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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended OctoberJuly 31, 19981999

                                       or

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

For the transition period from ______________ to ______________

Commission File Number:  0-28132

                             LANVISION SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

         Delaware                                         31-1455414
(State or other jurisdiction of                       (I.R.S. Employer
 incorporation or organization)                      Identification No.)

                           One Financial Way,4700 Duke Drive, Suite 400
                           Cincinnati, Ohio 45242-5859170
                              Mason, OH 45040-9374
               (Address of principal executive offices) (Zip Code)

                                 (513) 794-7100
              (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. Yes X No -----     -----____

         Number of shares of Registrant's Common Stock ($.01 par value per
share) issued and outstanding, as of December 11, 1998: 8,814,520.

         This report consists of 29 pages, and the Exhibit Index appears on page
23.September 10, 1999: 8,838,033.


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TABLE OF CONTENTS
Page Part I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements....................................................... 3 Condensed Consolidated Balance Sheets at OctoberJuly 31, 19981999 and January 31, 1998....................1999....................... 3 Condensed Consolidated Statements of Operations for the three and ninesix months ended OctoberJuly 31, 19981999 and 1997.....................................................................................1998.......................................................................................... 5 Condensed Consolidated Statements of Cash Flows for the ninesix months ended OctoberJuly 31, 19981999 and 1997..............................................................................................1998... 6 Notes to Condensed Consolidated Financial Statements.............................................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................ 219 Part II. OTHER INFORMATION Item 1. Legal Proceedings................................................................................. 2120 Item 3. Defaults on Senior Securities..................................................................... 21 Item 5. Other Information................................................................................. 21 Item 6. Exhibits and Reports on Form 8-K.................................................................. 2221 Signatures........................................................................................ 2221
2 3
PART I. FINANCIAL INFORMATION Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS Assets
(Unaudited) (Audited) OctoberJuly 31, January 31, 1998 1998 -------------------- --------------------1999 1999 ------------ ------------ Current assets: Cash and cash equivalents $ 1,371,9534,001,122 $ 2,142,881 Investment securities 5,014,435 5,074,2585,445,498 Accounts receivable, net of allowance for doubtful accounts of $310,000$355,000 and $265,000,$325,000, respectively 3,132,826 2,992,9873,366,279 3,642,330 Unbilled receivables 2,940,027 1,135,3651,856,951 2,383,964 Other 1,276,603 1,179,603 -------------------- --------------------1,006,197 1,024,960 ------------ ------------ Total current assets 13,735,844 12,525,09410,230,549 12,496,752 Property and equipment: Computer equipment 4,406,425 3,876,9624,442,631 4,407,863 Computer software 590,591 588,441 487,841 Office furniture, fixtures and equipment 1,515,654 1,424,0361,379,043 1,534,206 Leasehold improvements 949,490 931,020 -------------------- -------------------- 7,460,010 6,719,859648,230 930,920 ------------ ------------ 7,060,495 7,461,430 Accumulated depreciation and amortization (2,868,189) (1,563,202) -------------------- -------------------- 4,591,821 5,156,657 Investment securities - 3,834,908(3,895,017) (3,321,466) ------------ ------------ 3,165,478 4,139,964 Capitalized software development costs, net of accumulated amortization of $878,561$1,010,228 and $661,896,$920,228, respectively 692,368 612,033809,701 749,701 Other 87,046 71,430 -------------------- --------------------86,429 98,633 ------------ ------------ $ 19,107,07914,292,157 $ 22,200,122 ==================== ====================17,485,050 ============ ============
3 See Notes to Condensed Consolidated Financial Statements. 3 4
LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS Liabilities, Convertible Redeemable Preferred Stock and Stockholders' Equity
(Unaudited) (Audited) OctoberJuly 31, January 31, 1998 1998 ------------------ ------------------1999 1999 ------------ ------------ Current liabilities: Accounts payable $ 319,172642,137 $ 1,631,941474,189 Accrued compensation 581,435 943,221363,101 543,790 Accrued other expenses 2,281,264 1,746,8832,224,712 3,105,021 Deferred revenues 1,053,187 1,061,996 ------------------ ------------------1,509,406 1,083,837 ------------ ------------ Total current liabilities 4,235,058 5,384,0414,739,356 5,206,837 Long-term debt 6,000,000 -6,000,000 Long-term accrued interest 231,833 -831,571 431,167 Convertible redeemable preferred stock, $.01 par value per share 5,000,000 shares authorized - --- -- Stockholders' equity: Common stock, $.01 par value per share, 25,000,000 shares authorized, 8,896,500 shares issued 88,965 88,965 Capital in excess of par value 35,051,461 35,102,459 35,110,817 Treasury stock, at cost, 81,98068,467 and 90,50081,980 shares, respectively (325,451) (389,692) (430,188) Accumulated other comprehensive income 25,152 75,203 Accumulated (deficit) (26,186,696) (18,028,716) ------------------ ------------------(32,093,745) (28,954,686) ------------ ------------ Total stockholders' equity 8,640,188 16,816,081 ------------------ ------------------2,721,230 5,847,046 ============ ============ $ 19,107,07914,292,157 $ 22,200,122 ================== ==================17,485,050 ============ ============
See Notes to Condensed Consolidated Financial Statements. 4 5 LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three and Six Months Ended July 31, (Unaudited)
LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three and Nine Months Ended October 31, (Unaudited) Three Months Ended NineSix Months Ended --------------------------------- -------------------------------------------------------------- ----------------------------- 1999 1998 19971999 1998 1997 --------------- --------------- --------------- --------------------------- ------------ ------------ ------------ Revenues: Systems sales $ 1,307,886541,678 $ 1,160,1161,565,010 $ 4,979,8261,468,648 $ 2,758,963 Service,3,671,940 Services, maintenance and support 1,276,852 1,168,599 4,047,450 3,251,7311,459,805 1,334,998 2,749,958 2,770,598 Service bureau operations 251,591 - 422,305 - --------------- --------------- --------------- ----------------- 108,214 154,925 170,714 ------------ ------------ ------------ ------------ Total revenues 2,836,329 2,328,715 9,449,581 6,010,6942,001,483 3,008,222 4,373,531 6,613,252 Operating expenses: Cost of systems sales 315,912 493,633 1,525,768 1,658,513114,783 431,135 550,247 1,209,856 Cost of service,services, maintenance and support 1,340,522 1,276,395 4,298,875 3,630,152979,010 1,431,677 1,909,055 2,958,353 Cost of service bureau operations 755,534 - 2,103,374 -405,457 725,571 831,876 1,347,840 Selling, general and administrative 1,516,922 2,205,518 6,092,729 7,129,4601,194,846 2,109,586 2,456,085 4,575,807 Product research and development 722,443 1,304,364 3,121,056 3,534,214525,042 948,122 1,071,054 2,398,613 Restructuring expense - --- 300,000 - --------------- --------------- --------------- ----------------- 300,000 ------------ ------------ ------------ ------------ Total operating expenses 4,651,333 5,279,910 17,441,802 15,952,339 --------------- --------------- --------------- ---------------3,219,138 5,946,091 6,818,317 12,790,469 ------------ ------------ ------------ ------------ Operating (loss) (1,815,004) (2,951,195) (7,992,221) (9,941,645)(1,217,655) (2,937,869) (2,444,786) (6,177,217) Interest income 94,112 287,484 291,741 901,00539,188 94,366 88,132 197,629 Interest expense 390,000 - 457,500 - --------------- --------------- --------------- ---------------401,572 67,500 782,405 67,500 ------------ ------------ ------------ ------------ Net (loss) $ (2,110,892)(1,580,039) $ (2,663,711)(2,911,003) $ 8,157,980(3,139,059) $ (9,040,640) =============== =============== =============== ===============(6,047,088) ============ ============ ============ ============ Basic net (loss) per common share $ (.24)(.18) $ (.30)(.33) $ (.93)(.36) $ (1.02) =============== =============== =============== ===============(.69) ============ ============ ============ ============ Diluted net (loss) per common share $ (.24)(.18) $ (.30)(.33) $ (.93)(.36) $ (1.02) =============== =============== =============== ===============(.69) ============ ============ ============ ============ Number of shares used in per common share computations 8,814,520 8,806,000 8,809,856 8,834,716 =============== =============== =============== ===============8,819,073 8,808,871 8,816,834 8,807,459 ============ ============ ============ ============
See Notes to Condensed Consolidated Financial Statements. 5 6 LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended July 31, (Unaudited)
LANVISION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended October 31, (Unaudited)1999 1998 1997 ------------------ ------------------------------ ------------ Operating activities: Net (loss) $ (8,157,980)(3,139,059) $ (9,040,640)(6,047,088) Adjustments to reconcile net (loss) to net cash (used for) operating activities: Depreciation and amortization 1,521,653 722,732955,358 1,039,755 Increase in long-term accrued interest 400,404 32,500 Cash provided by (used for) assets and liabilities: Accounts and unbilled receivables (1,944,501) (233,563)798,209 (2,007,077) Other current assets (97,000) (762,452)23,618 (300,411) Accounts payable and accrued expenses (1,140,175) 300,429(746,444) (536,230) Deferred revenues (8,809) 695,412 Long-term accrued interest 231,833 - ------------------ ------------------425,569 (1,959) ------------ ------------ Net cash (used for) operating activities (9,594,979) (8,318,082)(1,282,345) (7,820,510) Investing activities: Purchases of investment securities -- (9,836,409) (20,990,860) Sales of investment securities 13,681,089 31,828,880-- 11,663,279 Proceeds from disposal of property and equipment 9,006 -- Purchases of property and equipment (740,151) (1,742,328)(46,484) (720,824) Capitalization of software development costs (297,000) (297,000)(150,000) (198,000) Other (15,616) (34,046) ------------------ ------------------12,204 (14,639) ------------ ------------ Net cash (used for) provided by investing activities 2,791,913 8,764,646(175,274) 893,407 Financing activities: Proceeds of long-term debt -- 6,000,000 - Sale of treasury stock to employee stock purchase plan 13,243 32,138 - Purchase of treasury stock - (430,188) ------------------ ------------------------------ ------------ Net cash provided by (used for) financing activities 13,243 6,032,138 (430,188) ------------------ ------------------ Increase (decrease)------------ ------------ Decrease in cash (770,928) 16,376(1,444,376) (894,965) Cash and short term cash equivalents at beginning of period 5,445,498 2,142,881 664,223 ------------------ ------------------------------ ------------ Cash and short term cash equivalents at end of period $ 1,371,9534,001,122 $ 680,599 ================== ==================1,247,916 ============ ============ Supplemental cash flow disclosures: Income taxes paid $ - $ - Interest paid $ 152,000362,000 $ ---
See Notes to Condensed Consolidated Financial Statements. 6 7 LANVISION SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - BASIS OF PRESENTATION The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by the Company without audit, in accordance with generally accepted accounting principles for interim financial information, pursuant to the rules and regulations applicable to quarterly reports on Form 10-Q of the Securities and Exchange Commission. Accordingly, they do not include all of 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 accruals) considered necessary for a fair presentation of the Condensed Consolidated Financial Statements have been included. These Condensed Consolidated Financial Statements should be read in conjunction with the financial statements and notes thereto included in the LanVision Systems, Inc. Annual Report on Form 10-K, Commission File Number 0-28132. Operating results for the three and nineor six months ended OctoberJuly 31, 1998,1999, are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 1999.2000. Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies is presented beginning on page 1821 of its 19971998 Annual Report to Stockholders. Users of financial information for interim periods are encouraged to refer to the footnotes contained in the Annual Report to Stockholders when reviewing interim financial results. There has been no material change in the accounting policies followed by the Company during 1998. The Company is accounting for the minimum guaranteed rate of return on the long-term debt (see note 4) as if the loan were guaranteed to earn a 25% compound annual return. Accordingly, in addition to the 12% coupon interest, the Company records as interest expense the difference between the minimum guarantee and the 12% coupon interest as additional interest expense. This liability is reflected as long-term accrued interest.1999. Note 3 - CHANGES IN BALANCE SHEET ACCOUNT BALANCES The net decrease in cash and cash equivalents and investment securities results from the sale of investments and use of cash to fund current operations and purchase additional fixed assets. The increasedecrease in receivables is due to increased salesimproved collections, lower revenues in the current quarter compared withto the quarter endingprior period ended January 31, 1998. Revenue recorded1999, and the write off of some previously reserved accounts. In August 1997, the Company announced the formation of Virtual Healthware Services (VHS), a new healthcare information application service provider division that delivers high quality, transaction-based document imaging/management services to healthcare providers from a central data center. Also, in August 1997, the Company announced that The Detroit Medical Center (DMC) signed a three-year agreement with VHS and the contract was expected to generate in excess of milestone billings$6,000,000 in revenues over the initial term of the agreement. In 1997, and the first part 7 8 of 1998, the Company spent approximately $4,000,000 to build the central data center and place it into production. During the first quarter of 1998, VHS began production at the DMC. However, during 1998, The Detroit Medical Center encountered financial difficulties, and as previously announced in February, 1999, the DMC as part of an overall financial restructuring, notified the Company that it sought to terminate its agreement with VHS. The agreement between the DMC and LanVision does not provide for early termination, and the Company has filed a complaint seeking the recovery of damages in excess of $2,000,000 and initiated arbitration proceedings against the DMC. However, at the present time, the Company is recorded as unbilled receivables.unable to predict the outcome of these proceedings. At July 31, 1999, LanVision's receivables due from the DMC approximated $667,000. Management believes it has adequately provided for any possible uncollectible amounts. The increasedecrease in unbilled receivablesproperty and equipment is due to an increase in new sales contracts, royalties due in accordance 7 8 with the termsdownsizing of facilities including the Remarketing Agreement with Shared Medical Systems Corporation (See Resultsdisposal of Operations),excess office furniture and the implementationequipment and abandonment of additional phases of existing contracts.certain leasehold improvements. Other current assets consist primarily of prepaid expenses, including commissions, and acquired software and hardware awaiting installation. The increase at October 31, 1998, results primarily from prepaid expenses related to the long-term debt (see note 4) which is being amortized over the life of the loan. The increase in property and equipment relates primarily to the purchase of equipment for the service bureau operations, which went on-line in the first half of fiscal 1998. The decrease in accounts payable is due to a reduction in purchasesthe timing of hardware and third-party software for resale and reduced levels of capital expenditures in the current quarter compared with the quarter ended January 31, 1998.payments on certain payables. The decrease in accrued compensation results from a smaller accrual for bonuses.reduction in headcount and the payment of incentive compensation. The increasedecrease in accrued other expenses results from an increase in reserves for the possible settlement of contractual issues relating to certain aspects of implementation on several contracts.contracts and the use of the accrued restructuring liability for facilities downsizing. The increase in deferred revenues is due to the receipt of advance payments on several contracts prior to revenue recognition. Note 4 - LONG-TERM DEBT In July, 1998, the Company issued a $6,000,000 note to The HillStreet Fund, L.P., which bears interest at 12%, payable monthly. The note is repayable in quarterly installments of $500,000 commencing October, 2001 through July, 2004. In July, 2002, the Company has a one-time option to prepay in full the then outstanding balance of the note. The note is secured by all of the assets of the Company and the loan agreement restricts the Company from incurring additional indebtedness for borrowed money, including capitalized leases, limits certain investments, restricts substantial asset sales, capital expenditures, cash dividends, stock repurchases and mergers and consolidations with unaffiliated entities. In addition, the Company is required to maintain certain financial conditions, including minimum levels of revenues, combined cash and investments and net worth. In connection with the issuance of the note, the Company issued Warrants to purchase 750,000 shares of common stock of the Company at $3.87 per share at any time after May 16, 1999 through July 16, 2008. The Warrants are subject to the customary antidilution and registration rights provisions. Under the terms of the loan agreement, the Company has guaranteed the lender that the increase in the market value of the stock underlying the Warrants, at the time of loan maturity, over the exercise price plus the 12% interest paid on the loan will yield the lender a 25% compound annual return. If the yield from the Warrants plus interest paid does not provide the lender with the guaranteed return, the Company is required to pay the additional amount in cash at the time of maturity. Should the Company exercise its prepayment option in July, 2002, then the minimum guaranteed rate of return is increased to 30%. However, to the extent that the computed 8 9 minimum compound annual rate of return exceeds 30% at the date of the prepayment, the Company has the right to cancel up to 150,000 warrants. In addition, the founders and majority shareholders of the Company have consented to certain restrictions on the sale or transfer of their shares. Maturities of long-term debt are as follows: fiscal years 1999 & 2000, $-0-; 2001, $1,000,000; 2002, $2,000,000; 2003, $2,000,000; 2004, $1,000,000. The Company was in compliance with all of the terms and conditions of the loan agreement as of October 31, 1998. Note 5 - STOCKHOLDERS' EQUITY The Company has reserved 2,271,321 shares of Common Stock for issuance as follows: 750,000 shares for issuance upon exercise of the Warrants issued in connection with the long-term debt (see Note 4), and 1,521,321 shares for issuance in connection with various Stock Option Plans and the Employee Stock Purchase Plan. On June 30,1998, 8,520 shares of Treasury Stock were sold to the Employee Stock Purchase Plan. The $8,358 loss on the sale of the Treasury Stock has been recorded as a reduction of capital in excess of par value in the Stockholders' Equity. Note 6 - STOCK OPTIONS During the first ninesix months of the current fiscal year, the Company granted 248,000101,000 stock options at the weighted average exercise price of $3.00 per share under the 1996 Employee Stock Option Plan. During the same period 24,875202,387 options were forfeited under all plans. In August, 1999, options to purchase 10,000 shares of Common Stock were exercised. Note 75 - RESTRUCTURING EXPENSE During the second quarter,prior fiscal year, the company restructured certain aspects of its operations to flatten the management structure, reduce expenses in all areas, and, at the same time, improve customer service.operations. Accordingly, the Company accrued $300,000$700,000 for the anticipated costs of severance and related taxes and fringe benefits for the reduction of the work force by 16 people. The liability was recorded as apeople and downsizing the existing facilities to the current liability at the endand near term need. At July 31, 1999, approximately $632,000 of the second quarter and substantially all of the liability was paid during the third quarter. As LanVision has completed certain of its major software development projects, the Companyaccrual has been able to reduce its staffused for the restructuring and the use of outside contractors in product development.approximately $68,000 remains for additional facilities downsizing. 8 9 10 Note 86 - EARNINGS PER SHARE The basic (loss) per common share is calculated using the weighted average number of common shares outstanding during the period. The diluted (loss) per common share calculation, excludes the effect of the common stock equivalents (stock options) as the inclusion thereof would be antidilutive. Note 97 - COMPREHENSIVE INCOME The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income. Accordingly, the Company has accounted for the unrealized holding gains on available-for-sale securities in accordance with this new accounting standard, as follows:
Three months ended OctoberJuly 31, NineSix months ended OctoberJuly 31, ------------------------------------ ----------------------------------------------------------------- ------------------------------ 1999 1998 19971999 1998 1997 --------------- -------------- -------------- ------------------------- ----------- ----------- ----------- Net (loss) $ (2,110,892) $ (2,663,711) $ (8,157,980) $ (9,040,640)$(1,580,039) $(2,911,003) $(3,139,059) $(6,047,088) Unrealized holding gains (losses) arising during the period 12,023 8,661 6,393 119,240-- (4,827) -- (5,630) Reclassification adjustment for gains included in Net (loss) (1,758) (23,200) (56,444) (88,858) --------------- -------------- -------------- ---------------- (14,164) -- (54,686) ----------- ----------- ----------- ----------- Comprehensive (loss) $ (2,100,627) $ (2,678,250) $ (8,208,031) $ (9,010,258) =============== ============== ============== ==============$(1,580,039) $(2,929,994) $(3,139,059) $(6,107,404) =========== =========== =========== ===========
Note 8 - LONG-TERM DEBT At the present time the Company's Long-term Debt Agreement includes certain financial covenants requiring the Company to maintain a minimum cash balance of $2,400,000 and maintain minimum revenues and net worth. The Company is renegotiating these covenants with the Lender and the minimum cash balance required will increase to $2,700,000 at October 31, 1999. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition to historical information contained herein, this Discussion and Analysis, as well as other Items in this Form 10-Q, contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements, included herein. These risks and uncertainties include, but are not limited to, the impact of competitive products and pricing, product demand and market acceptance, new product development, key strategic alliances with vendors that resell LanVision products, the ability of the Company to control costs, availability of products produced from third party vendors, the healthcare regulatory environment, healthcare information systems budgets, availability of healthcare information systems trained personnel for implementation of new systems, as well as maintenance of legacy systems, Year 2000 Compliance priorities, fluctuations in operating results and other risks detailed from time to time in the LanVision Systems, Inc. filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking 9 10 statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revision to these forward-looking statements, which may be 10 11 made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS GENERAL LanVision(TM)LanVision Systems, Inc. ("LanVision"(TM) or the "Company") is a leading providersupplier of healthcare information access systemsHealthcare Information Access Systems and web-based outsourced data center operationsservices and an Application Service Provider with solutions that can utilize the power of the Internet/Intranet to link hospitals, physicians, patients and payers to a robust electronic medical record that enable, hospitals and integrated healthcare networkson a real-time basis, access to capture, store, manage, route, retrieve and process vast amountsall the various forms of clinical and financial patient information.information from a single permanent health information repository. LanVision's solutions enable the coordination of both "structured" and "unstructured" patient data through a single health information repository. The Company's products are complementary to existing clinical and financial systems, and use document imaging and workflow tools to ensure end users can electronically access all the various forms of healthcare information including clinician's handwritten notes, photographs, insurance cards, etc. LanVision's solutions offer value to all of the constituents in the healthcare delivery process by enabling them to simultaneously access information from virtually any location, including the physician's desktop and eventually a patient's home using web browser technology. Web access to the entire medical record significantly improves physician productivity and reduces administrative costs such as filing, storage, retrieval and upkeep of medical records and clinical costs, such as redundant diagnostic testing. The Company's solutions integrate a proprietary document imaging platform, application suites, and image and web-enabling tools, that allow for the seamless merger of "back office" functionality with existing Clinical Information Systems at the desktop. The Company offers a robust document imaging/management infrastructure that is built for high volume transaction processing and is optimized for the healthcare industry. In addition to providing the clinician access to information not previously available at the desktop, the Company's applications fulfill the administrative and legal needs of the Medical Records and Patient Financial Services departments. Furthermore, these systems have been specifically designed to integrate with other Clinical and Patient Account Information Systems. For example, the Company has integrated its products with selected systems from Shared Medical Systems Corporation, Cerner Corporation, IDX Systems Corporation, and Oacis Healthcare Holdings Corp. By offering electronic access to all the components of the Medical Record, this integration completes one of the most difficult tasks necessary to provide a true Computer Based Patient Record. The Company's systems deliver on-line enterprise-wideenterprisewide access to fully-updated patient information which historically was maintained on a variety of media, including paper, magnetic disk, optical disk, x-ray film, video, audio and microfilm. LanVision's systems, which incorporate data management, document imaging/management and workflow technologies, consolidate patient information into a single repository and provide fast and efficient access to patient information from universal workstations located throughout the enterprise, including the point of patient care. The systems are specifically designed to meet the needs of physicians and other medical and administrative personnel and can accommodate multiple users requiring simultaneous access to patient information, thereby eliminating file contention. By providing access to all forms of patient information, the Company believes that its Healthcare Information Access Systems are essential components of the computer-based patient record. The Company's revenues are derived from: the licensing and sale of systems comprising LanVision software and third-party software and hardware components;components, product support, maintenance, and professional services;services, and service bureau operations (outsourced data center operations).operations. Professional services include implementation and training, 10 11 project management, and custom software development and currently are provided only to the Company's customers with installed systems or who are in the process of installing systems. Revenues from professional services, maintenance and support services typically are expected to increase as the number of installed systems increase. The Company earns its highest margins on proprietary LanVision software and the lowest margins aremargin is on third-party hardware. Systems sales to customers may include differingdifferent configurations of software and hardware, resulting in varying margins among contracts. The margins on professional services revenues are expected to fluctuate based upon the negotiated terms of the agreement with each customer and the Company's ability to fully utilize its professional services, maintenance and support services staff. Revenues from the Company's service bureau operations, which provides high quality, transaction-based document imaging/management services from a centralizedcentral data center, commenced in the first quarter of fiscal 1998 and are expected to increase as the number of hospitals outsource services to the Company's Virtual Healthware Services division (VHS)("VHS"). Additionally, revenue from each VHS customer is expected to increase as the volume of archived historical data increases and retrievals of data increaseincreases as the systems are fully implemented within a healthcare facility. VHS is currently installing its system at The Health Alliance, Inc., a group of five hospitals in the Greater Cincinnati Area. The systems and service bureau operations enable hospitals and integrated healthcare networks to capture, store, manage, route, retrieve and process vast amounts of clinical and financial patient information. LanVision's systems, which incorporate data management, document imaging/management and workflow technologies, consolidate patient information into a single repository and provide fast and efficient access to patient information from universal workstations, wherever located, including the point of patient care. Sales are made by the Company's direct sales force and through a Remarketing Agreement with Shared Medical Systems Corporation. 11 12 On February 23, 1998, the Company entered into a Remarketing Agreement with Shared Medical Systems Corporation ("SMS"). Under the terms of the agreement, SMS was granted an exclusive worldwide license to distribute WebView(TM), ChartVision(R), On-Line Chart Completion(TM) and Release of Information (ROI)(TM) (formerly called Enterprisewide Correspondence(TM)) to the SMS customer base and prospect base, as defined in the agreement, and a non-exclusive license to distribute all other LanVision products. If SMS distributes any other electronic medical record product competing with LanVision's products, the Company may terminate the SMS Remarketing Agreement. SMS has over 1,800 customers in the United States and a total of 3,500 customers in 20 countries and territories in North America and Europe. The large Healthcare Information Access Systems providers, such as SMS, are often able to positively influence the buying decisions within their customer base. LanVision management believes the distribution of its products by SMS will shorten sales cycles and increase revenues. Although SMS has already begun to actively promote LanVision's products, the full impact of this distribution agreement will likely not be realized until later in fiscal 1998 or early 1999, as more of the SMS organization is trained to sell and implement the LanVision products. OnTo date SMS has sold six systems to end users through August 18, 1998, the Company announced that SMS had completed its first sale of ChartVision, which included a license for more than 250 concurrent users. In 1996, the Company entered into a non-exclusive Remarketing Agreement with Lanier Worldwide, Inc. (Lanier). Under the terms of the Agreement, Lanier was entitled to market and distribute ChartVision, On-Line Chart Completion and related products throughout North America. Through April 30, 1998, Lanier had licensed the Company's products to two customers. The Remarketing Agreement expired and has not been extended. Under the terms of a settlement with Lanier, LanVision has no ongoing royalty obligation to Lanier. LanVision refunded to Lanier $131,250 of development fees related to porting certain software to the Lanier platform. This liability had been previously accrued. Additionally, the Company forgave $210,385 of receivables due from Lanier, and of this $160,521 was charged to expense in the second quarter and $49,864 charged to expense in the third quarter.31, 1999. 11 12 The decision by a healthcare provider to replace, substantially modify or upgrade its information systems is a strategic decision and often involves a large capital commitment requiring an extended approval process. Throughout 1996, 1997, 1998 and the first ninesix months of 1998,1999, the Company has experienced extended sales cycles, and sales in each yearperiod have been less than the Company's internal plans. It is common for sales cycles to take six to eighteen months from initial contact to the execution of an agreement. As a result, the sales cycles can cause significant variations in quarter to quarter results. Furthermore, healthcare organizations are assessing and implementing many new technology solutions, including Year 2000 Compliance, etc., and although many of these systems do not compete with the LanVisionLanVision's products, these systems do compete for capital budget dollars and the available time of information system personnel within the healthcare organizations. The LanVision agreements cover the entire implementation of the system and specify the implementation schedule, which typically takes place in phases. The agreements 12 13 generally provide for the licensing of the Company's proprietary software and third-party software with a one-time perpetual license fee that is adjusted depending on the number of workstations using the software. Third-party hardware is sold outright, with a one-time fee charged for installation and training. Interfaces with existing customer systems and other consulting services are sold on a fixed fee or a time and materials basis. Generally, revenues from systems sales are recognized when a purchase agreement is signed and products are delivered. Revenues from the service elements of a contract including: routine installation, integration, project management, interface development, training, etc. are deferred until the work is performed. If an agreement requires the Company to perform services and modifications that are deemed significant to system acceptance, revenue is recorded either on the percentage-of-completion method or revenue related to the delivered hardware and software components is deferred until such obligations are completed, depending on the contractual terms. Revenues from maintenance and support agreements are recognized ratably over the term of the agreements. Billings to customers recorded prior to the recognition of the revenue are classified as deferred revenues. Revenue recognized prior to progress billings to customers is recorded as unbilled receivables. YEAR 2000 COMPLIANCE The Year 2000 Compliance issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of the Company's internal use computer programs and hardware as well as its software products that are date sensitive may recognize a date using "00" as the Year 1900 rather than the Year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities for both the Company and its customers who rely on its products. The Company is actively engaged in, but has not yet completed all stages of reviewing, correcting and testing all of the Year 2000 Compliance issues. Based on the current, albeit incomplete review and remediation, the Company has determined that it will be requiredissues related to modify or replace some of its internal use software and hardware modify certain existing softwareand the Company's products, including third-party software so that they will function properly, as a system, with respect to dates in the Year 2000 and thereafter.components offered for resale. 12 13 The Company presently believes that with modifications to its products and third-party software and the replacement of internal use software and non-compatible hardware, the Year 2000 Compliance issue will not pose significant operational problems for the Company or its customers. However, if such modificationsclients do not make the necessary changes to equipment and replacements are not made, or not completedupgrade to Year 2000 Compliant software in a timely manner, the Year 2000 Compliance issue could have a material impact on the Company and its customers. The Company has divided the Year 2000 Compliance issue into two areas: software products and systems sold to customers;customers and internal use software and hardware. 13 14 With regard to software products sold to customers, the Company has: completed the overall Year 2000 Compliance remediation plan; made a preliminary review of the existing software code; corrected all known Year 2000 code problems; and developed a test plan. The testing ofplan; and tested the revised code and thefor quality assurance. The Year 2000 compliant third-partyquality assurance testing, which included integration testing of LanVision software products that are requirements of the overall LanVision System has begun and based upon the test results, the code may need further revisions, with re-testing in successive iterations, until such time as all of the components are determined to be Year 2000 compliant. Based on current estimates, the above phases should be completed by December 31, 1998. The Company has begun the integration testing phase of the various components of the system, LanVision software,other third-party software and hardware system components, has been completed and where necessary the major hardware components, for compatibilitycode was modified. This testing and interoperability as they relate to themodification was done in several iterations. All LanVision Year 2000 Compliance issue. Based on current estimates, the above integration-testing phase should beCompliant software products have completed by December 31, 1998. The Company will then deliver revised Year 2000 compliant software to its customers forBeta testing at the customer sites using the customers then current hardware configurations.and are in General Release. The Company believes that Year 2000 compatible equipment is available for acquisition by customers, if necessary, to ensure installed systems operate properly. Should the LanVisionThe Company is now working with its customers to upgrade their systems sold to customers not be timely modified to be Year 2000 compliant, the most likely worst case scenario would be that customers could: suspend use of the system until such time as the Year 2000 Compliance issues are remediated; or continue to use the systems with reduced functionality. However, basedCompliance. Based upon current information and the time remaining for clients to complete the remediation,upgrade their systems to be Year 2000 Compliant, including upgrading to LanVision's Year 2000 Compliant software, the Company believes that the risk of such occurrencea customer not having a Year 2000 Compliant system is minimal. Contingency plans have not yet been developed. However, if needed, contingency plans will be developed if they are needed.developed. With regard to the Company's service bureau operations, the Company has determined that its systems and equipment are Year 2000 compliant except forCompliant, including the LanVision software products discussed above which are in the process of remediation, and telecommunications services provided by outside vendors. The Company is in the process of determining the Year 2000 Compliance issues that could affect operations should the telecommunications vendors not be compliant. Without Year 2000 compliantCompliant LanVision software and telecommunications, the service bureau operations willwould not be able to provide current levels of services to its customers and no contingency plan has yet been developed.developed based upon our current review of the systems, software and telecommunications services. However, if needed, contingency plans will be developed if they are needed.developed. With regard to internal use software and hardware, the Company has reviewed substantially all of the internal useinternally used software and equipment, and has determined that a small amount of older computer equipment must be replaced, but the type and amount are not significant and will be replaced in the ordinary course as systems are upgraded. With regard to third-party software, it has been determined that some software is not compliant and will need to be upgraded, in 1999, as vendors provide Year 2000 compliantCompliant versions. The companyCompany also utilizes third-party vendors for processing data and payments, e.g. payroll services, 401(k) plan administration, check processing, medical benefits processing, etc. The Company has initiated communications with its vendors to determine the status of their systems. Should theseThe major vendors not be compliant in a timely manner,have advised the 13 14 15 the Company may be required to process transactions manually or delay processing until such time as the vendorsthey are currently Year 2000 compliant.Compliant. No contingency plan has yet been developed. However, if needed, contingency plans will be developed if they are needed.developed. The Company will utilizeutilized both internal and external resources to reprogram, or replace and test its software products for the Year 2000 modifications. The Company anticipates completing the Year 2000 Compliance project as soon as practical, but not later than December 31, 1998, which is prior to any anticipated impact.modifications. The total cost of the Year 2000 projectCompliance remediation is not considered to be material, and will be funded through existing cash resources and future operating cash flows. The requirements for the correction of Year 2000 Compliance issues and the date on which the Company believes it will complete the Year 2000 Compliance modifications are based on management's current best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that may cause such material differences include, but are not limited to, the availability of personnel trained in this area, the ability to locate and collect all relevant computer codes and similar uncertainties.less than $500,000 The Company has warranted, to certain customers, that its products will be Year 2000 compliant. In addition, provisionsCompliant. If the Company were unable to provide a Year 2000 Compliant solution to these customers, the customers could claim breach of itscontract and seek available legal remedies. Provisions of the Company's long-term debt agreement and the Remarketing Agreement with SMS requirerequired the Company's products be Year 2000 compliant. Non-compliance withCompliant by December 31, 1998. Although, LanVision's products were modified to be Year 2000 Compliant by December 31, 1998, all Alpha and Beta testing was not completed as of that date. Waivers of compliance have been received from our lender and the product warranties, debt covenants and Remarketing Agreement would result in an event of default on the long-term debt and may give rise legal action for breach of contract relating to the product warranties and Remarketing Agreement.with SMS is being amended. Based upon the current best estimate for remediation of the Year 2000 Compliance issues, the Company believes the risk is minimal that the Company willhas not complycomplied with current commitments and internal processing needs.commitments. UNEVEN PATTERNS OF QUARTERLY OPERATING RESULTS The Company's revenues from systems sales have varied, and may continue to vary, significantly from quarter to quarter as a result of the volume and timing of systems sales and delivery. Professional services revenues also fluctuate from quarter to quarter as a result of the timing of the installation of software and hardware, project management and customized programming. Revenues from maintenance services do not fluctuate significantly from quarter to quarter, but have been increasing as the number of customers' increase. Revenues from the VHS service bureau which commenced operations in the first quarter of 1998, are expected to increase over time, as more hospitals outsource services to VHS, existing customers increase the volume of documents stored on the systems, and the number of retrievals increase. VHS is currently installing its system at The Health Alliance, Inc., a group of five hospitals in the Greater Cincinnati Area. Because a significant percentage of the Company's operating costs are expensed as incurred, a variation in the usage of VHS services, the timing of systems sales and installations and the resulting revenue recognition, can cause significant variations in operating results from quarter to quarter. 15 16 The Company's revenues and operating results may vary significantly from quarter to quarter as a result of a number of other factors, many of which are outside the Company's control. These factors include the relatively high purchase price of a LanVision document imaging and workflow systems,system, unpredictability in the number and timing of systems sales, length of the sales cycle, delays in the installation process and changes in the customer's financial condition or budget. As a result, period to period comparisons may not be meaningful with respect to the past operations of the Company nor are they necessarily indicative of the future operations of the Company. 14 15 REVENUES Revenues for the thirdsecond fiscal quarter ended OctoberJuly 31, 1998,1999, were $2,836,329, a 22% increase,$2,001,483, compared with $2,328,715$3,008,222 reported in the comparable quarter of 1997.1998. Revenues for the first ninesix months ended OctoberJuly 31, 1998,1999, were $9,449,581, a 57% increase,$4,373,531 compared with $6,010,694$6,613,252 in the comparable periodprior period. Revenues for the second quarter and first six months of 1997. Althoughfiscal 1999 do not include approximately $1,270,000 of revenues for previously announced sales made by our Remarketing Partner Shared Medical Systems Corporation. As previously disclosed, revenues on the three and nine months ended were greater than the corresponding periods in fiscal 1997, revenues for the periods were less than the Company's internal plan. During the first quarter, the Company signed one new contract with Christiana Care Health Services.contracts have been deferred until certain integration was completed. During the second quarter, LanVision delivered to SMS signed its first contract to sell ChartVision,versions of LanVision's Medical Record Suite that were integrated with SMS's Patient Accounts Imaging Management System. SMS and LanVision successfully completed the initial integration testing. Revenue will be recognized, probably in the third quarter, LanVision signed onewhen final integration testing of the software is completed. The decrease in revenues, in both periods, results primarily from the decrease in new contract with the Medical University of South Carolina. Through the first nine months of 1998, the Company recognized approximately $2,600,000 of revenues from these three contracts. The remaining systems sales revenuescustomers during the nine months came from implementation of previously signed agreements (backlog) and from add-on sales to existing customers. During the first quarter, the Company's newly formed Virtual Healthware Services division began operations. Sales activity has been slower than plannedcurrent periods as manymost healthcare institutions are focusedorganizations concentrated on resolving Year 2000 Compliance problems withremediation of legacy systems rather than installing new systems. Additionally, consolidations and mergers within the healthcare industry and the attendant changes in management have delayed or terminated sales discussions. Additionally, healthcare institutions are assessing and implementing many new technologies. Although many of these systems do not compete with the LanVision products, these systems do compete for capital budget dollars and the available time of information systems personnel within the healthcare industries. Management believes the healthcare industry's focus on Year 2000 Compliance will continue to adversely affect potential sales opportunities for its direct sales force through at least the first halfmost of fiscal 1999. Also, the Remarketing Agreement with Shared Medical Systems Corporation has developed more slowly than expected. However,To date, SMS's Marketing of LanVision's products has been conducted by a small specialized sales force. Additionally, SMS's strategy is to tightly control marketing activities until such time that the recent sales pipeline reportintegrated LanVision/SMS solution can be successfully demonstrated at its key customers. The integrated products have been delivered to two SMS customers and initial integration testing has been successfully completed. Final integration testing is encouragingscheduled for September. LanVision expects that SMS's marketing activities related to the LanVision products will increase and LanVision remains optimistic about the long-term revenue potential of this Remarketing Agreement. Management believes revenue from this Remarketing Agreement will represent a greater percentage of the Company's total revenues in the future. 16 17 As previously discussed, afterAfter an agreement is executed, LanVision does not record revenues until it delivers the hardware and software or performs the agreed upon services. The commencement of revenue recognition varies depending on the size and complexity of the system and the scheduling of the implementation, training, interface development and other services requested by the customer. Accordingly, significant variations in revenues can result as more fully discussed under "Uneven Patterns of Quarterly Operating Results." Three customers accounted for approximately 56%47% of the revenues for the thirdsecond quarter of 1998 and three customers accounted for 31% of the revenues39% for the first ninesix months of 1998.1999 compared with 53% and 37%, respectively, of revenues in the comparable periods of the prior year. 15 16 OPERATING EXPENSES Cost of Systems Sales The cost of systems sales includes amortization of capitalized software development costs on a straight-line basis, royalties and the cost of third-party software and hardware. Cost of systems sales as a percentage of systems sales may vary from period to period depending on the mix of hardware and software of the systems or add-on sales delivered. The cost of systems sales as a percentage of systems sales for the thirdsecond quarter of 1999 and 1998 were 21% and 1997 were 24% and 43%27%, respectively, and 31% and 60%, respectively for the first nine months of 1998 and 1997.respectively. The lower cost reflects the higherchange in the mix of LanVision software with higher margins relative to the hardware and third-partythird party software components with lower margins and higher costs. In addition, theThe cost of systems sales as a percentage of systems sales for the ninefirst six months includes an $83,333 write off of 1999 and 1998 were 37% and 33%, respectively reflecting the lower mix of LanVision software previously acquired from a third-party.and higher hardware sales in the current period compared with the prior period. Cost of Service,Services, Maintenance and Support The cost of service,services, maintenance and support includes compensation and benefits for support and professional services personnel and the cost of third-party maintenance contracts. As a percentage of service,services, maintenance and support revenues, the cost of such service,services, maintenance and support was 105%67% and 109%107% for the thirdsecond quarter of fiscal 1998 and 1997, respectively69% and 106% and 112%, respectively,107% for the first ninesix months of fiscal 1999 and 1998, respectively. The improvement in the cost of sales is due to reduced operating expenses and 1997. The LanVision Customer Support existing staff is sufficient tomore effective utilization of the professional services and support the existing customer base. Increases in customers do not require a proportional increase in support staffing or total support costs.staffs. The Company's support margins are highest on LanVision's proprietary software. Accordingly, margins are expected to improve as more customers are added. The LanVision Professional Services staff provides services on a time and material or fixed fee basis. The Professional Services staff has, in the past, experienced some inefficiencies in the delivery of services, and certain projects have taken longer to complete than originally estimated, thus adversely affecting operating performance. Additionally, the Professional Services staff does spend a portion of its time on non-billable activities, such as developing training courses and developing plans to move to LanVision's new product releases, etc. Management believes the 17 18 increase in experience of its Professional Services staff and thean increase in backlog should improve the overall efficiency and operating performance of this group. Cost of Services Bureau Operations The cost of service bureau operations has declined in both the current quarter and first six months compared with the comparable prior periods as the overall operations were significantly reduced when The Detroit Medical Center terminated their agreement. See Note 3 of the Notes to Condensed Consolidated Financial Statements. The ongoing cost of the service bureau operations is primarily depreciation and core staff assisting in the implementation of a new VHS customer, The Health Alliance, Inc., which is expects to begin using the system in production in the third quarter. 16 17 Selling, General and Administrative Selling, General and Administrative expenses consist primarily of: compensation and related benefits and reimbursable travel and living expenses related to the Company's sales, marketing and administrative personnel; advertising and marketing expenses, including trade shows and similar type sales and marketing expenses; and general corporate expenses, including occupancy costs. During the thirdsecond quarter of fiscal 1998,1999, Selling, General and Administrative expenses decreased to $1,516,922$1,194,846 compared with $2,205,518$2,109,586 in the comparable prior quarter and decreased to $6,092,729 in the first nine months$2,456,085 compared with $7,129,460$4,575,807 in the comparable prior period. For the ninesix months Selling, General and Administrative expenses include a charge of approximately $160,000 related to the expiration of the Lanier Remarketing Agreement.1998. The reductions in Selling, General and Administrative expenses is due to decreased staffing levels and reduced expenses in other areas. At October 31, 1998,The Company has gradually reduced its direct sales staff as the Company'sCompany focuses its sales efforts on indirect distribution through its current and marketing staff consisted of ten personnel compared with twenty-nine personnel at October 31, 1997. Additionally, general and administrative staffing at October 31, 1998 was fourteen compared with nineteen at October 31, 1997.future Remarketing Partners. Product Research and Development Product research and development expenses consist primarily of: compensation and related benefits; the use of independent contractors for specific development projects; and an allocated portion of general overhead costs, including occupancy. At October 31, 1998,During the productsecond quarter of fiscal 1999, research and development staff consisted of sixteen employeesexpenses decreased to $525,042 compared with thirty-one employees at October 31, 1997. However, the Company supplements its development staff through the use of independent contractors and software development firms. Research and development expenses$948,122 in the firstcomparable prior quarter and decreased to $1,071,054 compared with $2,398,613 in the comparable prior six months of fiscal 1998, increased to $1,450,491 as a result of stepped-upa reduction of staff and use of outside contractors as major development efforts related to the many new products recently released. Research and development expenses for the second quarterprojects were $948,122 and $722,443completed in the third quarter, reflecting the use of fewer contractors and reduced staffing subsequent to completion of major projects. During the current fiscal year LanVision released upgrades to ChartVision and provided the general release of On-Line Chart Completion, Release of Information (ROI) formerly known as Enterprisewide Correspondence, OmniVision(TM), WebView(TM), and new Document Capture System(TM) modules. These new releases have enabled LanVision to offer an expanded product portfolio to new customers and allowed existing customers to expand their uselater portion of the LanVision systems.prior fiscal year. The Company capitalized, in accordance with Statement of Financial Accounting Standards No. 86, $297,000$150,000 and $198,000 of product research and development costs in the first ninesix months of fiscal 1999 and 1998, and 1997.respectively. Interest income consists primarily of interest on investment securities.invested cash. The decrease in interest income results from the sale of investment securities and use of cash to fund operations and acquire fixed assets. 18 19 Interest expense relates to the new long-term debt (see Item 1, Note 4 of Notes to Financial Statements).debt. Net loss The net loss for the third fiscalsecond quarter of 1998fiscal 1999 was $2,110,892$1,580,039 ($.24).0.18 per share) compared with a net loss of $2,663,711$2,911,003 ($.30).0.33 per share) in the thirdsecond quarter of 1997.fiscal 1998. The net loss for the first ninesix months of 1998fiscal 1999 was $8,157,980$3,139,059 ($.93).0.36 per share) compared with a net loss of $9,040,640$6,047,088 ($1.02).0.69 per share) in the first ninesix months of 1997. Thefiscal 1998.The decrease in the net lossesloss for the periods results primarily from the increased margins on systems sales, with a higher mix of LanVision proprietary software, reductions in selling, general and administrative expenses and product research and development. Excluding the $1,987,258 operating lossdevelopment as well as reductions in costs of the new VHS division, the $293,718 in special charges mentioned abovesales, primarily as a result of staff reductions and the $300,000 restructuring charge, LanVision's operating loss for the nine months ended October 31,1998 was $5,411,245, a significant improvement when compared with an operating lossbetter utilization of $9,941,645 in the corresponding nine months of 1997.staff. 17 18 In spite of the less than anticipated number of new customer agreements signed in the past, nine months, management continues to believe that the healthcare document imaging and workflow market is going to be a significant market. Management believes it has made the investments in the talent and technology necessary to establish the Company as a leader in this marketplace, and continues to believe the Company is well positioned to experience significant revenue growth.growth primarily through third party distributors and remarketing partners, and potentially emerging healthcare Internet Service Providers, Application Service Providers and content/E-commerce organizations. Since commencing operations in 1989, the Company has incurred operating losses. Although the Company achieved profitability in fiscal years 1992 and 1993, the Company incurred a net loss in fiscal years 1994 through 1997.1998. In view of the Company's prior operating history, there can be no assurance that the Company will be able to achieve consistent profitability on a quarterly or annual basis or that it will be able to sustain or increase its revenue growth in future periods. Based upon the expenses associated with current and planned staffing levels, profitability is dependent upon increasing revenues. LIQUIDITY AND CAPITAL RESOURCES Since its inception in 1989, LanVisionthe Company has funded its operations, working capital needs and capital expenditures primarily from a combination of cash generated by operations, a 1994 private placement of convertible redeemable preferred stock, and an initial public offering and borrowings, including in July, 1998, a $6,000,000 loan ( see Item 1, Note 4 of the Notes to Financial Statements).in July, 1998. The Company's customers typically have been well-established hospitals or medical facilities with good credit histories, and payments have been received within normal time frames for the industry. However, recently some healthcare organizations have experienced significant operating losses as a result of limits on third-party reimbursements from insurance companies and governmental entities. Agreements with customers often involve significant amounts and contract terms typically require customers to make progress payments. 19 20 The Company has no significant obligations for capital resources, other than noncancelable operating leases in the total amount of approximately $2,500,000,$1,400,000, payable over the next sixfive years. However, the VHS service bureau operationoperations will need to acquire additional software and equipment as VHS adds additional hospitals and clinics to its customer base. The centralizedcentral data center has been originally configured to serve approximately fifty hospitals, with significant expansion capabilities. However, for each customer,certain new customers VHS establisheswill operate one or more onsite document capture centers and provideswill provide the necessary scanning equipment. Each document capture center is expected to require approximately $125,000 of equipment. Also, because VHS charges for its services on a per transaction fee basis, LanVision'sthe Company's cash flow for capital and operating expenses will normally be greater than cash inflows until customers begin to use the system at anticipated normal volumes for a period of time. 18 19 Over the last several years, the Company's revenues have been less than the Company's internal plans. However, during the same time period, the Company has expended significant amounts for capital expenditures, product research and development, sales, support and consulting expenses as the Company expanded its operations in anticipation of significant revenue growth. This has resulted in significant net cash outlays over the last twothree years. Although the Company has increased its revenues, reduced staffing levels and related expenses and improved operating performance, the Company's expenses continue to exceed its revenues. Accordingly, to achieve profitability and positive cash flow, it is necessary for the Company to increase revenues or continue to reduce expenses. Management believes that the recent general release of thenew or enhanced versions of products described above under "Product Research and Development" has significantly strengthened the product portfolio.lines. Additionally, the SMS Remarketing Agreement has significantly expanded the sales distribution capabilities, and management believes that market opportunities are such that the Company should be able to continue to increase its revenues. However, there can be no assurance the Company will be able to continue to increase its revenues. At October 31, 1998,July 31,1999, the Company had unrestricted cash and investmentscash equivalents of $3,986,388. Investments$4,001,122. Cash equivalents consist primarily of U.S. Government obligations with maturities ranging from one month to twelve months. In December, 1998,overnight bank repurchase agreements. Under the terms of its loan agreement, the Company announced that it has retained CIBC Oppenheimer Corporation asagreed to maintain a financial advisor to evaluate alternatives for maximizing shareholder value. If overminimum cash and investment balance of $2,400,000. Management has significantly reduced operating expenses throughout 1998 and the nextfirst six months of fiscal year 1999, and believes the Company is well positioned to achieve quarterly break-even or profitability, before interest, expense, in the second half of fiscal year 1999 with modest increases in revenues. However, based upon current expenditure levels and in the absence of increased revenues, dothe Company would continue to operate at a loss. Accordingly, for the foreseeable future, management will need to continually assess its revenue prospects compared to its current expenditure levels. If it does not appear likely that revenues will increase, it will be necessary for the Company to further reduce operating expenses or secureraise cash through additional borrowings, which will require lender approval,the sale of assets, or other equity financing. CIBC OppenheimerCertain of these actions will assist the Company in this process.require lender approval. However, there can be no assurance the Company will be successful in itsany of these efforts. If it is necessary to significantly reduce operating expenses, this could have an adverse affect on future operating performance. In December, 1998, the Company retained CIBC World Markets [ formerly CIBC Oppenheimer Corp.] as a financial advisor to help the Company plan for future capital needs and assist the Company with decisions that maximize shareholder value. To date, inflation has not had a material impact on the Company's revenues or income.expenses. Additionally, the Company does not have any significant market risk exposure at July 31, 1999. SIGNED AGREEMENTS - BACKLOG LanVision enters into master agreements with its customers to specify the scope of the system to be installed, services to be provided by LanVision, the agreed upon aggregate price, and the timetable for implementation. The master agreement typically provides that the Company will deliver the system in phases pursuant to the customer's purchase orders, thereby allowing the customer 19 20 21flexibility in the timing of its receipt of systems and to make adjustments that may arise based upon changes in technology or changes in customer needs. The master agreement also allows the customer to request additional components as the installation progresses, which additions are then separately negotiated as to price and terms. Certain Master Agreements allow customers to cancel subsequent phases without penalty. Historically, customers have ultimately purchased systems and services in addition to those originally contemplated by the master agreement, although there can be no assurance that this trend will continue in the future. At OctoberJuly 31, 1998,1999, the Company's customers (excluding customers of the Virtual Healthware Services division) had entered into master agreements for systems and related services (excluding support and maintenance, and transaction based revenues for VHS)maintenance) which had not yet been delivered, installed and accepted which, if fully performed, would generate sales of approximately $9,000,000. See "Results of Operations: General" for a description$6,073,000, compared with $6,616,000 and $6,881,000 at the end of the Company's agreements with customers.first quarter of fiscal 1999 and the end of fiscal 1998, respectively. The systems and services related to the agreements are currently expected to be delivered or performed, based upon customer implementation schedules, over the next two to three years. In addition, the Company anticipates approximately $2,000,000 in transaction-based fee revenues for the Virtual Healthware Services division's new client over the four-year life of the contract. Because implementation and service bureau transaction-based fees are dependent upon the customer's schedule and usage, the Company is unable to predict accurately the amount of these revenues in future periods. As previously discussed, an additional $1,270,000 in revenues on systems sold by SMS will probable be recognized in the third quarter. The Company's master agreements also generally provide for an initial maintenance period and give the customer the right to subscribe for maintenance and support services on a monthly, quarterly or annual basis. In addition,Maintenance and support revenues for fiscal years 1998 and 1997 and 1996 were approximately $2,755,000, $2,151,000 and $1,186,000, respectively and are expected to increase as new or expanded systems are installed. The commencement of revenue recognition varies depending on the size and complexity of the system, the implementation schedule requested by the customer and usage by customers of the VHS division has entered intoservice bureau operations. Therefore, LanVision is unable to accurately predict the revenue it expects to achieve in any particular period. The Company's master agreements generally provide that the customer may terminate its agreement upon a material breach by the Company, or may delay certain aspects of the installation. There can be no assurance that a customer will not cancel all or any portion of its master agreement or delay installations. A termination or installation delay of one or more phases of an agreement, which is expected to generate revenues in excess of $5,500,000 overor the remaining lifefailure of the contract. Item 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company invests its cash balances, in excess of its current needs, in U.S. Government Securities. The Company does not invest for the purposes of trading in securities, however, the portfolio is managed and invested for maximum returnto procure additional agreements, could have a material adverse effect on the investment. The marketable securities at October 31, 1998, which are recorded at a fair valueCompany's business, financial condition and results of $5,014,435 and include unrealized gains of $25,152, have exposure to price risk. This risk is estimated, absent any economic justification for the selection of a different amount, as the potential loss in fair value resulting from a hypothetical 10% adverse change in price quoted by dealers and amounts to $501,444. Actual results may differ. The fair market values of investment securities are based on the quoted market prices at the reporting date for those investments. The estimated fair market value of investment securities by contractual maturity at October 31, 1998 is as follows: $5,014,435 in 1998.operations. Part II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company is not currently engaged in any material adverse litigation. 20 21 Item 3. DEFAULTS ON SENIOR SECURITIES The Company is not in default under its existing Loan AgreementAgreement. Item 5. OTHER INFORMATION On December 2, 1998,In July, 1999, the Company announced that it has retained CIBC Oppenheimer Corporationmoved its Corporate Headquarters from offices at One Financial Way, Cincinnati, OH to assist the Company in evaluating several possible strategies to enhance 21 22 shareholder value and optimize LanVision's position in the marketplace. (See also Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation.4700 Duke Drive, Suite 170, Mason, OH, 45040-9374. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10(a) First Amendment to the Employment10 Lease Termination Agreement among LanVision Systems, Inc., LanVision, Inc. and J. Brian Patsy. 10(b) First Amendment to the Employment Agreement among LanVision Systems, Inc., LanVision, Inc. and Eric S. Lombardo. 10(c) First Amendment to Loan and Security Agreement between The HillStreet Fund, L.P. and LanVision Systems, Inc. 11 Computation of Earnings (Loss) Per Common Share 27 Financial Data Schedule (b) Reports on Form 8-K None. 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. LANVISION SYSTEMS, INC. DATE: December 11, 1998September 14, 1999 By: /s/ J. BRIAN PATSY ------------------------ ----------------------------------------------------------------------------- J. Brian Patsy Chief Executive Officer and President DATE: December 11, 1998September 14, 1999 By: /s/ THOMAS E. PERAZZO ------------------------ ----------------------------------------------------------------------------- Thomas E. Perazzo Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer 21 22 23
INDEX TO EXHIBITS Exhibit No. Exhibit 10(a) # First Amendment to the Employment Agreement among LanVision Systems, Inc., LanVision, Inc. and J. Brian Patsy................................................... 10(b) # First Amendment to the Employment Agreement among LanVision Systems, Inc., LanVision, Inc. and Eric S. Lombardo................................................. 10(c) First Amendment to Loan and Security Agreement between The HillStreet Fund, L.P. and LanVision Systems, Inc............................................................... 11 Computation of Earnings (Loss) Per Common Share...................................... 27 Financial Data Schedule.............................................................. - ---------------- # Management Contracts and Compensatory Agreements.
23INDEX TO EXHIBITS Exhibit No. Exhibit ----------- ------- 10 Lease Termination Agreement 11 Computation of Earnings (Loss) Per Common Share 27 Financial Data Schedule 22