)Three and Nine Months Ended
          September 30, 2005 and 2006
      4Consolidated
          Statements of Cash Flows (unaudited)Nine Months Ended September
          30, 2005 and 2006
      5Notes
          to Consolidated Financial Statements (unaudited)
      6-13Item
          2.
      
      Managements
          Discussion and Analysis of Financial Condition and Results of Operations
      14-25Item
          3.
      
      Quantitative
          and Qualitative Disclosures About Market Risk
      25Item
          4.
      
      Controls
          and Procedures
      25Part
          II. Other InformationItem
          6.
      
      Exhibits
      26Signatures
      27Exhibit
          Index
      28


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Part 1. Financial Information

Item 1. Financial Statements

eResearchTechnology,
  Inc. and Subsidiaries

Consolidated
  Balance Sheets

(In
  thousands, except share and per share amounts)



December
          31, 2005
      
      September
          30, 2006(unaudited)AssetsCurrent
          Assets:Cash
          and cash equivalents
      
      $
      18,432
      
      $
      13,265Short-term
          investments
      
      
      33,569
      
      
      38,805Accounts
          receivable, net
      
      
      15,178
      
      
      15,265Prepaid
          income taxes
      
      
      27
      
      
      2,524Prepaid
          expenses and other
      
      
      2,501
      
      
      3,282Deferred
          income taxes
      
      
      841
      
      
      843Total
          current assets
      
      
      70,548
      
      
      73,984Property
          and equipment, net
      
      
      28,670
      
      
      29,724Goodwill
      
      
      1,212
      
      
      1,212Long-term
          investments
      
      
      3,008
      
      
      1,248Deferred
          income taxes
      
      
      335
      
      
      Other
          assets
      
      
      993
      
      
      748Total
          assets
      
      $
      104,766
      
      $
      106,916Liabilities
          and Stockholders EquityCurrent
          Liabilities:Accounts
          payable
      
      $
      2,332
      
      $
      4,330Accrued
          expenses
      
      
      5,155
      
      
      4,044Income
          taxes payable
      
      
      1,041
      
      
      746Current
          portion of capital lease obligations
      
      
      153
      
      
      79Deferred
          revenues
      
      
      16,072
      
      
      7,415Total
          current liabilities
      
      
      24,753
      
      
      16,614Capital
          lease obligations, excluding current portion
      
      
      40
      
      
      Commitments
          and contingenciesStockholders
          Equity:Preferred
          stock - $10.00 par value, 500,000 shares authorized, none issued and
          outstanding
      
      
      
      
      
      Common
          stock - $.01 par value, 175,000,000 shares authorized, 56,871,010 and
          58,129,449 shares issued, respectively
      
      
      569
      
      
      581Additional
          paid-in capital
      
      
      73,290
      
      
      82,842Accumulated
          other comprehensive income
      
      
      586
      
      
      1,088Retained
          earnings
      
      
      61,915
      
      
      67,981Treasury
          stock, 7,847,119 and 8,247,119 shares at cost, respectively
      
      
      (56,387
      )
      
      (62,190
      )Total
          stockholders equity
      
      
      79,973
      
      
      90,302Total
          liabilities and stockholders equity
      
      $
      104,766
      
      $
      106,916


The accompanying notes are an integral part of these statements.

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eResearchTechnology, Inc. and Subsidiaries

Consolidated
  Statements of Operations

(In
  thousands, except per share amounts)

(unaudited)



Three
          Months Ended September 30,
      
      Nine
          Months Ended September 30,2005
      
      2006
      
      2005
      
      2006Net
          revenues:Licenses
      
      $
      1,009
      
      $
      602
      
      $
      4,418
      
      $
      2,336Services
      
      
      15,037
      
      
      14,493
      
      
      42,184
      
      
      42,040Site
          support
      
      
      4,880
      
      
      7,131
      
      
      14,815
      
      
      22,067Total
          net revenues
      
      
      20,926
      
      
      22,226
      
      
      61,417
      
      
      66,443Costs
          of revenues:Cost
          of licenses
      
      
      82
      
      
      75
      
      
      319
      
      
      228Cost
          of services
      
      
      6,108
      
      
      6,674
      
      
      18,174
      
      
      19,130Cost
          of site support
      
      
      3,455
      
      
      4,548
      
      
      9,786
      
      
      14,492Total
          costs of revenues
      
      
      9,645
      
      
      11,297
      
      
      28,279
      
      
      33,850Gross
          margin
      
      
      11,281
      
      
      10,929
      
      
      33,138
      
      
      32,593Operating
          expenses:Selling
          and marketing
      
      
      2,208
      
      
      2,471
      
      
      6,653
      
      
      8,687General
          and administrative
      
      
      2,685
      
      
      3,945
      
      
      8,220
      
      
      11,758Research
          and development
      
      
      1,081
      
      
      980
      
      
      2,975
      
      
      3,328Total
          operating expenses
      
      
      5,974
      
      
      7,396
      
      
      17,848
      
      
      23,773Operating
          income
      
      
      5,307
      
      
      3,533
      
      
      15,290
      
      
      8,820Other
          income, net
      
      
      321
      
      
      339
      
      
      486
      
      
      1,067Income
          before income taxes
      
      
      5,628
      
      
      3,872
      
      
      15,776
      
      
      9,887Income
          tax provision
      
      
      1,601
      
      
      1,407
      
      
      5,711
      
      
      3,821Net
          income
      
      $
      4,027
      
      $
      2,465
      
      $
      10,065
      
      $
      6,066Basic
          net income per share
      
      $
      0.08
      
      $
      0.05
      
      $
      0.20
      
      $
      0.12Diluted
          net income per share
      
      $
      0.08
      
      $
      0.05
      
      $
      0.19
      
      $
      0.12Shares
          used to calculate basic net income per share
      
      
      50,158
      
      
      49,540
      
      
      50,305
      
      
      49,302Shares
          used to calculate diluted net income per share
      
      
      52,979
      
      
      51,376
      
      
      53,145
      
      
      51,525


The accompanying notes are an integral part of these statements.



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eResearchTechnology,
  Inc. and Subsidiaries

Consolidated
  Statements of Cash Flows

(In
  thousands)

(unaudited)



Nine
          Months Ended September 30,2005
      
      2006Operating
          activities:Net
          income
      
      $
      10,065
      
      $
      6,066Adjustments
          to reconcile net income to net cash provided
          by operating activities:Depreciation
          and amortization
      
      
      7,940
      
      
      8,537Cost
          of sales of equipment
      
      
      312
      
      
      3,483Provision
          for uncollectible accounts
      
      
      88
      
      
      Non-cash
          share-based compensation
      
      
      
      
      
      2,319Stock
          option income tax benefit
      
      
      1,587
      
      
      Investment
          impairment charge
      
      
      284
      
      
      Changes
          in operating assets and liabilities:Accounts
          receivable
      
      
      2,934
      
      
      44Prepaid
          expenses and other
      
      
      (2,149
      )
      
      (452
      )Accounts
          payable
      
      
      691
      
      
      1,966Accrued
          expenses
      
      
      257
      
      
      (1,156
      )Income
          taxes
      
      
      195
      
      
      (3,062
      )Deferred
          revenues
      
      
      522
      
      
      (8,744
      )Net
          cash provided by operating activities
      
      
      22,726
      
      
      9,001Investing
          activities:Purchases
          of property and equipment
      
      
      (10,842
      )
      
      (12,269
      )Purchases
          of investments
      
      
      (29,077
      )
      
      (24,516
      )Proceeds
          from sales of investments
      
      
      18,035
      
      
      21,040Net
          cash provided by investing activities
      
      
      (21,884
      )
      
      (15,745
      )Financing
          activities:Repayment
          of capital lease obligations
      
      
      (196
      )
      
      (114
      )Proceeds
          from exercise of stock options
      
      
      1,094
      
      
      3,548Excess
          tax benefit related to stock options
      
      
      
      
      
      3,702Repurchase
          of common stock for treasury
      
      
      (9,421
      )
      
      (5,803
      )Net
          cash provided by (used in) financing activities
      
      
      (8,523
      )
      
      1,333Effect
          of exchange rate changes on cash
      
      
      (287
      )
      
      244Net
          decrease in cash and cash equivalents
      
      
      (7,968
      )
      
      (5,167
      )Cash
          and cash equivalents, beginning of period
      
      
      45,806
      
      
      18,432Cash
          and cash equivalents, end of period
      
      $
      37,838
      
      $
      13,265


The accompanying notes are an integral part of these statements.

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eResearchTechnology, Inc. and Subsidiaries

Notes
  to Consolidated Financial Statements

(unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements, which include the accounts of eResearchTechnology, Inc. (the Company or we) and its wholly-owned subsidiaries, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. Further information
on potential factors that could affect our financial results can be found in our Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission and in this Form 10-Q.

Note 2. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current periods presentation.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates.

Property and Equipment

Pursuant to Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, we capitalize costs associated with internally developed and/or purchased software systems for new products and enhancements to existing products that have reached the application development stage and meet recoverability tests. These costs are included in property and equipment. Capitalized costs include external direct costs of materials and services utilized in developing or obtaining internal-use software, and payroll and payroll-related expenses for employees who are directly associated with and devote time to the internal-use software project.

Amortization of capitalized software development costs is charged to cost of revenues. Amortization of capitalized software development costs was $0.3 million and $0.2 million for the three months ended September 30, 2005 and 2006, respectively, and $1.0 million and $1.0 million for the nine months ended September 30, 2005 and 2006, respectively. For the nine months ended September 30, 2005 and 2006, we capitalized $2.7 million and $3.6 million, respectively, of software development costs related to labor and consulting. As of September 30, 2006, $10.2 million of capitalized costs have not yet been placed in service and are therefore not being amortized.

Long-lived Assets

In
  accordance with the provisions of Statement of Financial Accounting Standards
  (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived
  Assets, when events or circumstances so indicate, we assess the potential
  impairment of our long-lived assets based on anticipated undiscounted cash flows
  from theassets. Such events and circumstances
  include a sale of all or a significant part of the operations associated with
  the long-lived asset, or a significant decline in the operating performance
  of the asset. If an impairment is indicated, the amount of the impairment charge
  would be calculated by comparing the anticipated discounted future cash flows
  to the carrying value of the long-lived asset. No impairment was indicated during
  either of the nine-month periods ended September 30, 2005 or September 30, 2006.

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Software Development Costs

Research and development expenditures are charged to operations as incurred. SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility. Since software development costs have not been significant after the establishment of technological feasibility, all such costs have been charged to expense as incurred.

Stock-Based Compensation

Accounting for Stock-Based Compensation

Prior to January 1, 2006, we accounted for stock-based compensation under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations. No compensation expense related to stock option plans was reflected in our Consolidated Statements of Operations as all options had an exercise price equal to the market value of the underlying common stock on the date of grant. SFAS No. 123, Accounting For Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by SFAS No. 123, we elected to continue to apply the intrinsic-value-based method of APB 25, described above, and adopted only the disclosure requirements of SFAS No. 123, as
amended by SFAS No. 148, Accounting For Stock-Based Compensation - Transition and Disclosure.

On January 1, 2006, we adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R), which requires that the costs resulting from all share-based payment transactions be recognized in the financial statements at their fair values. We adopted SFAS No. 123R using the modified prospective application method under which the provisions of SFAS No. 123R apply to new awards and to awards modified, repurchased or cancelled after the adoption date. Additionally, compensation cost for the portion of the awards for which the requisite service had not been rendered that were outstanding as of January 1, 2006 is recognized in the Consolidated Statements of Operations over the remaining service period after such date based on the awards original estimate of fair value. The aggregate share-based compensation expense recorded in the Consolidated
Statements of Operations for the three and nine months ended September 30, 2006 under SFAS No. 123R was $0.7 million and $2.3 million, respectively. We would have recorded no share-based compensation expense for the three and nine months ended September 30, 2006 if we had continued to account for share-based compensation under APB 25. For the three months ended September 30, 2006, this additional share-based compensation lowered pre-tax earnings by $0.7 million, lowered net income by $0.6 million and lowered basic and diluted earnings per share by $0.01. For the nine months ended September 30, 2006, this additional share-based compensation lowered pre-tax earnings by $2.3 million, lowered net income by $1.9 million and lowered basic and diluted earnings per share by $0.04. SFAS No. 123R also amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included
within operating cash flows. Results for prior periods have not been restated.

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Fair Value Disclosures - Prior to SFAS No. 123R Adoption

Had we adopted SFAS No. 123 at the beginning of fiscal 2005, the impact on the financial results for the three and nine months ended September 30, 2005 would have been as follows:



Three MonthsEndedSeptember 30,2005


      

        Nine MonthsEndedSeptember 30,2005Net income, as reported


      


      $


      4,027


      


      $


      10,065Deduct: Net stock-based employee compensation expense determined under fair-value-based method, net of related tax effects

        

        

        (624

        )

        

        (2,152

        )Pro forma net income

        

        $

        3,403

        

        $

        7,913Earnings per share:Basic - as reported

        

        $

        0.08

        

        $

        0.20Basic - pro forma

        

        $

        0.07

        

        $

        0.16Diluted - as reported

        

        $

        0.08

        

        $

        0.19Diluted - pro forma

        

        $

        0.06

        

        $

        0.15


The fair value of the Companys stock-based awards to employees during the first nine months of fiscal 2005 was estimated at the date of grant using the Black-Scholes closed form option-pricing model (Black-Scholes), assuming no dividends and using the weighted-average valuation assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees. Expected volatility was based on historical volatility for a period equal to the stock options expected life, calculated on a daily basis.



Risk-free interest rate


      


      3.51


      %Expected dividend yield

        


      0.00


      %Expected life

        

        3.5 yearsExpected volatility

        

        63.01


      %


The above assumptions were used to determine the weighted-average per share fair value of $7.01 for stock options granted during the first nine months of 2005.

Valuation Assumptions for Options Granted during Fiscal 2006

The fair value of each stock option granted during the first nine months of fiscal 2006 was estimated at the date of grant using Black-Scholes, assuming no dividends and using the weighted-average valuation assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees. Expected volatility was based on historical volatility for a period equal to the stock options expected life, calculated on a daily basis.



Risk-free
          interest rate
      
      4.82
      %Expected
          dividend yield
      
      0.00
      %Expected
          life
      
      3.5
          yearsExpected
          volatility
      
      59.68
      %


The above assumptions were used to determine the weighted-average per share fair value of $6.15 for stock options granted during the first nine months of 2006.

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Stock Option Plans

In
  1996, we adopted a stock option plan (the 1996 Plan) that authorized
  the grant of both incentive and non-qualified options to acquire up to 3,375,000
  shares of the Companys common stock. Our Board of Directors determined
  the exercise price of the options under the 1996 Plan. The exercise price of
  incentive stock options was not below the fair value of the common stock on
  the grant date. Incentive stock options under the 1996 Plan expire ten years
  from the grant date and are exercisable in accordance with vesting provisions
  set by the Board, which generally are over three to five years. In May 1999,
  the stockholders approved an amendment to the 1996 Plan that increased the number
  of shares which could be acquired through option grants under the 1996 Plan
  by 4,050,000 to 7,425,000 and provided for an annual option grant of 5,000 shares
  to each outside director. In April 2001, the stockholders approved an amendment
  to the 1996 Plan that increased the number of shares which could be acquired
  through option grants under the 1996 Plan by 2,025,000 to 9,450,000. No additional
  options have been granted under this plan, as amended, since December 31, 2003.

In
  May 2003, the stockholders approved a new stock option plan (the 2003
  Plan) that authorized the grant of both incentive and non-qualified options
  to acquire up to 3,818,625 shares of our common stock and provided for an annual
  option grant of 10,000 shares to each outside director. The Compensation Committee
  of our Board of Directors determines the recipients of option grants, the exercise
  price and other terms of the options under the 2003 Plan. The exercise price
  of incentive stock options may not be set below the fair value of the common
  stock on the grant date. Incentive stock options under the 2003 Plan expire
  ten years from the grant date, or at the end of such shorter period as may be
  designated by the Compensation Committee, and are exercisable in accordance
  with vesting provisions set by the Compensation Committee, which generally are
  over four years. In April 2006, the stockholders approved an amendment to the
  2003 Plan that increased the number of shares which could be acquired through
  option grants under the 2003 Plan by 3,500,000 to 7,318,625. The Company funds
  shares issued upon exercise out of available authorized shares.

In December 2005, we accelerated the vesting of unvested stock options to acquire 490,000 shares of common stock with exercise prices greater than $19.00 per share. As a result, these options became immediately exercisable. The decision to accelerate vesting of these stock options was made primarily to avoid recognizing compensation cost in future years upon our adoption of SFAS No. 123R on January 1, 2006. In addition, management believed that the incentive and retentive value of these options was significantly lower than their valuation using Black-Scholes.

On February 7, 2006, we entered into a new employment agreement with our former President and Chief Executive Officer in connection with the announcement of his retirement from his position as President and Chief Executive Officer and Director of the Company. His employment terminated on September 11, 2006 and any options not then exercisable became exercisable in full. As a result of this modification to his option terms, we revalued his options as of February 7, 2006 and amortized the resulting expense through September 11, 2006. This change resulted in additional pre-tax compensation expense of $266,000 in the first nine months of 2006.

Information with respect to outstanding options under our plans is as follows:



Shares
      
      WeightedAverageExercise Price
      
      RemainingContractualTerm
      
      IntrinsicValue(in thousands)Outstanding
          as of December 31, 2005
      
      5,347,020
      
      $
      6.61Granted
      
      753,900
      
      
      13.00Exercised
      
      (1,258,439
      )
      
      2.82Cancelled/forfeited
      
      (134,750
      )
      
      14.67Outstanding
          as of September 30, 2006
      
      4,707,731
      
      
      8.41
      
      5.5
      
      $
      14,416Options
          exercisable at September 30, 2006
      
      3,437,152
      
      
      7.12
      
      5.3
      
      $
      13,827Options
          expected to vest at September 30, 2006
      
      1,079,992
      
      
      11.92
      
      6.2
      
      $
      500


The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Companys closing common stock price on the last trading day of the third quarter of 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2006. This amount changes based on the fair market value of the Companys common stock. The total intrinsic value of options exercised for the nine months ended September 30, 2005 and 2006 was $3.8 million and $10.6 million, respectively.

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As of September 30, 2006, there was $4.2 million of total unrecognized compensation cost related to non-vested stock options granted under the plans. That cost is expected to be recognized over a weighted-average period of 2.5 years.

Tax Effect Related to Stock-based Compensation Expense

SFAS
     No. 123R provides that income tax effects of share-based payments are recognized

  in the financial statements for those awards that will normally result in tax
     deductions under existing tax law. Under current U.S. federal tax law, we
    receive
  a compensation expense deduction related to non-qualified stock options only
     when those options are exercised. Accordingly, the financial statement recognition

  of compensation cost for non-qualified stock options creates a deductible temporary
     difference which results in a deferred tax asset and a corresponding deferred

  tax benefit in the statement of operations. We do not recognize a tax benefit
     for compensation expense related to incentive stock options (ISOs) unless
    the
  underlying shares are disposed of in a disqualifying disposition. Accordingly,
     compensation expense related to ISOs is treated as a permanent difference
    for
  income tax purposes. The tax benefit recognized in our Consolidated Statement
     of Operations in the nine months ended September 30, 2006 related to stock-based

  compensation expense was approximately $0.4 million.

Note
          3.Net Income per Common
          Share


Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period, adjusted for the dilutive effect of common stock equivalents, which consist of stock options. The dilutive effect of stock options is calculated using the treasury stock method.

The tables below set forth the reconciliation of the numerators and denominators of the basic and diluted net income per share computations (in thousands, except per share amounts):

Three
          Months Ended September 30,

2005
      
      NetIncome
      
      Shares
      
      Per ShareAmountBasic
          net income
      
      $
      4,027
      
      50,158
      
      $
      0.08Effect
          of dilutive shares
      
      
      
      
      2,821
      
      
      Diluted
          net income
      
      $
      4,027
      
      52,979
      
      $
      0.082006Basic
          net income
      
      $
      2,465
      
      49,540
      
      $
      0.05Effect
          of dilutive shares
      
      
      
      
      1,836
      
      
      Diluted
          net income
      
      $
      2,465
      
      51,376
      
      $
      0.05


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Nine Months Ended September 30,

2005


      

        NetIncome


      


      Shares


      

        Per ShareAmountBasic net income


      


      $


      10,065


      


      50,305


      


      $


      0.20Effect of dilutive shares

        

        

        

        

        2,840

        

        

        (0.01

        )Diluted net income

        

        $

        10,065

        

        53,145

        

        $

        0.19


2006Basic
          net income
      
      $
      6,066
      
      49,302
      
      $
      0.12Effect
          of dilutive shares
      
      
      
      
      2,223
      
      
      Diluted
          net income
      
      $
      6,066
      
      51,525
      
      $
      0.12


In computing diluted net income per share, options to purchase 1,159,000 and 1,877,000 shares of common stock were excluded from the computations for the three months ended September 30, 2005 and 2006, respectively and options to purchase 1,179,000 and 1,436,000 shares of common stock were excluded from the computations for the nine months ended September 30, 2005 and 2006, respectively. These options were excluded from the computations because the exercise prices of such options were greater than the average market price of our common stock during the respective period.

Note 4. Comprehensive Income

SFAS No. 130, Reporting Comprehensive Income, requires companies to classify items of other comprehensive income by their nature in the financial statements and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the stockholders equity section of the balance sheet. Our comprehensive income includes net income and unrealized gains and losses from foreign currency translation as follows (in thousands):



Three Months Ended September 30,

        

        Nine Months Ended September 30,2005

        

        2006

        

        2005

        

        2006Net income


      


      $


      4,027


      

        $


      2,465


      

        $


      10,065


      

        $


      6,066Other comprehensive income (loss):Currency translation adjustment, net of tax

        

        

        (187

        )

        

        (173)

        

        

        (733

        )

        

        502Comprehensive income

        

        $

        3,840

        

        $

        2,292

        

        $

        9,332

        

        $

        6,568


Note 5. Recent Pronouncements

In
  May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154,
  Accounting Changes and Error Corrections. SFAS No. 154 requires
  retroactive application to prior period financial statements of a voluntary
  change in accounting principle unless it is impracticable. SFAS No. 154 also
  requires that a change in method of depreciation, amortization, or depletion
  for long-lived, non-financial assets be accounted for as a change in accounting
  estimate that is affected by a change in accounting principle. SFAS No. 154
  replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3,
  Reporting Accounting Changes in Interim Financial Statements. SFAS
  No. 154 was effective for accounting changes and corrections of errors made
  in fiscal years beginning after December 15, 2005. The adoption of SFAS No.
  154 did not have any impact on our consolidated financial statements.

In
  September 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting
  for Uncertainty in Income Taxes, which becomes effective beginning with
  our first quarter 2007 fiscal period. This interpretation was issued to clarify
  the accounting for uncertainty in income taxes recognized in the financial statements
  and prescribes a recognition threshold and measurement attribute for the financial
  statement recognition and measurement of a tax position taken or expected to
  be taken in a tax return. We are currently evaluating the potential impact of
  this interpretation.

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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for reporting fair value and expands disclosures about fair value measurements. SFAS No. 157 becomes effective beginning with our first quarter 2008 fiscal period. We are currently evaluating the potential impact of this standard.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 is effective as of the end of our 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to beginning retained earnings as of January 1, 2006 for errors that were not previously deemed material. We do not expect the adoption of SAB 108 to have a material impact on our financial condition or results of operations.

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Note 6. Operating Segments / Geographic Information

We consider our operations to consist of one segment as this represents managements view of our operations. We operate on a worldwide basis with two locations in the United States and one location in the United Kingdom, which are categorized below as North America and Europe, respectively. The majority of our revenues are allocated based upon the profit split transfer pricing methodology. The 2005 information presented in the following tables has been adjusted to reflect the impact of the changes in transfer pricing, which we implemented in the third quarter of 2005, as if the changes were in effect as of January 1, 2005.

Geographic information is as follows (in thousands of dollars):



Three
          Months EndedSeptember 30,
          2005NorthAmerica


      

        Europe


      

        TotalLicense revenues


      


      $


      1,009


      


      $


      


      


      $


      1,009Service revenues

        

        

        12,247

        

        

        2,790

        

        

        15,037Site support revenues

        

        

        3,670

        

        

        1,210

        

        

        4,880Net revenues from external customers

        

        $

        16,926

        

        $

        4,000

        

        $

        20,926Operating income

        

        $

        4,785

        

        $

        522

        

        $

        5,307Long-lived assets

        

        $

        17,844

        

        $

        9,237

        

        $

        27,081Identifiable assets

        

        $

        105,161

        

        $

        14,065

        

        $

        119,226




Three
          Months Ended September 30,
          2006NorthAmerica


      

        Europe


      

        TotalLicense revenues


      


      $


      602


      


      $


      


      


      $


      602Service revenues

        

        

        11,813

        

        

        2,680

        

        

        14,493Site support revenues

        

        

        5,304

        

        

        1,827

        

        

        7,131Net revenues from external customers

        

        $

        17,719

        

        $

        4,507

        

        $

        22,226Operating income

        

        $

        3,271

        

        $

        262

        

        $

        3,533Long-lived assets

        

        $

        21,361

        

        $

        8,363

        

        $

        29,724Identifiable assets

        

        $

        90,784

        

        $

        16,132

        

        $

        106,916




Nine
          Months Ended September 30, 2005NorthAmerica


      

        Europe


      

        TotalLicense revenues


      


      $


      4,418


      


      $


      


      


      $


      4,418Service revenues

        

        

        33,543

        

        

        8,641

        

        

        42,184Site support revenues

        

        

        10,951

        

        

        3,864

        

        

        14,815Net revenues from external customers

        

        $

        48,912

        

        $

        12,505

        

        $

        61,417Operating income

        

        $

        13,645

        

        $

        1,645

        

        $

        15,290Long-lived assets

        

        $

        17,844

        

        $

        9,237

        

        $

        27,081Identifiable assets

        

        $

        105,161

        

        $

        14,065

        

        $

        119,226




Nine
          Months Ended September 30, 2006NorthAmerica


      

        Europe


      

        TotalLicense revenues


      


      $


      2,336


      


      $


      


      


      $


      2,336Service revenues

        

        

        34,255

        

        

        7,785

        

        

        42,040Site support revenues


      


      


      16,391


      


      


      5,676


      


      


      22,067Net revenues from external customers

        

        $

        52,982

        

        $

        13,461

        

        $

        66,443Operating income

        

        $

        8,005

        

        $

        815

        

        $

        8,820Long-lived assets

        

        $

        21,361

        

        $

        8,363

        

        $

        29,724Identifiable assets

        

        $

        90,784

        

        $

        16,132

        

        $

        106,916


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

Cautionary Statement for Forward-Looking Information

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes to the consolidated financial statements appearing elsewhere in this Form 10-Q. The following discussion includes a number of forward-looking statements made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995 that reflect our current views with respect to future events and financial performance. We use words such as anticipate, believe, expect, intend and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. These forward-looking statements are subject to risks and uncertainties such as competitive factors, technology development, market demand and our ability to obtain new
contracts and accurately estimate net revenues due to uncertain regulatory guidance, variability in size, scope and duration of projects and internal issues at the sponsoring client. These and other risk factors have been further discussed in our Form 10-K for the year ended December 31, 2005. Such risks and uncertainties could cause actual results to differ materially from historical results or future predictions. Further information on potential factors that could affect our financial results can be found throughout this Form 10-Q and our other reports filed with the Securities and Exchange Commission.

Overview

We were founded in 1977 to provide Cardiac Safety services to evaluate the safety of new drugs. We provide technology and services that enable the pharmaceutical, biotechnology and medical device industries to collect, interpret and distribute cardiac safety and clinical data more efficiently. We are a market leader in providing centralized electrocardiographic (ECG) services (Cardiac Safety services or EXPeRT® ECG services) and a leading provider of technology and services that streamline the clinical trials process by enabling our clients to evolve from traditional, paper-based methods to electronic processing using our Clinical Data Management products and services.

Our solutions improve the accuracy, timeliness and efficiency of trial set-up, data collection from sites worldwide, data interpretation and new drug, biologic and device application submissions. We offer Cardiac Safety services, which are utilized by clinical trial sponsors and Clinical Research Organizations (CROs) during the conduct of clinical trials, including comprehensive Thorough QTc studies. Thorough QTc studies are typically of large volume and of short duration, with ECGs performed over a two- to six-month period. The Digital ECG Franchise program was designed to address the capacity demands for eRTs ECG services through partnerships with sponsors that desired dedicated resources within eRT to address specific levels of cardiac safety monitoring transactions. We have decided to discontinue the offering of the Digital ECG Franchise program as we feel we can
offer our clients a better value proposition in other ways in the current operating environment. We also offer site support which includes the rental and sale of cardiac safety equipment along with related supplies and freight. Additionally, we offer the licensing and, at the clients option, hosting of our proprietary Clinical Data Management software products and the provision of maintenance and consulting services in support of our proprietary Clinical Data Management software products. We offer the following products and services on a global basis:

EXPeRT®. EXPeRT® Cardiac Safety services provide for workflow-enabled cardiac safety data collection, interpretation and distribution of ECG data and images as well as for analysis and cardiologist interpretation of ECGs performed on research subjects in connection with our clients clinical trials. In addition, we establish rules for standardized, semi-automated and automated workflow management, allowing audit trail accounting and generating safety and operational metrics reports for sponsors and investigators. Also included in EXPeRT® Cardiac Safety services is FDA XML delivery, which provides for the delivery of ECGs in a format compliant with the United States Food and Drug Administrations XML standard for digital ECGs.

eRC.eResearch Community (eRC) is a central command and control portal that provides real-time information related to monitoring clinical trial activities, data quality and safety.

eDE.eData Entry (eDE) technology provides a comprehensive electronic data capture (EDC) system comprised of technology and consulting services formulated to deliver rapid time to benefit for electronic trial initiatives.

eResNet.The eResearch Network (eResNet) technology provides an integrated end-to-end clinical research solution that includes trials, data and safety management modules.

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Project Assurance/Implementation Assurance. We provide a full spectrum of consulting services for all of our products that augment the study management and implementation efforts of clients in support of their clinical research requirements.

Our
  license revenues consist of license fees for perpetual licenses and monthly
  and annual licenses. Our services revenues consist of Cardiac Safety services,
  technology consulting and training services and software maintenance services.
  Our site support revenues consist of cardiac safety equipment rentals and sales
  along with related supplies and freight.

We recognize software revenues in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Accordingly, we recognize up-front license fee revenues under the residual method when a formal agreement exists, delivery of the software and related documentation has occurred, collectability is probable and the license fee is fixed or determinable. We recognize monthly and annual license fee revenues over the term of the arrangement. Hosting service fees are recognized evenly over the term of service. Cardiac Safety services revenues consist of services that we provide on a fee for services basis and are recognized as the services are performed. Site support revenues are recognized at the time of sale or over the rental
period. We recognize revenues from software maintenance contracts on a straight-line basis over the term of the maintenance contract, which is typically twelve months. We provide consulting and training services on a time and materials basis and recognize revenues as we perform the services.

For arrangements with multiple deliverables where the fair value of each element is known, the revenue is allocated to each component based on the relative fair values of each element. For arrangements with multiple deliverables where the fair value of one or more delivered elements is not known, revenue is allocated to each component of the arrangement using the residual method provided that the fair value of all undelivered elements is known. Fair values for undelivered elements are based primarily upon stated renewal rates for future products or services.

Cost of licenses consists primarily of applications service provider (ASP) fees for those clients that choose hosting, the cost of producing compact disks and related documentation and royalties paid to third parties in connection with their contributions to our product development. Cost of services includes the cost of Cardiac Safety services and the cost of technology consulting, training and maintenance services. Cost of Cardiac Safety services consists primarily of direct costs related to our centralized Cardiac Safety services and includes wages, depreciation and other direct operating costs. Cost of technology consulting, training and maintenance services consists primarily of wages and other compensation-related costs, fees paid to outside consultants and other direct operating costs related to our consulting and client support functions. Cost of site support consists
primarily of wages and other compensation-related costs, cardiac safety equipment rent and depreciation, related supplies, cost of equipment sold, shipping expenses and other direct operating costs. Selling and marketing expenses consist primarily of wages and other compensation-related costs, travel expenses and advertising and promotional expenditures. General and administrative expenses consist primarily of wages and other compensation-related costs and direct costs for our finance, administrative, corporate information technology, legal and executive management functions, in addition to professional service fees and corporate insurance. Research and development expenses consist primarily of wages and other compensation-related costs paid to our product development staff, costs paid to outside consultants and direct costs associated with the development of our technology products.

We conduct our operations through offices in the United States and the United Kingdom. Our international net revenues represented approximately 20% and 20% of total net revenues for the nine months ended September 30, 2005 and 2006, respectively. The majority of our revenues are allocated among our geographic segments based upon the profit split transfer pricing methodology. The international net revenues as a percentage of total net revenues reflect the application of the change in transfer pricing methodology, which we implemented in the third quarter of 2005, as if the changes were in effect as of January 1, 2005.

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Results of Operations

Executive Overview

On
  November 8, 2006, we announced approximately $25 million in third quarter 2006
  signings, following our announcements of approximately $30 million to $40 million
  in signings in each of the prior four quarters. Historically, the third quarter
  is our weakest quarter for new bookings due to summer vacations in our key markets.
  This, coupled with the fact that last years quarter benefited disproportionately
  from pent up demand in Cardiac Safety backlog due to the FDA guidance issued
  earlier in 2005, created a challenging comparison that obscures the solid progress
  we made in the third quarter.

Due
     to the Companys results for the nine months ended September 30, 2006
  and the delays that the Company witnessed in clinical trial start dates for
  several
  trials, management reassessed prior full year 2006 guidance and provided an
  update on November 8, 2006. For the year ending December 31, 2006, the Company
  now anticipates that revenues will be approximately $85 million to $87 million
  and that earnings per diluted share will be $0.14 to $0.16. The guidance estimates
  for the year includes consideration of the anticipated impact of expenses associated
     with management changes, the settlement of a contract dispute and stock
     option expense under SFAS No. 123R; the impact of these items are approximately
     $0.08 per diluted share for the year ending December 31, 2006.

For fiscal year 2007, management expects revenue growth at a rate of approximately 20 percent over 2006 based upon the strength of contract signings over the past year and the prospects for continued growth of the Cardiac Safety business. The Company will provide more precise guidance on fiscal year 2007 in the January 2007 time frame.

On
  January 1, 2006, we adopted the provisions of SFAS No. 123 (revised 2004), Share-Based
  Payment (SFAS No. 123R), which requires that the costs resulting from
  all share-based payment transactions be recognized in the financial statements
  at their fair values. We adopted SFAS No. 123R using the modified prospective
  application method under which the provisions of SFAS No. 123R apply to new
  awards and to awards modified, repurchased or cancelled after the adoption date.
  Additionally, compensation cost for the portion of the awards for which the
  requisite service had not been rendered that were outstanding as of January
  1, 2006 is recognized in the Consolidated Statements of Operations over the
  remaining service period after such date based on the awards original
  estimate of fair value. The aggregate share-based compensation expense recorded
  in the Consolidated Statements of Operations for the nine months ended September
  30, 2006 under SFAS No. 123R was $2.3 million. We expect share-based compensation
  expense before income taxes to be approximately $0.5 million in the fourth quarter
  of 2006, although this amount may increase with the hiring of additional executives
  or a significant number of other additional employees. Such amounts may change
  as a result of additional grants, forfeitures, modifications in assumptions
  and other factors.

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The following table presents certain financial data as a percentage of total net revenues:



Three
          Months Ended September 30,
      
      Nine
          Months Ended September 30,2005
      
      2006
      
      2005
      
      2006Net
          revenues:Licenses
      
      4.8
      %
      2.7
      %
      7.2
      %
      3.5
      %Services
      
      71.9
      %
      65.2
      %
      68.7
      %
      63.3
      %Site
          support
      
      23.3
      %
      32.1
      %
      24.1
      %
      33.2
      %Total
          net revenues
      
      100.0
      %
      100.0
      %
      100.0
      %
      100.0
      %Costs
          of revenues:Cost
          of licenses
      
      0.4
      %
      0.3
      %
      0.5
      %
      0.3
      %Cost
          of services
      
      29.2
      %
      30.0
      %
      29.6
      %
      28.8
      %Cost
          of site support
      
      16.5
      %
      20.5
      %
      15.9
      %
      21.8
      %Total
          costs of revenues
      
      46.1
      %
      50.8
      %
      46.0
      %
      50.9
      %Gross
          margin
      
      53.9
      %
      49.2
      %
      54.0
      %
      49.1
      %Operating
          expenses:Selling
          and marketing
      
      10.5
      %
      11.1
      %
      10.8
      %
      13.1
      %General
          and administrative
      
      12.8
      %
      17.8
      %
      13.4
      %
      17.7
      %Research
          and development
      
      5.2
      %
      4.4
      %
      4.9
      %
      5.0
      %Total
          operating expenses
      
      28.5
      %
      33.3
      %
      29.1
      %
      35.8
      %Operating
          income
      
      25.4
      %
      15.9
      %
      24.9
      %
      13.3
      %Other
          income, net
      
      1.5
      %
      1.5
      %
      0.8
      %
      1.6
      %Income
          before income taxes
      
      26.9
      %
      17.4
      %
      25.7
      %
      14.9
      %Income
          tax provision
      
      7.7
      %
      6.3
      %
      9.3
      %
      5.8
      %Net
          income
      
      19.2
      %
      11.1
      %
      16.4
      %
      9.1
      %


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Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005.

The
  following table presents our consolidated statements of operations with product
  line detail (dollars in thousands):



Three Months Ended September 30,2005
      
      2006
      
      Increase (Decrease)Licenses:Net revenues
      
      $
      1,009
      
      $
      602
      
      $
      (407
      )
      (40.3
      %)Costs of revenues
      
      
      82
      
      
      75
      
      
      (7
      )
      (8.5
      %)Gross margin
      
      $
      927
      
      $
      527
      
      $
      (400
      )
      (43.1
      %)Services:Cardiac SafetyNet revenues
      
      $
      13,149
      
      $
      12,668
      
      $
      (481
      )
      (3.7
      %)Costs of revenues
      
      
      5,369
      
      
      5,913
      
      
      544
      
      10.1
      %Gross margin
      
      $
      7,780
      
      $
      6,755
      
      $
      (1,025
      )
      (13.2
      %)Technology consulting and trainingNet revenues
      
      $
      649
      
      $
      859
      
      $
      210
      
      32.4
      %Costs of revenues
      
      
      490
      
      
      502
      
      
      12
      
      2.4
      %Gross margin
      
      $
      159
      
      $
      357
      
      $
      198
      
      124.5
      %Software maintenanceNet revenues
      
      $
      1,239
      
      $
      966
      
      $
      (273
      )
      (22.0
      %)Costs of revenues
      
      
      249
      
      
      259
      
      
      10
      
      4.0
      %Gross margin
      
      $
      990
      
      $
      707
      
      $
      (283
      )
      (28.6
      %)Total servicesNet revenues
      
      $
      15,037
      
      $
      14,493
      
      $
      (544
      )
      (3.6
      %)Costs of revenues
      
      
      6,108
      
      
      6,674
      
      
      566
      
      9.3
      %Gross margin
      
      $
      8,929
      
      $
      7,819
      
      $
      (1,110
      )
      (12.4
      %)Site support:Net revenues
      
      $
      4,880
      
      $
      7,131
      
      $
      2,251
      
      46.1
      %Costs of revenues
      
      
      3,455
      
      
      4,548
      
      
      1,093
      
      31.6
      %Gross margin
      
      $
      1,425
      
      $
      2,583
      
      $
      1,158
      
      81.3
      %Total:Net revenues
      
      $
      20,926
      
      $
      22,226
      
      $
      1,300
      
      6.2
      %Costs of revenues
      
      
      9,645
      
      
      11,297
      
      
      1,652
      
      17.1
      %Gross margin
      
      
      11,281
      
      
      10,929
      
      
      (352
      )
      (3.1
      %)Operating expenses:Selling and marketing
      
      
      2,208
      
      
      2,471
      
      
      263
      
      11.9
      %General and administrative
      
      
      2,685
      
      
      3,945
      
      
      1,260
      
      46.9
      %Research and development
      
      
      1,081
      
      
      980
      
      
      (101
      )
      (9.3
      %)Total operating expenses
      
      
      5,974
      
      
      7,396
      
      
      1,422
      
      23.8
      %Operating income
      
      
      5,307
      
      
      3,533
      
      
      (1,774
      )
      (33.4
      %)Other income, net
      
      
      321
      
      
      339
      
      
      18
      
      5.6
      %Income before income taxes
      
      
      5,628
      
      
      3,872
      
      
      (1,756
      )
      (31.2
      %)Income tax provision
      
      
      1,601
      
      
      1,407
      
      
      (194
      )
      (12.1
      %)Net income
      
      $
      4,027
      
      $
      2,465
      
      $
      (1,562
      )
      (38.8
      %)


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The following table presents costs of revenues as a percentage of related net revenues and operating expenses as a percentage of total net revenues:



Three
          Months Ended September 30,
      
      Increase(Decrease)2005
      
      2006Cost
          of licenses
      
      8.1
      %
      12.5
      %
      4.4
      %Cost
          of services:Cardiac
          Safety
      
      40.8
      %
      46.7
      %
      5.9
      %Technology
          consulting and training
      
      75.5
      %
      58.4
      %
      (17.1
      %)Software
          maintenance
      
      20.1
      %
      26.8
      %
      6.7
      %Total
          cost of services
      
      40.6
      %
      46.0
      %
      5.4
      %Cost
          of site support
      
      70.8
      %
      63.8
      %
      (7.0
      %)Total
          costs of revenues
      
      46.1
      %
      50.8
      %
      4.7
      %Operating
          expenses:Selling
          and marketing
      
      10.5
      %
      11.1
      %
      0.6
      %General
          and administrative
      
      12.8
      %
      17.8
      %
      5.0
      %Research
          and development
      
      5.2
      %
      4.4
      %
      (0.8
      %)


License revenues decreased primarily due to a decline in the number of licenses sold.

The
  decrease in Cardiac Safety service revenues was primarily due to a decrease
  in average revenue per transaction. The decrease in average revenue per transaction
  was largely due to the impact of increased activity in semi-automated processing,
  which generally includes lower fees per transaction than other studies, as well
  as competitive pricing adjustments. A small decrease in the number of transactions
  also contributed to the decrease in Cardiac Safety service revenues. Partially
  offsetting this decrease was the recognition of the balance of deferred revenues
  of $1.2 million that remained upon the termination of a Digital ECG Franchise
  at the end of August 2006.

The
  increase in technology consulting and training revenues was primarily related
  to professional services performed in connection with a second quarter of 2006
  license sale as well as an increase in consulting revenue from Clinical Data
  Management clients related to protocol set-up work.

Software maintenance revenues decreased due to the cancellation of maintenance agreements in a prior period. The decline was partially offset by maintenance on several new software licenses sold after the third quarter of 2005.

Site
  support revenue increased primarily due to an increase in the number of cardiac
  safety equipment units sold in the third quarter of 2006 as compared to the
  third quarter of 2005. Our clients use cardiac safety equipment to perform cardiac
  safety procedures. The increase was also due to an increase in the rental of
  cardiac safety equipment in the third quarter of 2006 as compared to the third
  quarter of 2005.

The
  increase in the cost of Cardiac Safety services, both in absolute terms and
  as a percentage of Cardiac Safety revenues, was primarily due to unanticipated
  additional third-party service charges for services previously provided, stock
  option compensation expense in 2006 related to the initial application of SFAS
  No. 123R and increased labor costs. These increases were partially offset by
  a decrease in bonuses related to a bonus accrual in the third quarter of 2005
  while no bonus expense was booked in the third quarter of 2006.

The increase in the cost of site support was due primarily to an increase in the cost of sales of cardiac safety equipment and increased freight costs. The decrease in the cost of site support as a percentage of site support revenues was due to the sale of equipment with a lower net book value in 2006 as compared to 2005 and the fact that we achieved operating leverage on related fixed costs.

The increase in selling and marketing expenses, both in absolute terms and as a percentage of total net revenues, was primarily due to stock option compensation expense recognized in 2006 related to the initial application of SFAS No. 123R and increases in labor costs relating to new personnel. The increase was partially offset by a decrease in bonuses due to lower bookings against targets in 2006 as compared to 2005.

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The
  increase in general and administrative expenses, both in absolute terms and
  as a percentage of total net revenues, was due primarily to $0.9 million of
  stock option compensation expense and costs for severance associated with the
  former CEO and CFO. Costs also increased due to the timing of charitable contributions
  which were made in the third quarter of 2006 and the fourth quarter of 2005
  and increased personnel costs.

The
  decrease in research and development expenses, both in absolute terms and as
  a percentage of total net revenues, was due primarily to an increase in the
  portion of overall cost that was charged to the EXPeRT® 2 project, lower
  placement fees, bonuses and other operating costs.

Our
  effective tax rate was 28.4% and 36.3% for the three months ended September
  30, 2005 and 2006, respectively. We expect our effective tax rate for the fourth
  quarter of 2006 to be 39.5%. The tax rate for the three months ended September
  30, 2005 included a tax benefit of approximately $560,000 related to the recovery
  of prior year taxes and an adjustment to the year-to-date effective tax rate,
  primarily due to a change in our transfer pricing methodology. The tax rate
  for the three months ended September 30, 2006 included a tax benefit of approximately
  $82,000 related to the true-up of the 2005 tax provision to the 2005 tax return
  and an adjustment to the year-to-date effective tax rate, primarily due to a
  reforecast of tax-exempt interest.

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Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005.

The following table presents our consolidated statements of operations with product line detail (dollars in thousands):



Nine Months Ended September 30,2005


      

        2006


      

        Increase (Decrease)Licenses:Net revenues

        


      $


      4,418

        


      $


      2,336

        


      $


      (2,082

        )


      (47.1

        %)Costs of revenues

        

        

        319

        

        

        228

        

        

        (91

        )

        (28.5

        %)Gross margin

        

        $

        4,099

        

        $

        2,108

        

        $

        (1,991

        )

        (48.6

        %)Services:Cardiac SafetyNet revenues

        

        $

        36,881

        

        $

        37,030

        

        $

        149

        

        0.4

        %Costs of revenues

        

        

        15,970

        

        

        16,964

        

        

        994

        

        6.2

        %Gross margin

        

        $

        20,911

        

        $

        20,066

        

        $

        (845

        )

        (4.0

        %)Technology consulting and trainingNet revenues

        

        $

        1,696

        

        $

        2,003

        

        $

        307

        

        18.1

        %Costs of revenues

        

        

        1,408

        

        

        1,401

        

        

        (7

        )

        (0.5

        %)Gross margin

        

        $

        288

        

        $

        602

        

        $

        314

        

        109.0

        %Software maintenanceNet revenues

        

        $

        3,607

        

        $

        3,007

        

        $

        (600

        )

        (16.6

        %)Costs of revenues

        

        

        796

        

        

        765

        

        

        (31

        )

        (3.9

        %)Gross margin

        

        $

        2,811

        

        $

        2,242

        

        $

        (569

        )

        (20.2

        %)Total servicesNet revenues

        

        $

        42,184

        

        $

        42,040

        

        $

        (144

        )

        (0.3

        %)Costs of revenues

        

        

        18,174

        

        

        19,130

        

        

        956

        

        5.3

        %Gross margin

        

        $

        24,010

        

        $

        22,910

        

        $

        (1,100

        )

        (4.6

        %)Site support:Net revenues

        

        $

        14,815

        

        $

        22,067

        

        $

        7,252

        

        49.0

        %Costs of revenues

        

        

        9,786

        

        

        14,492

        

        

        4,706

        

        48.1

        %Gross margin

        

        $

        5,029

        

        $

        7,575

        

        $

        2,546

        

        50.6

        %TotalNet revenues

        

        $

        61,417

        

        $

        66,443

        

        $

        5,026

        

        8.2

        %Costs of revenues

        

        

        28,279

        

        

        33,850

        

        

        5,571

        

        19.7

        %Gross margin

        

        

        33,138

        

        

        32,593

        

        

        (545

        )

        (1.6

        %)Operating expenses:Selling and marketing

        

        

        6,653

        

        

        8,687

        

        

        2,034

        

        30.6

        %General and administrative

        

        

        8,220

        

        

        11,758

        

        

        3,538

        

        43.0

        %Research and development

        

        

        2,975

        

        

        3,328

        

        

        353

        

        11.9

        %Total operating expenses

        

        

        17,848

        

        

        23,773

        

        

        5,925

        

        33.2

        %Operating income

        

        

        15,290

        

        

        8,820

        

        

        (6,470

        )

        (42.3

        %)Other income, net

        

        

        486

        

        

        1,067

        

        

        581

        

        119.5

        %Income before income taxes

        

        

        15,776

        

        

        9,887

        

        

        (5,889

        )

        (37.3

        %)Income tax provision

        

        

        5,711

        

        

        3,821

        

        

        (1,890

        )

        (33.1

        %)Net income

        

        $

        10,065

        

        $

        6,066

        

        $

        (3,999

        )

        (39.7

        %)


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The following table presents costs of revenues as a percentage of related net revenues and operating expenses as a percentage of total net revenues:



Nine
          Months Ended September 30,
      
      Increase(Decrease)2005
      
      2006Cost
          of licenses
      
      7.2
      %
      9.8
      %
      2.6
      %Cost
          of services:Cardiac
          Safety
      
      43.3
      %
      45.8
      %
      2.5
      %Technology
          consulting and training
      
      83.0
      %
      69.9
      %
      (13.1
      %)Software
          maintenance
      
      22.1
      %
      25.4
      %
      3.3
      %Total
          cost of services
      
      43.1
      %
      45.5
      %
      2.4
      %Cost
          of site support
      
      66.1
      %
      65.7
      %
      (0.4
      %)Total
          costs of revenues
      
      46.0
      %
      50.9
      %
      4.9
      %Operating
          expenses:Selling
          and marketing
      
      10.8
      %
      13.1
      %
      2.3
      %General
          and administrative
      
      13.4
      %
      17.7
      %
      4.3
      %Research
          and development
      
      4.9
      %
      5.0
      %
      0.1
      %




License revenues decreased primarily due to a decline in the number of licenses sold, conversions of subscription licenses to perpetual licenses in 2005 and terminations of subscription licenses.

The increase in Cardiac Safety service revenues was primarily due to the recognition of $1.2 million of deferred revenues that remained upon the termination of a Digital ECG Franchise at the end of August 2006 and an increase in the number of transactions and associated fees which are a result of the increase in bookings starting in the third quarter of 2005. The impact of the increased transactions was partially offset by a decrease in average revenue per transaction. The decrease in average revenue per transaction was largely due to the impact of increased activity in semi-automated processing, which generally includes lower fees per transaction than other studies, as well as competitive pricing adjustments.

The
  increase in technology consulting and training revenues was primarily related
  to professional services performed in connection with a second quarter of 2006
  license sale as well as an increase in consulting revenue from Clinical Data
  Management clients related to protocol set-up work and consulting revenue from
  Cardiac Safety clients related to reporting capabilities.

Software maintenance revenues decreased due to the cancellation of maintenance agreements and the settlement of a contract dispute which resulted in our providing software maintenance at no charge for a four-year period beginning August 30, 2005. These declines were partially offset by maintenance on several new software licenses sold during 2005 and 2006.

Site
  support revenue increased primarily due to an increase in the number of cardiac
  safety equipment units sold in 2006 as compared to 2005. Our clients use cardiac
  safety equipment to perform cardiac safety procedures. The increase was also
  due to an increase in the rental of cardiac safety equipment in 2006 as compared
  to 2005.

The decrease in cost of licenses was primarily due to a reduction in third party ASP hosting fees. The increase in cost of licenses as a percentage of license revenues was due to the decrease in perpetual license revenues which have very little incremental cost of sales, such that revenue reductions lead to minimal cost savings.

The increase in the cost of Cardiac Safety services, both in absolute terms and as a percentage of Cardiac Safety revenues, was primarily due to unanticipated additional third-party service charges for services previously provided, stock option compensation expense in 2006 related to the initial application of SFAS No. 123R, increased labor costs including payroll taxes related to option exercises, increased facilities costs due to a rent increase associated with a lease extension and increased software maintenance costs. These increases were partially offset by the initial costs associated with a move to a new facility in the UK in 2005, a decrease in bonuses related to a bonus accrual in the third quarter of 2005 while no bonus expense was booked in the third quarter of 2006 and lower depreciation resulting from a one-time adjustment in 2005 related to leasehold improvements.
The increase in the cost of Cardiac Safety services as a percentage of Cardiac Safety service revenues was also due to the fact that some of the costs do not necessarily change in direct relation with changes in revenue.

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The increase in the cost of site support was due primarily to an increase in the cost of sales of equipment and depreciation costs associated with cardiac safety rental equipment as well as increased freight costs. The decrease in the cost of site support as a percentage of site support revenues was due to the sale of equipment with a lower net book value in 2006 as compared to 2005 and the fact that we achieved operating leverage on related fixed costs.

The
  increase in selling and marketing expenses, both in absolute terms and as a
  percentage of total net revenues, was primarily due to increases in compensation
  expenses, predominately salaries relating to new personnel and bonuses relating
  to increased bookings, as well as stock option compensation expense recognized
  in 2006 related to the initial application of SFAS No. 123R and higher tradeshow
  costs.

The
  increase in general and administrative expenses, both in absolute terms and
  as a percentage of total net revenues, was due primarily to $3.5 million of
  costs associated with the settlement of a contract dispute, stock option compensation
  expense and costs for severance associated with the former CEO and CFO. In addition,
  cost increases for compensation and depreciation are offset by decreases due
  to a reduction in the cost of consultants related to internal control work required
  by the Sarbanes-Oxley Act and certain non-income taxes.

The
     increase in research and development expenses, both in absolute terms and
    as
  a percentage of total net revenues, was due primarily to added costs of personnel
     associated with increased effort for various research and development projects

  partially offset by an increase in the portion of overall cost that was capitalized
    as part of the EXPeRT® 2 project, lower placement fees, bonuses and other
    operating  costs. Research and development expenses as a percentage of net
    revenues also
  increased due to the fact that many of the research and development expenses
     do not necessarily change in direct relation with changes in revenues.

Other income, net, consisted primarily of interest income realized from our cash, cash equivalents and investments, net of an impairment charge related to a cost basis investment in 2005, interest expense related to capital lease obligations and foreign exchange losses. Other income, net increased for the first nine months of 2006, primarily due to an impairment charge recognized in 2005, a reduction in foreign exchange losses and increased interest income.

Our effective tax rate was 36.2% and 38.6% for the nine months ended September 30, 2005 and 2006, respectively. We expect our effective tax rate for the fourth quarter of 2006 to be 39.5%. The tax rate for the nine months ended September 30, 2005 included a tax benefit of approximately $560,000 related to the recovery of prior year taxes primarily due to a change in our transfer pricing methodology. The tax rate for the nine months ended September 30, 2006 included a tax benefit of approximately $82,000 related to the true-up of the 2005 tax provision to the 2005 tax return.

Liquidity and Capital Resources

At
    September 30, 2006, we had $13.3 million of cash and cash equivalents and
    $40.1 million invested in short-term and long-term investments. We generally
    place our investments in money market funds, municipal securities, bonds
    of government sponsored agencies, certificates of deposit with fixed rates
    with maturities of less than one year and A1P1 rated commercial bonds and
    paper.

For
  the nine months ended September 30, 2006, our operations provided cash of $9.0
  million compared to $22.7 million during the nine months ended September 30,
  2005. The change was primarily the result of a decrease of $8.7 million in deferred
  revenues in the nine months ended September 30, 2006 compared to an increase
  of $0.5 million in the nine months ended September 30, 2005. In the 2006 period,
  the decrease in deferred revenues was primarily due to the excess of Digital
  ECG Franchise revenue recognized over Digital ECG Franchise payments received.
  Additionally, an increase in prepaid income taxes used $2.5 million of cash in 2006
  and accounts receivable provided $2.9 million of cash in 2005 but less than
  $0.1 million in 2006. Net income decreased by $4.0 million but the impact was
  partially offset by an increase of $3.2 million in the non-cash impact of the cost of sales of equipment.

For the nine months ended September 30, 2006, our investing activities used cash of $15.7 million compared to $21.9 million during the nine months ended September 30, 2005. The change was primarily the result of net activity related to investments, which used $3.5 million of cash for the nine months ended September 30, 2006, compared to $11.0 million for the nine months ended September 30, 2005. Additionally, there was a $1.4 million increase in cash used for purchases of property and equipment for the nine months ended September 30, 2006.

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Included in property and equipment is internal use software associated with the development of a data and communications management services software product (EXPeRT®) used in connection with our centralized core Cardiac Safety ECG services. We capitalize certain internal use software costs in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The amortization is charged to the cost of Cardiac Safety services beginning at the time the software is ready for its intended use. The initial development costs of EXPeRT® were for the basic functionality required for this product. Additional development costs of EXPeRT® were incurred to develop new functionalities and enhancements. We started a new internal use software
project to allow for semi-automated processing of ECGs in the second quarter of 2003 and further enhancements were begun in October 2004 and completed in April 2005. We also began capitalizing costs associated with an upgrade to EXPeRT® (EXPeRT® 2) beginning in the fourth quarter of 2003. In April 2005, we began developing enhancements to EXPeRT® which are necessary while EXPeRT® 2 continues to be developed.

At
  the beginning of April 2005, we extended the amortization period for EXPeRT®
  through July 2006, which coincides with our standard useful life for internal
  use software of four years. We had previously reduced the depreciation period
  when it appeared that EXPeRT® would be retired early, which has not been
  the case. The extension of the amortization period resulted in a decrease in
  monthly amortization expense of $32,000 beginning in April 2005.

In the first quarter of 2006, we began development of a data warehouse that enables centralized capture of cardiac safety data and the ability to integrate with the Food and Drug Administrations ECG data warehouse. At this time, we expect EXPeRT® 2 and the data warehouse to go into production in the first half of 2007.

The following table presents the internal use software costs and related amortization as of September 30, 2006 (in thousands):





Amortization
          Period
      
      Labor
          andConsulting
      
      RelatedDirect Costsof Materials
      
      TotalCapitalizedCosts
      
      MonthlyAmortization
      
      AccumulatedAmortizationEXPeRT®Initial
          costs
      
      August
          2002 -July 2006
      
      $
      2,618
      
      $
      1,413
      
      $
      4,031
      
      $
      
      
      $
      4,031Additional
          costs
      
      April
          2003 -July 2006
      
      
      1,003
      
      
      50
      
      
      1,053
      
      
      
      
      
      1,047Additional
          enhancements
      
      October
          2005 -September 2007
      
      
      463
      
      
      
      
      
      463
      
      
      20
      
      
      231Semi-automated
          ECG processing softwareInitial
          costs
      
      February
          2004 -January 2008
      
      
      449
      
      
      361
      
      
      810
      
      
      17
      
      
      540Enhancements
      
      October
          2004 -September 2008
      
      
      380
      
      
      
      
      
      380
      
      
      8
      
      
      190Additional
          enhancements
      
      April
          2005 -March 2009
      
      
      376
      
      
      
      
      
      376
      
      
      8
      
      
      141EXPeRT®
          2
      
      To
          be determined
      
      
      8,529
      
      
      1,139
      
      
      9,668
      
      
      
      
      
      Data
          warehouse
      
      To
          be determined
      
      
      515
      
      
      
      
      
      515
      
      
      
      
      
      Total
      
      
      
      $
      14,333
      
      $
      2,963
      
      $
      17,296
      
      $
      53
      
      $
      6,180


For
  the nine months ended September 30, 2006, our financing activities provided
  cash of $1.3 million compared to a use of cash of $8.5 million for the nine
  months ended September 30, 2005. The change was primarily the result of the
  purchase of $5.8 million of common stock under our stock buy-back program in
  the first quarter of 2006 compared to $9.4 million during the nine months ended
  September 30, 2005. There was no purchase under the stock buy-back program in
  the second or third quarter of 2006. There was also a $2.5 million increase in
  proceeds from the exercise of stock options during the nine months ended September
  30, 2006 compared to the nine months ended September 30, 2005. Additionally,
  excess tax benefit related to stock options of $3.7 million was included in
  financing activities in 2006 in accordance with SFAS No. 123R.

We have a line of credit arrangement with Wachovia Bank, National Association totaling $3.0 million. To date, we have not borrowed any amounts under our line of credit. As of September 30, 2006, we had outstanding letters of credit of $0.5 million, which reduced our available borrowings under the line of credit to $2.5 million.

We have a commitment to purchase approximately $5.0 million of private label cardiac safety equipment from a manufacturer over the twelve-month period ending in July 2007. This cardiac safety equipment is expected to be purchased in the normal course of business and thus does not represent a significant commitment above our expected purchases of ECG equipment during that period.

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We expect that existing cash and cash equivalents, short-term investments and cash flows from operations will be sufficient to meet our foreseeable cash needs for at least the next year. However, there may be acquisition and other growth opportunities that require additional external financing and we may from time to time seek to obtain additional funds from the public or private issuances of equity or debt securities. There can be no assurance that any such acquisitions will occur or that such financings will be available or available on terms acceptable to us.

In the second quarter of 2005, the stock buy-back program that was originally announced in April 2004 and extended to 2,500,000 shares in October 2004 was extended by an additional 10,000,000 shares to a total of 12,500,000 shares. The purchase of the remaining shares authorized could require us to use a significant portion of our cash, cash equivalents and short-term and long-term investments and could also require us to seek additional external financing. The stock buy-back authorization allows us, but does not require us, to purchase the authorized shares. During the nine months ended September 30, 2006, we purchased 400,000 shares of our common stock at a cost of $5.8 million, all of which were purchased in the three months ended March 31, 2006.

Inflation

We believe the effects of inflation and changing prices generally do not have a material adverse effect on our results of operations or financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary financial market risks include fluctuations in interest rates and currency exchange rates.

Interest Rate Risk

We generally place our investments in money market funds, municipal securities, bonds of government sponsored agencies, certificates of deposit with fixed rates with maturities of less than one year and A1P1 rated commercial bonds and paper. We actively manage our portfolio of cash equivalents and short-term investments, but in order to ensure liquidity, will only invest in instruments with high credit quality where a secondary market exists. We have not held and do not hold any derivatives related to our interest rate exposure. Due to the average maturity and conservative nature of our investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio. Management estimates that had the average yield of our investments decreased by 100 basis points, our interest income for the nine months ended September 30, 2006 would have
decreased by approximately $0.4 million. This estimate assumes that the decrease occurred on the first day of 2006 and reduced the yield of each investment by 100 basis points. The impact on interest income of future changes in investment yields will depend largely on the gross amount of our cash, cash equivalents and short-term investments. See Liquidity and Capital Resources within Managements Discussion and Analysis of Financial Condition and Results of Operations.

Foreign Currency Risk

We operate on a global basis from locations in the United States (U.S.) and the United Kingdom (UK). All international net revenues are billed and expenses incurred in either U.S. dollars or pounds sterling. As such, we face exposure to adverse movements in the exchange rate of the pound sterling. As the currency rate changes, translation of the statement of operations of our UK subsidiary from the local currency to U.S. dollars affects year-to-year comparability of operating results. We do not hedge translation risks because any cash flows from UK operations are generally reinvested in the UK. Management estimates that a 10% change in the exchange rate of the pound sterling would have impacted the reported operating income for the nine months ended September 30, 2006 by approximately $80,000.

Item 4. Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended, as of September 30, 2006. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company (including our consolidated subsidiaries) in our periodic filings with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time periods specified in the Commissions rules and forms. There has been no change in our internal control over financial reporting during the quarter ended
September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II. Other Information

Item
          6.

        Exhibits




10.30


      Promissory Note to Wachovia Bank, National Association.10.31

        Loan Agreement with Wachovia Bank, National Association.31.1

        Certification of Chief Executive Officer.31.2

        Certification of Chief Financial Officer.32.1

        Statement of Chief Executive Officer Pursuant to Section 1350 of Title 18 of the United States Code.32.2

        Statement of Chief Financial Officer Pursuant to Section 1350 of Title 18 of the United States Code.


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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.



eResearchTechnology, Inc.

(Registrant)Date: November 9, 2006

        

        By:

        /s/ Michael J. McKelveyMichael J. McKelvey

        President
          and Chief Executive Officer, 
          Director (Principal executive officer)




Date:
          November 9, 2006
      
      By:
      /s/
          Richard A. BaronRichard
          A. Baron
        Executive
          Vice President and Chief Financial Officer (Principal financial and
          accounting officer)


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EXHIBIT INDEX



Exhibit No.


      


      Exhibit10.30


      

        Promissory Note to Wachovia Bank, National Association.10.31

        

        Loan Agreement with Wachovia Bank, National Association.31.1

        

        Certification of Chief Executive Officer.31.2

        

        Certification of Chief Financial Officer.32.1

        

        Statement of Chief Executive Officer Pursuant to Section 1350 of Title 18 of the United States Code.32.2

        

        Statement of Chief Financial Officer Pursuant to Section 1350 of Title 18 of the United States Code.


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