You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited condensed financial statements and related notes appearing elsewhere herein.

This discussion and analysis contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified generally by the use of forward-looking terminology and words such as "expects," "anticipates," "estimates," "believes," "predicts," "intends," "plans," "potential," "may," "continue," "should," "will" and words of comparable meaning. Without limiting the generality of the preceding statement, all statements in this report relating to estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and future financial results are forward-looking statements. We caution investors that any such forward-looking statements are only predictions and are not guarantees of future performance. Certain risks, uncertainties and other factors may cause actual results to differ materially from those projected in the forward-looking statements. Such factors may include:

• overall business and economic conditions affecting the healthcare industry;

• saturation of our target market and hospital consolidations;

• changes in customer purchasing priorities, capital expenditures and demand for information technology systems;

• competition with companies that have greater financial, technical and marketing resources than we have;

• failure to develop new technology and products in response to market demands;

• fluctuations in quarterly financial performance due to, among other factors, timing of customer installations;

• failure of our products to function properly resulting in claims for medical losses;

• government regulation of our products and customers, including changes in healthcare policy affecting Medicare reimbursement rates and qualifying technological standards;

• changes in accounting principles generally accepted in the United States of America;

• general economic conditions, including changes in the financial markets that may affect the availability and cost of credit to us or our customers; and

• interruptions in our power supply and/or telecommunications capabilities.

Additional information concerning these and other factors which could cause differences between forward-looking statements and future actual results is discussed under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission.

Background

CPSI was founded in 1979 and specializes in delivering comprehensive healthcare information systems and related services to community hospitals and other healthcare providers. Our systems and services are designed to support the primary functional areas of a hospital and to enhance access to needed financial and clinical information. We sell a fully integrated, enterprise-wide financial and clinical hospital information system comprised of all necessary software, hardware, peripherals, forms and office supplies, together with comprehensive support and maintenance services. We also offer business management services, including electronic billing submissions, patient statement processing and accounts receivable management, as part of our overall information system solution, enabling our customers to outsource certain data-related business processes which we can perform more efficiently. Our products and services provide solutions and enhance hospital performance in key areas, including patient management, financial and revenue cycle management, clinical care, cost control and regulatory compliance and clinical, enterprise and office automation, which improve clinical, financial and administrative outcomes for our customers.

Our target market includes acute care community hospitals with 300 or fewer beds and small specialty hospitals. Hospitals having 100 or fewer acute care beds comprise approximately 94% of our customers. In addition to servicing small-to-medium-sized hospitals, we provide technology services to other related entities in the healthcare industry, such as nursing homes, home health agencies and physician clinics. From our initial hospital installation in 1981, we have grown to serve more than 650 hospital customers across 47 states and the District of Columbia.

Management Overview

We primarily seek revenue growth through sales of healthcare information technology systems and related services to existing and new customers within our historic target market. Our strategy has produced consistent revenue growth over the long-term, as reflected in five- and ten-year compounded annual growth rates in revenues of approximately 8.0% and 14.1%, respectively. Selling new and additional products and services back into our existing customer base is an important part of CPSI's future revenue growth. We believe that as our customer base grows, the demand for additional products and services, including business management services, will also continue to grow, supporting further increases in recurring revenues. We also expect to drive revenue growth from new product development that we may generate from our research and development activities.

In addition to revenue growth, our business model is focused on earnings growth. Once a hospital has installed our system, we continue to provide support and maintenance services to our customers on an ongoing basis. These services are typically provided by the same personnel who perform our system installations but at a reduced cost to us, and therefore at an increased gross margin. We also periodically look to increase margins through cost containment measures where appropriate.

During the current economic recession, hospitals have experienced reduced availability of third party credit and an overall reduction in their investment portfolios. In addition, healthcare organizations with a large dependency on Medicaid populations, such as community based hospitals, have been impacted by the challenging financial condition of many state governments and government programs. Accordingly, we recognize that prospective hospital customers often do not have the necessary capital to make investments in information technology. Additionally, in response to these challenges, hospitals have become more selective regarding where they invest capital, resulting in a focus on strategic spending that generates a return on their investment. Despite the current economic environment, we believe healthcare information technology is often viewed as more strategic to hospitals than other possible purchases because the technology offers the possibility of a quick return on investment. Information technology also plays an important role in healthcare by improving safety, efficiency and reducing cost. Additionally, we believe most hospitals recognize that they must invest in healthcare information technology to meet current and future regulatory, compliance and government reimbursement requirements.

We have experienced an increase in customers seeking financing arrangements from us over the past twenty-four months for system installations as a result of current economic conditions and disruptions in the credit markets. Historically, we have made financing arrangements available to customers on a case-by-case basis depending upon various aspects of the proposed contract and customer attributes. These financing arrangements include short-term payment plans, longer-term lease financing through us and our facilitating third-party financing arrangements. We intend to continue to work with prospective customers to provide for financing arrangements to purchase our systems so long as such arrangements do not adversely affect our financial position and liquidity. We believe that meeting the financial needs of community-based hospitals while allowing for the profitable expansion of our footprint in this market will remain both an opportunity and a challenge for us in the foreseeable future.

Despite the economic upheaval, including the credit crisis, we have not experienced a considerable decline in demand for our products and services, nor have we experienced any significant increase in defaults from our customers. We hope this trend continues through the remainder of 2009, but we realize that, should the general economy continue to decline, a reversal of this trend could develop.

American Recovery and Reinvestment Act of 2009

While the current economic recession and credit crisis has impacted and could continue to impact the community hospitals that comprise our target market, we believe that the American Recovery and Reinvestment Act of 2009 (the "ARRA"), which became law on February 17, 2009, will increase demand for healthcare information technology and will have a positive impact on our business prospects. The ARRA includes more than $19 billion in funding to aid healthcare organizations in modernizing their operations through the acquisition and wide-spread use of healthcare information technology. Included in the funding is approximately $17.2 billion in incentives through Medicare and Medicaid reimbursement systems to encourage and assist healthcare providers in adopting and using electronic health records ("EHRs"). These incentive payments are set to begin as early as 2010 and last through 2015. If an eligible healthcare provider does not begin to demonstrate meaningful use of EHRs by 2015, then reimbursement under Medicare will begin to be reduced.

While many elements of the ARRA are still unclear or undefined, we are focused on ensuring that we take the necessary steps now to meet the needs of community hospitals to help them gain access to those incentives. Primary among those steps is ensuring that our technology meets the ARRA's EHR certification requirements. The initial set of certification requirements is expected to be promulgated for comment by the Secretary of Health and Human Services before December 31, 2009, with draft recommendations having been issued by the Meaningful Use Workgroup of the HIT Policy Committee under authority of the Office of the National Coordinator for Health Information Technology, Department of Health and Human Services on June 16, 2009. In this regard, we created our new Product Development Division earlier this year to help ensure that our technology remains on the leading edge of the development curve and can react quickly and effectively to any technical requirements that arise under the ARRA. We have also hired over 100 new employees so far this year so that we have a sufficient number of adequately trained and technically proficient support staff in place when our existing customers and any prospective hospital customers proceed to implement EHRs.

While we do not expect an immediate increase in revenue from the healthcare information technology provisions of the ARRA, we believe that the longer-term potential could be significant. The ARRA is expected to provide states with badly needed Medicaid dollars, which should help improve the financial health of hospitals and incentivize them to make investments in information technology. Additionally, we expect that community hospitals, which rely more heavily on Medicare and Medicaid to fund their operations than larger hospitals, will be seeking to invest in any information technology applications that will increase their Medicaid funding. We believe that our footprint among community hospitals positions us well to benefit from these incentives.

Health Care Reform

Each of the U.S. Senate and House of Representatives is soon expected to approve a bill providing for the reform of the U.S. healthcare and health insurance industries and it appears increasingly likely that some form of healthcare and health insurance reform may be enacted within the next six months. It is still too early for us to determine whether and to what extent the ultimate legislation will effect the healthcare information technology industry as well as our current and any potential future customers.

Results of Operations

In the nine months ended September 30, 2009, we generated revenues of $94.0 million from the sale of our products and services, as compared to $87.6 million in the nine months ended September 30, 2008, an increase of 7.3%. We installed our financial and patient accounting system in 22 new hospitals in the first nine months of 2009 compared to 18 in the first nine months of 2008. Our net income for the nine months ended September 30, 2009 increased 9.4% from the first nine months of 2008, principally as a result of the increase in sales. Cash flow from operations decreased 50.3% from the first nine months of 2008 primarily due to an increase in financing receivables and accounts receivable. While our operating cash flows did decline during the first nine months of 2009 compared to the first nine months of 2008, we have maintained a strong cash position sufficient to meet our operating requirements and continue our dividends at historical levels. We believe that a strong cash position enables us to compete better in the marketplace and maintain the quality of our customer service and product offerings.

The following table sets forth certain items included in our results of operations for the three and nine months ended September 30, 2009 and 2008, expressed as a percentage of our total revenues for these periods (dollar amounts in thousands):

                                         Three Months Ended September 30,                Nine Months Ended September 30,
                                           2009                    2008                    2009                    2008
                                     Amount    % Sales       Amount    % Sales       Amount    % Sales       Amount    % Sales
INCOME DATA:
Sales revenues:
System sales                        $ 11,578      35.1 %    $ 10,742      35.4 %    $ 30,916      32.9 %    $ 29,856      34.1 %
Support and maintenance               13,957      42.3 %      13,398      44.1 %      41,611      44.3 %      39,617      45.2 %
Business management services           7,473      22.6 %       6,213      20.5 %      21,464      22.8 %      18,149      20.7 %

Total sales revenues                  33,008     100.0 %      30,353     100.0 %      93,991     100.0 %      87,622     100.0 %
Costs of sales:
System sales                           9,428      28.6 %       8,675      28.6 %      25,716      27.4 %      23,792      27.2 %
Support and maintenance                5,595      17.0 %       4,862      16.0 %      15,916      16.9 %      14,432      16.5 %
Business management services           4,372      13.2 %       3,522      11.6 %      12,612      13.4 %      10,747      12.3 %

Total costs of sales                  19,395      58.8 %      17,059      56.2 %      54,244      57.7 %      48,971      55.9 %

Gross profit                          13,613      41.2 %      13,294      43.8 %      39,747      42.3 %      38,651      44.1 %
Operating expenses:
Sales and marketing                    2,297       7.0 %       2,175       7.2 %       6,625       7.0 %       6,564       7.5 %
General and administrative             5,211      15.8 %       4,986      16.4 %      15,393      16.4 %      15,747      18.0 %

Total operating expenses               7,508      22.7 %       7,161      23.5 %      22,018      23.4 %      22,311      25.5 %

Operating income                       6,105      18.5 %       6,133      20.2 %      17,729      18.9 %      16,340      18.6 %
Other income:
Interest income                          219       0.7 %         244       0.8 %         690       0.7 %         740       0.8 %

Total other income                       219       0.7 %         244       0.8 %         690       0.7 %         740       0.8 %

Income before taxes                    6,324      19.2 %       6,377      21.0 %      18,419      19.6 %      17,080      19.5 %
Income taxes                           2,303       7.0 %       2,284       7.5 %       6,832       7.3 %       6,489       7.4 %

Net Income                          $  4,021      12.2 %    $  4,093      13.5 %    $ 11,587      12.3 %    $ 10,591      12.1 %

Three Months Ended September 30, 2009 Compared with Three Months Ended September 30, 2008

Revenues. Total revenues for the three months ended September 30, 2009 increased 8.7%, or $2.7 million, compared to the three months ended September 30, 2008. There were no significant changes in the makeup or mix of our revenue streams during the third quarter of 2009.

System sales revenues increased by 7.8%, or $0.8 million, for the comparative three month periods. We installed our core system at 11 new hospital clients in the third quarter of 2009 compared to 7 in the third quarter of 2008. Sales to existing customers accounted for 63.2% of our system sales revenue for the third quarter of 2009 compared to 61.9% for the third quarter of 2008.

Support and maintenance revenues increased by 4.2%, or $0.6 million, for the comparative three month periods. This increase was attributable to an increase in recurring revenues as a result of a larger customer base and an increase in support fees for add-on business sold to existing customers.

Business management services revenues increased by 20.3%, or $1.3 million, for the comparative three month periods. We experienced an increase in business management services revenues as a result of continued growth in existing customer demand for electronic billing and accounts receivable management services. We were providing full business office management services to 26 customers at September 30, 2009, compared to 21 customers at September 30, 2008. We opened a new business management services office in Monroe, Louisiana toward the end of the second quarter of 2009. We expect the new office to be fully operational by the end of the year.

Costs of Sales. Total costs of sales increased by 13.7%, or $2.3 million, for the comparative three month periods. As a percentage of total revenues, costs of sales increased 260 basis points to 58.8% from 56.2%.

Cost of system sales increased by 8.7%, or $0.8 million, for the comparative three month periods. Gross margin on system sales fell to 18.6% in the third quarter from 19.2% in the same quarter of the prior year. Payroll and related costs increased by 19.7%, or $0.8 million, for the comparative three month periods. This increase is primarily due to salary costs of additional support personnel hired during 2009 in anticipation of an increase in future installations stemming from electronic medical record requirements contained in the American Recovery and Reinvestment Act of 2009 (the "ARRA"). The training curve of a newly hired employee is generally 6 to 12 months and may depress gross margins on system sales in the short term. Travel and related costs increased 9.4%, or $0.2 million, as a result of increases in airline rates and more labor intensive clinical installations compared to the same quarter of the prior year.

Cost of support and maintenance increased by 15.1%, or $0.7 million, for the comparative three month periods. The gross margin on support and maintenance revenues decreased to 59.9% from 63.7% in the same quarter of the prior year. The decrease in gross margin was due to a 19.4%, or $0.8 million, increase in payroll and related costs due to the addition of the new personnel during 2009.

Our costs associated with business management services increased by 24.1%, or $0.9 million, for the comparative three month periods. This increase was caused by an increase in temporary labor as we move to utilizing temporary labor agencies for all new business management services employees due to historically high turnover costs. Temporary labor accounted for 20.6% of total labor and related costs for the third quarter of 2009 as compared to 7.4% during the third quarter of 2008. We expect this transition to contract labor services to improve costs, margins and efficiencies in the long term. We also incurred additional temporary labor and other costs in opening the new office in Monroe, Louisiana during the second quarter of 2009. The gross margin on business management services decreased to 41.5% from 43.5% in the same quarter of the prior year. Postage costs also increased $0.2 million for the comparative three month periods due to a $0.02 postage rate increase in May 2009.

Sales and Marketing Expenses. Sales and marketing expenses increased by 5.6%, or $0.1 million, for the comparative three month periods. The increase is attributable to a $0.2 million increase in salary and commission expense offset by a slight decrease in other marketing expenses.

General and Administrative Expenses. General and administrative expenses increased by 4.5%, or $0.2 million, for the comparative three month periods. This increase was attributable to a $0.4 million increase in bad debt expense as the result of an increased accounts receivable balance at the end of the quarter ended September 30, 2009 compared to the quarter ended September 30, 2008. This increase was partially offset by a $0.2 million decrease in costs related to our national user group conference which will be incurred in the fourth quarter of 2009 compared to the third quarter of 2008. The Company has reserved a set percentage of its entire accounts receivable balance as uncollectible on a consistent basis since becoming public in 2002, and will reserve specific accounts as uncollectible when any type of legal reorganization is filed by a customer. As such, bad debt expense will fluctuate with the accounts receivable balance and is not necessarily indicative of customer collection status.

As a percentage of total revenues, sales and marketing expenses, and general and administrative expenses decreased to 22.7% for the three months ended September 30, 2009 from 23.5% for the three months ended September 30, 2008.

Net Income. Net income for the three months ended September 30, 2009 decreased slightly, by 0.2%, or $0.1 million, to $4.0 million, or $0.37 per diluted share, as compared with net income of $4.1 million, or $0.38 per diluted share, for the three months ended September 30, 2008. Net income represented 12.2% of revenue for the three months ended September 30, 2009, as compared to 13.5% of revenue for the three months ended September 30, 2008.

Nine Months Ended September 30, 2009 Compared with Nine Months Ended September 30, 2008

Revenues. Total revenues for the nine months ended September 30, 2009 increased by 7.3%, or $6.4 million, compared to the nine months ended September 30, 2008.

System sales revenues increased by 3.6%, or $1.1 million, for the comparative nine month periods. However, system sales further increased in the third quarter of 2009 as the result of an increased interest by community hospitals in implementing electronic health record systems in order to qualify for incentives offered under the ARRA. While many hospitals are delaying installation of EHR systems until final requirements are promulgated, we are aggressively recommending to hospitals that they begin the installation of an EHR system early in order to avoid any delays that may result if they defer the installation. Sales to existing customers accounted for 62% of system sales revenue for the first nine months of 2009 compared to 64.4% for the first nine months of 2008.

Support and maintenance revenues increased by 5.0%, or $2.0 million, for the comparative nine month periods. This increase was attributable to an increase in recurring revenues as a result of a larger customer base and increased sales of add-on business to existing customers.

Business management services revenues increased by 18.3%, or $3.3 million, for the comparative nine month periods. We experienced an increase in business management services revenues as a result of continued growth in existing customer demand for electronic billing and accounts receivable management services.

Costs of Sales. Total costs of sales increased by 10.8%, or $5.3 million, for the comparative nine month periods. As a percentage of total revenues, costs of sales increased 180 basis points to 57.7% from 55.9%.

Cost of system sales increased by 8.1%, or $1.9 million, for the comparative nine month periods. Payroll and related costs increased by 13.9%, or $1.7 million, due to the addition of new personnel as described previously. Travel and related costs have increased by 6.3%, or $0.3 million, due to increased airline rates and more labor intensive clinical system installations during 2009 compared to 2008. All other system sales costs remained relatively in-line as a percentage of sales.

Cost of support and maintenance increased by 10.3%, or $1.5 million, for the comparative nine month periods. The gross margin on support and maintenance revenues decreased to 61.8% compared to 63.6% for the same nine month period in 2008. The decrease in gross margin was primarily due to a 12.9%, or $1.5 million, increase in payroll and related costs due to the addition of personnel as described previously.

Our costs associated with business management services increased by 17.4%, or $1.9 million, for the comparative nine month periods. This increase was caused primarily by an increase of $1.4 million in payroll, temporary labor and related expenses as a result of an increase in the number of employees needed to support our growing business management services operations. Temporary labor accounted for 19.9% of our labor costs for the nine month period ended September 30, 2009 compared to 4.2% in the same period of the prior year as we move to a temp-to-hire basis for all new business management services employees due to historically high turnover costs. Postage expense also increased $0.4 million due to a $.02 postage increase in May of 2009.

Sales and Marketing Expenses. Sales and marketing expenses increased 0.9%, or $0.1 million, for the comparative nine month periods due to increased payroll and related costs.

General and Administrative Expenses. General and administrative expenses decreased by 2.2%, or $0.4 million, for the comparative nine month periods. This decrease was attributable to a $0.6 million decrease in bad debt expense. Bad debt expense in the prior year nine month period was negatively impacted by a large write-off of a single customer. Expenses for shipping and our national users conference decreased by 32.2%, or $0.4 million, as much of this expense will be incurred in the fourth quarter of 2009 compared to the third quarter of 2008. These decreases were partially offset by a $0.6 million increase in health insurance related costs due to negative claims experience during the first nine months of 2009. We began a company-wide wellness program in the third quarter of 2009 in an effort to help contain future health insurance related costs.

As a percentage of total revenues, sales and marketing expenses, and general and administrative expenses decreased to 23.4% for the nine months ended September 30, 2009 from 25.5% for nine months ended September 30, 2008.

Net Income. Net income for the nine months ended September 30, 2009 increased by 9.4%, or $1.0 million, to $11.6 million, or $1.06 per diluted share, as compared with net income of $10.6 million, or $0.98 per diluted share, for the nine months ended September 30, 2008. Net income represented 12.3% of revenue for the nine months ended September 30, 2009, as compared to 12.1% of revenue for the nine months ended September 30, 2008.