EXHIBIT 99.1
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and the consolidated financial statements and the
related notes included elsewhere in this document.
FINANCIAL OVERVIEW
YEAR ENDED MARCH 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS:
Revenue:
Data products............................... $14,107 $11,930 $ 9,934 $ 8,037 $ 4,821
Consulting.................................. 4,386 3,523 3,661 3,966 4,047
------- ------- -------- -------- --------
Net revenue........................... 18,493 15,453 13,595 12,003 8,868
Cost of revenue............................... 5,964 5,571 5,959 4,679 4,129
------- ------- -------- -------- --------
Gross profit................................ 12,529 9,882 7,636 7,324 4,739
Operating costs:
Research and development.................... 3,127 2,602 2,336 1,855 1,647
Sales and marketing......................... 3,049 2,667 3,651 3,349 2,588
General and administrative.................. 3,028 3,305 3,172 2,273 1,686
Reorganization and other special charges.... 419 749 1,706 908 --
------- ------- -------- -------- --------
Total operating costs................. 9,623 9,323 10,865 8,385 5,921
Operating income (loss)..................... 2,906 559 (3,229) (1,061) (1,182)
Interest expense.............................. -- -- -- (274) (224)
Interest and other income, net................ 908 738 808 368 26
------- ------- -------- -------- --------
Income (loss) before provision for income
taxes..................................... 3,814 1,297 (2,421) (967) (1,380)
Provision for income tax expense.............. 1,024 102 40 -- --
Net income (loss)........................... 2,790 1,195 (2,461) (967) (1,380)
Accretion of redeemable preferred stock....... -- -- -- (110) (173)
------- ------- -------- -------- --------
Net income (loss) attributable to common
stockholders.............................. $ 2,790 $ 1,195 $ (2,461) $ (1,077) $ (1,553)
======= ======= ======== ======== ========
Basic earnings (loss) per share............... $ 0.40 $ 0.17 $ (0.37) $ (0.22) $ (0.44)
Weighted average common stock outstanding..... 7,029 6,860 6,710 4,918 3,508
Diluted earnings (loss) per share............. $ 0.37 $ 0.17 $ (0.37) $ (0.22) $ (0.44)
Weighted average common and dilutive potential
common stock outstanding.................... 7,523 7,195 6,710 4,918 3,508
YEAR ENDED MARCH 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and securities
available-for-sale............................ $9,971 $16,656 $13,678 $19,980 $ 1,190
Total assets.................................... 29,772 23,830 20,631 25,581 4,949
Redeemable common and preferred stock........... -- -- -- -- 3,069
Long-term debt.................................. -- -- -- -- 4,949
Stockholders' (deficit) equity.................. 23,956 19,770 17,962 19,901 (3,223)
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE DISCUSSION AND ANALYSIS BELOW CONTAINS TREND ANALYSIS AND OTHER
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING
STATEMENTS AS A RESULT OF THE RISK FACTORS SET FORTH BELOW IN "RISK FACTORS" AND
FACTORS CONTAINED HEREIN AND OTHER REPORTS FILED BY MECON.
OVERVIEW
MECON is a leading healthcare benchmarking solutions company. MECON believes
that its database together with its family of software products and consulting
services can be used to produce and sustain improved performance in healthcare
delivery systems. From its incorporation until 1989, its revenue was primarily
derived from consulting services for acute care hospitals. Since 1990, MECON has
focused upon building critical mass in its MECON-PEERx database product as well
as increasing the installed base for software products, MECON-OPTIMIS and
MECON-Action*Point. As a result, MECON has transitioned into providing a variety
of products and services that employ its proprietary database comprised of acute
care hospitals' operational cost and key performance information. Although 76%
of its revenues were derived from data products sales during the fiscal year
ended March 31, 1999, MECON believes that an increasing proportion of its
revenues will be derived from consulting services.
MECON believes this change in business mix will result from its recently
adopted customer intimacy strategy. MECON's ability to develop and maintain
long-term customer relationships is core to this strategy. As a key imperative
of this strategy, MECON must deliver immediate, significant and sustainable
value, in the form of operational cost reductions, to its customers. Without
consulting services, hospital management teams may not have the breadth and
depth to act upon the cost reduction opportunities identified by the PEERx
database. If no action is taken, customers may not perceive value from the
database, and as a result, not renew their subscriptions.
Tactics supporting the customer intimacy strategy include, but are not
limited to, selling the MECON-Integrated Solution-TM- whenever possible,
cross-selling existing products to existing customers and remaining firm on
MECON-PEERx pricing related to the renewal of older, low margin subscriptions.
The MECON-Integrated Solution is a packaged product offering that includes a
MECON-PEERx subscription, MECON-Advisory and MECON-OPTIMIS. MECON believes that
such a packaged offering assures that the customer achieves immediate,
significant and sustainable cost savings by not only receiving benchmark-based
cost management reports that identify cost reduction opportunities by department
but by also receiving its integrated consulting approach of implementing such
identified cost reduction opportunities and installing MECON-OPTIMIS, its
operational cost monitoring software tool, to assure cost reductions are
sustained.
Many of the older multi-year MECON-PEERx subscriptions were grandfathered at
substantially lower prices than current subscriptions. MECON has adopted a firm
pricing policy to migrate expiring MECON-PEERx subscriptions to current list
prices, and accordingly, certain of these subscribers may not renew their low
margin subscriptions at higher margins due to pricing sensitivity. Accordingly,
MECON is emphasizing replacing the revenue stream up for renewal more heavily
than replacing all the expiring units. During the year ended March 31, 1999,
MECON renewed a majority of all expiring contracts at 130% of the related
customers' expiring contract values. However, as a result of this firm pricing
tactic, MECON believes that some of the expiring contracts may not renew. One
such contract that did not renew is a contract with a hospital consortium that
covers approximately 40 academic teaching hospitals. During fiscal 1998, this
contract totaled $1.1 million or 7% of revenue. The original three-year
contract, signed in
3
fiscal 1992, one of MECON's first multi-year contracts, was steeply discounted
and hence contributed very low margins. MECON has traditionally recognized
approximately 55% of the hospital consortium revenue in the September quarter
and the remaining 45% in the December quarter. Including the revenue impact of
this contract's non-renewal on the fiscal year, revenue for the year ended March
31, 1999 increased 18% to $17.8 million compared to $15.1 million for fiscal
1998. MECON believes that the termination of this contract has not adversely
effected earnings.
The total value of contracts signed in the year ended March 31, 1999
increased 28% to $21.8 million compared to $17.1 million signed in fiscal 1998.
The year-over-year growth in contract value signed continues to assist MECON in
executing on its customer intimacy strategy, build its revenue backlog and
improve its visibility to revenue in the immediate future. As a result of
continued increases in the total value of contracts signed, MECON has achieved
record revenue. These increases in total contract value continue to build
MECON's backlog, which is defined as the total value of contracts signed that
have not been recognized as revenue. Backlog is then depleted by the revenue
recognized during the period. Since the total value of contracts signed in the
fiscal 1999 was $21.8 million compared to $17.8 million in revenue recognized,
backlog increased by approximately $4.0 million in fiscal 1999 including the
backlog of contracts acquired from LBA. At March 31, 1999 MECON's contract
backlog stood at $16.7 million, an increase of 31% over the prior fiscal year.
Approximately 50% to 75% of MECON's quarterly revenue is derived from
backlog. The remaining 25% to 50% is generated from contracts signed during the
relevant quarter. The increase in the recurring base of revenue, strong renewals
and consulting contracts coupled with strong expense controls have continued to
drive improvement in MECON's gross and operating margins.
In January 1999, MECON announced the release of its new database product,
MECON-PEERnext. MECON-PEERnext enables customers with an industry-standard
browser to access the MECON-PEERx database. The interactive capability of
MECON-PEERnext provides customers the ability to create, analyze and quickly
access their individualized benchmarking reports. The product eliminates the
need for customers to install customized software on their computers to obtain
benchmarking reports. Additionally, customers can analyze performance metrics
from their organization relative to a peer group or over time in either
graphical or tabular format. MECON believes the release of MECON-PEERnext
leverages the value of the existing database to its customers, strengthens its
competitive position and creates cost efficiencies in MECON's internal
operations by greatly reducing printing and supply costs related to delivering
benchmarking reports through a browser. MECON intends to migrate existing
customers to MECON-PEERnext during the next twelve months.
In March 1999, MECON terminated its strategic relationship with HBOC. During
last fiscal year HBOC sales accounted for less that 3% of revenue. MECON
believes that the termination of this relationship will not adversely affect
future earnings.
The two fundamental cost drivers for healthcare delivery systems are
clinical efficiency and operational efficiency, both of which must be managed
while maintaining quality outcomes. Healthcare providers have been challenged to
obtain comprehensive, cost management solutions that address the complete
clinical and operational environment. On March 31, 1999 MECON acquired the
Implementation Consulting Group, or ICG, of HCIA, Inc., formerly known as LBA
Healthcare, for $7.5 million in cash. ICG, based in Denver, Colorado, is a
provider of benchmarking-based consulting services for clinical service lines.
ICG was renamed LBA Healthcare and will remain headquartered in Denver as a
division of MECON. MECON has accounted for the acquisition, valued at $7.5
million, as a purchase transaction. In conjunction with the transaction, MECON
has signed separate license agreements with HCIA allowing HCIA's use of LBA
Healthcare data and MECON's use of HCIA risk adjustment methodologies. MECON
recorded no revenue and expenses related to LBA Healthcare in fiscal 1999.
4
LBA's consulting services and data products are designed to lead hospitals
and physicians to improve their competitive position in clinical service lines,
with special focus in cardiology, pulmonary, orthopedics and neurosciences.
LBA services include analyzing opportunities related to physician practice
patterns, developing physician gain-sharing and joint venture models to align
physician incentives, and identifying market opportunities to protect and
increase market share, clinical service line revenue and margins. The LBA
acquisition adds LBA's clinical efficiency database and consulting services to
MECON's operations cost management solution.
In August 1999, MECON noted that the revenue being generated by LBA's
Clinical Value Enhancement (CVE) business line was not meeting its expectations
which was based on the projections MECON received at the time of the
acquisition. Based on this information, MECON concluded that it could better
utilize its resources in other areas and decided to exit the CVE business line.
In consideration of SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of", and MECON's decision to
exit the business, MECON reviewed the goodwill associated with LBA for
impairment. MECON performed an undiscounted cashflow analysis based on revenue
projections expected to be received from future operations of LBA which revealed
that the goodwill was impaired. MECON estimated the fair market value of the
goodwill using a discounted cash flow model and recognized an impairment charge
of $5,555,000. Based on a 15 year cashflow projection, assuming a growth rate
commensurate with MECON's overall growth rate and a 5% discount rate, the
forecasted cashflows represented managements' best estimate of future results.
MECON also wrote-off certain other capitalized software costs associated with
the CVE business.
On September 30, 1999, MECON issued 774,000 shares of common stock and
assumed all outstanding options in exchange for all the outstanding shares of
common stock of Clinical Dynamics, a provider of Web-based software reporting
tools that analyze clinical process and outcome metrics of care for clinicians
and administrators. Clinical Dynamics provides highly functional, Web-based
software reporting tools which help providers create, manage and analyze
clinical outcomes data. Its flagship Web-based product line, DYNAMO-TM- or
Dynamic Analysis of Measured Outcomes, provides information on clinical
performance through physician profiling, hospital benchmarking, clinical pathway
development and practice variance analysis. The Dynamo product suite provides
clinicians and administrators with quick desktop access to complex clinical,
financial and demographic patient data information for day-to-day evaluation and
decision-making. The acquisition was accounted for as a pooling-of-interests.
All of MECON'S financial data presented in the consolidated financial statements
and management's discussion and analysis of financial condition and results of
operations have been restated to include the historical financial information of
Clinical Dynamics. Prior to the combination, Clinical Dynamics fiscal year ended
December 31. In recording the pooling-of-interests combination, Clinical
Dynamics financial statements were recast to conform to our March 31 year end.
On November 29, 1999, MECON announced that it had signed a definitive
agreement to merge its operations with General Electric Company. In this
transaction, MECON's stockholders will receive $11.25 per share payable in
General Electric Company. stock. The transaction is subject to approval by
MECON's stockholders, and other governmental approvals as required.
5
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of net
revenue for the period indicated:
FISCAL YEAR ENDED
MARCH 31,
------------------------------
1999 1998 1997
-------- -------- --------
STATEMENTS OF OPERATIONS:
Revenue:
Data products............................................. 76% 77% 73%
Consulting................................................ 24% 23% 27%
--- --- ----
Net revenue........................................... 100% 100% 100%
Cost of revenue............................................. 32% 36% 44%
--- --- ----
Gross profit................................................ 68% 64% 56%
Operating costs:
Research and development.................................. 17% 17% 17%
Sales and marketing....................................... 16% 17% 27%
General and administrative................................ 17% 21% 23%
Reorganization and other special charges.................. 2% 5% 13%
--- --- ----
Total operating costs................................. 52% 60% 80%
--- --- ----
Operating income (loss)..................................... 16% 4% (24)%
Interest and other income, net.............................. 5% 5% 6%
--- --- ----
Income (loss) before provision for income taxes............. 21% 9% (18)%
Provision for income tax expense............................ 6% 1% --
--- --- ----
Net income (loss)........................................... 15% 8% (18)%
--- --- ----
FISCAL 1999 COMPARED TO FISCAL 1998
REVENUE
Revenue for fiscal 1999 increased 20% to $18.5 million compared to
$15.5 million for fiscal 1998. Data products increased 18% to $14.1 million
compared to $11.9 million for fiscal 1998 and accounted for 72% of the revenue
increase. The increase in total net revenue was primarily due to an increased
base of recurring revenue from multi-year subscription contracts and renewal
subscription contracts at higher prices.
Consulting revenue for fiscal 1999 increased 25% to $4.4 million compared to
$3.5 million for fiscal 1998. The increase was primarily due to the size and
timing of the contracts signed and delivery of related services that impacted
the timing of revenue recognition. MECON anticipates consulting to remain a
significant portion of its revenue as a result of its value proposition strategy
of assuring that its customers derive immediate, significant and sustainable
performance improvement from its solution of data, consulting and software.
COST OF REVENUE
Cost of revenue for fiscal 1999 increased 7% to $6.0 million compared to
$5.6 million for fiscal 1998. The increase was primarily due to an increase in
amortization of software development costs that increased to $761,000 for fiscal
1999 from $580,000 for fiscal 1998. There were additional increases in the
number of highly compensated independent contractor consultants utilized to
deliver consulting services, stronger telecommunications management and
decreased printing costs related to the non-renewal of the hospital
6
consortium contract. The hospital consortium contract required significant paper
deliverables to all 40 academic facilities related to the benchmarking reports.
Cost of revenue for fiscal 1999 decreased to 32% of total revenue compared to
36% for fiscal 1998, primarily due to a shift in revenue mix from data products
to higher margin consulting.
RESEARCH AND DEVELOPMENT
Research and development expenses for fiscal 1999 increased 20% to
$3.1 million compared to $2.6 million for fiscal 1998. This increase was
primarily due to an increase in personnel related to the development of
MECON-PEERnext versions 1.0 and 2.0. Version 1.0 was released in January 1999,
and Version 2.0 was released in the first quarter of fiscal 2000. During fiscal
1999, $1.3 million was capitalized for internally developed software related to
product development and internal databases supporting MECON's products compared
to approximately $800,000 for fiscal 1998. The increase in software development
costs capitalized primarily relates to the programming, testing and release
management efforts related to MECON-PEERnext Version 1.0, which was released in
January 1999. Research and development expenses for fiscal 1999 remained
unchanged as a percent of revenue compared to fiscal 1998. MECON anticipates
research and development spending to increase in absolute dollars but decrease
as a percent of revenue as it moves from the initial product development efforts
for MECON-PEERnext Version 2.0 to programming, testing and release management.
SALES AND MARKETING
Sales and marketing expenses for fiscal 1999 increased 14% to $3.0 million
compared to $2.7 million for fiscal 1998, primarily due to an increase in
commissions and travel costs. Sales and marketing expenses for fiscal 1999
decreased slightly to 16% of revenue from 17% for fiscal 1998. MECON anticipates
sales and marketing expenses to increase in absolute dollars but remain
relatively constant as a percent of revenue due to increased commissions related
to an increasing customer base and more robust marketing efforts related to its
consulting capabilities and new product launches.
GENERAL AND ADMINISTRATIVE
General and administrative expenses for fiscal 1999 decreased 8% to
$3.0 million compared to $3.3 million for fiscal 1998, primarily due to
reductions in the provision for bad debts, professional fees and expenses
related to office infrastructure. The reduction in the bad debts provision
accounted for 28% of the decrease and was the result of a reduction in
write-offs and improved cash collections. The remainder of the decrease was a
result of MECON's cost cutting policies and programs to create efficiencies in
office infrastructure expenses. General and administrative expenses for fiscal
1999 decreased to 17% of revenue compared to 21% for fiscal 1998, primarily due
to the aforementioned factors. MECON anticipates general and administrative
expenses to increase in absolute dollars and as a percent of revenue.
7
REORGANIZATION AND OTHER SPECIAL CHARGES
During fiscal 1999, MECON incurred $419,000 of special charges related to
recruiting a senior vice-president of product integration and management and
write-off of marketing materials which were obsolete given our acquisition of
LBA.
PROVISION FOR INCOME TAXES
Income taxes for fiscal 1999 increased dramatically to $1.0 million compared
to $102,000 for fiscal 1998. This increase was primarily attributable to MECON's
increased profitability offset by the use of MECON's net operating loss
carryforwards and other tax credits. As of March 31, 1999, MECON used all of its
remaining net operating loss carryforwards. With no remaining net operating loss
carryforwards, changes in the tax laws related to research credits and MECON's
anticipated profits, MECON expects its effective tax rate of 27% for fiscal 1999
to increase closer to statutory tax rates in the future.
FISCAL 1998 COMPARED TO FISCAL 1997
REVENUE
Revenue for fiscal 1998 increased 14% to $15.5 million compared to
$13.6 million for fiscal 1997. Data products revenue for fiscal 1998 increased
20% to $11.9 million compared to $9.9 million for fiscal 1997 and accounted for
essentially all of the increase. This increase was primarily due to increases in
renewing subscribers, an increased base of recurring revenue from multi-year
subscription contracts sold in prior years and an increase in value added
services related to MECON-PEERx-TM-. Consulting revenue for fiscal 1998
decreased 4% to $3.5 million compared to $3.7 million in fiscal 1997.
COST OF REVENUE
Cost of revenue for fiscal 1998 decreased 7% to $5.6 million compared to
$6.0 million for fiscal 1997, primarily due to the reduction in workforce during
the April 17, 1997 reorganization, offset by an increase in amortization of
software development costs related to MECON's MECON-PEERview product. Cost of
revenue for fiscal 1998 included $580,000 in amortization expense from the
capitalization of software development expenses compared to $227,000 for fiscal
1997. Cost of revenue for fiscal 1998 decreased to 36% of total revenue compared
to 44% for fiscal 1997, primarily due to the aforementioned factors.
RESEARCH AND DEVELOPMENT
Research and development expenses for fiscal 1998 increased 11% to
$2.6 million compared to $2.3 million for fiscal 1997, primarily due to the
development of MECON-OPTIMIS Release 4.2, MECON-Action*Point Release 5.0 and
MECON-PEERview Version 5.0's functional specifications. During fiscal 1998,
approximately $800,000 was capitalized for internally developed software related
to product development and internal databases supporting company products.
Although research and development expenses remained constant at 17% of revenue
for both fiscal 1998 and 1997, the dollar amount increased due to a continued
commitment to develop the next generation of MECON-PEERVIEW, Version 5.0.
SALES AND MARKETING
Sales and marketing expenses for fiscal 1998 decreased 27% to $2.7 million
compared to $3.7 million for fiscal 1997, primarily due to MECON's reduction in
workforce during the three months ended June 30, 1997, coupled with a
significant decrease in advertising, tradeshow participation and travel. Sales
and marketing expenses for fiscal 1998 decreased to 17% of revenue compared to
27% for fiscal 1997, primarily due to the aforementioned factors.
8
GENERAL AND ADMINISTRATIVE
General and administrative expenses for fiscal 1998 increased 4% to
$3.3 million compared to $3.2 million for fiscal 1997, primarily due to
increased salary and related costs from increased headcount, increased
depreciation expense and higher professional fees. General and administrative
expenses for fiscal 1998 decreased to 21% of revenue compared to 23% for fiscal
1997, primarily due to the increase in revenue.
REORGANIZATION AND OTHER SPECIAL CHARGES
Reorganization and other special charges for fiscal 1998 decreased 56% to
$749,000 compared to $1.7 million for fiscal 1997. The reorganization charge for
fiscal 1998 was primarily due to MECON's reorganization plan announced in the
first quarter of fiscal 1998 that consisted of employee severance costs related
to the termination of 38 employees. The reorganization charge for fiscal 1997
was primarily due to MECON's reorganization in the third quarter of fiscal 1997
that consisted of $1.3 million related to centralizing the management of product
development, sales and product support organizations. The remaining $369,000
related to an aborted acquisition and costs associated with the prior year
merger. Of the total $749,000 reorganization costs incurred for fiscal 1998,
$714,000 was paid during fiscal 1998 and $35,000 remained accrued and unpaid as
of March 31, 1998, and all amounts related to the 1997 charge had been paid.
QUARTERLY RESULTS
The following table sets forth certain unaudited quarterly financial data
for fiscal 1998 and fiscal 1999. In the opinion of MECON's management, this
unaudited information has been prepared on the same basis as the audited
information included elsewhere herein and includes all adjustments, consisting
only of normal recurring adjustments necessary to present fairly the information
set forth therein. The operating results for any quarter are not necessarily
indicative of results for any future period:
FISCAL 1998 FISCAL 1999
----------------------------------------- -----------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Revenue:
Data products............... $2,263 $2,842 $3,105 $3,720 $2,910 $3,731 $3,618 $3,848
Consulting.................. 977 1,080 924 542 1,118 428 1,188 1,652
------ ------ ------ ------ ------ ------ ------ ------
Net revenue............... 3,240 3,922 4,029 4,262 4,028 4,159 4,806 5,500
Cost of revenue............. 1,248 1,467 1,426 1,430 1,442 1,238 1,521 1,763
------ ------ ------ ------ ------ ------ ------ ------
Gross profit................ 1,992 2,455 2,603 2,832 2,586 2,921 3,285 3,737
------ ------ ------ ------ ------ ------ ------ ------
Total operating costs....... 2,813* 2,184 2,237 2,089 2,240 2,011 2,296 3,076**
Operating income (loss)..... (821) 271 366 743 346 910 989 661
Net income (loss)........... (650) 425 528 892 408 870 931 581
------ ------ ------ ------ ------ ------ ------ ------
- ------------------------
* Includes $749,000 in reorganization costs.
** Includes $419,000 in special charges.
9
FISCAL YEAR 1998 FISCAL YEAR 1999
----------------------------------------- -----------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-------- -------- -------- -------- -------- -------- -------- --------
Revenue:
Data products..................... 70% 72% 77% 87% 72% 90% 75% 70%
Consulting........................ 30% 28% 23% 13% 28% 10% 25% 30%
---- ---- ---- ---- ---- ---- ---- ----
Net revenue..................... 100% 100% 100% 100% 100% 100% 100% 100%
Cost of revenue................... 39% 37% 35% 34% 36% 30% 32% 32%
---- ---- ---- ---- ---- ---- ---- ----
Gross profit...................... 61% 63% 65% 66% 64% 70% 68% 68%
---- ---- ---- ---- ---- ---- ---- ----
Total operating costs............. 87% 56% 56% 49% 56% 48% 48% 55%
Operating income (loss)........... (26)% 7% 9% 17% 8% 22% 20% 13%
Net income (loss)................. (20)% 11% 13% 21% 10% 21% 19% 11%
---- ---- ---- ---- ---- ---- ---- ----
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999 MECON's cash, cash equivalents and securities
available-for-sale decreased by $6.7 million to $10.0 million compared to
$16.7 million at March 31, 1998 primarily as a result of the purchase of LBA for
$7.5 million. MECON generated $2.9 million of cash flow from operating
activities for fiscal 1999 compared to $3.8 million for fiscal 1998. This
decrease was primarily due to the addition of a few large customers with special
payment plans that extend beyond MECON's traditional collection cycle. MECON's
days of sales outstanding increased to 83 days at March 31, 1999 compared to 63
days at March 31, 1998. This increase was primarily due to the purchase of LBA
and the related accounts receivable without the benefit of any related income.
MECON used $9.0 million of cash flow in investing activities for fiscal 1999
compared to $784,000 for fiscal 1998, primarily due to $7.5 million of cash paid
for the acquisition of LBA.
As of March 31, 1999, MECON had net working capital of $10.9 million,
including cash, cash equivalents and securities available-for-sale of
$10.0 million.
NEW ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED
In December 1998, the AICPA issued Statement of Position 98-9, "MODIFICATION
OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS"
(SOP 98-9) which amends certain provisions of SOP 97-2 and is effective for
fiscal years beginning after March 15, 1999. MECON believes that the adoption of
SOP 98-9 will not have a material effect on its results of operations or
financial position.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (SFAS 133), as
amended by SFAS No. 137. SFAS No. 133 standardizes the accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts. MECON anticipates that the adoption of SFAS No. 133 will not have an
impact on its consolidated financial statements.
RISK FACTORS
CERTAIN OF THE STATEMENTS ABOVE ARE FORWARD-LOOKING STATEMENTS. THE
FOLLOWING ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE PROJECTED IN ANY SUCH FORWARD-LOOKING STATEMENTS.
10
PRICING
On April 17, 1997, MECON announced that the original management team had
rejoined MECON and adopted a "back-to-basics" strategy. One tactic supporting
this "back-to-basics" strategy is to remain firm on MECON-PEERx-TM- pricing
related to renewal subscriptions. This tactic may result in certain existing
customers not renewing their older, low margin contracts at higher total
contract values due to price sensitivity. Termination of customer relationships
could result in lower subscription revenues for MECON, which could have a
material adverse effect on MECON.
VARIABILITY OF QUARTERLY RESULTS; SEASONALITY
MECON's quarterly revenues and operating results have varied significantly
in the past and are likely to vary substantially from quarter to quarter in the
future. Quarterly revenues and operating results may fluctuate as a result of a
variety of factors, including: MECON's sales cycle and demand for its products
and services; changes in distribution channels; changes in MECON's product mix;
the termination of, or a reduction in, subscriptions to MECON's MECON-PEERnext
and MECON-PEERx-TM- product; the loss of customers due to consolidation in the
healthcare industry; customer delays in providing information needed by MECON to
complete implementation of, and revenue recognition from, sales of the MECON-
PEERnext and MECON-PEERx-TM- products; changes in customer budgets; investments
in MECON's marketing, sales, research and development and administrative
personnel necessary to support MECON's strategic growth plan; the timing of new
product introductions and enhancements by MECON and its competitors; marketing
and sales promotional activities and trade shows; the unpredictability of
revenues from consulting services; and general economic conditions. Accordingly,
MECON's operating results for any particular quarterly period may not be
indicative of results for future periods. Moreover, MECON's operating expense
levels are relatively fixed and, to a large degree, are based on anticipated
revenue levels. Consequently, if anticipated revenues in any given quarter do
not occur as expected, expense levels could be disproportionately high and may
result in losses.
MECON's quarterly results have been, and may continue to be, affected by
hospital budgeting practices that cause many discretionary purchase decisions to
be made shortly before the budgetary year end, which generally occurs on June 30
or December 31. Consequently, MECON's operating results have been somewhat
seasonal.
DEPENDENCE ON PRINCIPAL PRODUCTS
For the fiscal year ended March 31, 1999, approximately 75% of MECON's
revenues were derived from subscriptions and licenses to its MECON-PEERnext,
MECON-PEERx-TM-, MECON-OPTIMIS-TM- and MECON-Action*Point-SM- products.
Accordingly, any significant reduction in subscriptions or sales of such
products would have a material adverse effect on MECON. Although subscriptions
to the MECON-PEERnext and MECON-PEERx-TM- database generally have three-year
terms, MECON cannot assume that customers will not cancel their subscriptions
prior to the end of the subscription period. In addition, although MECON has
experienced a high customer renewal rate, MECON cannot assure that its customers
will renew their subscriptions or that any renewal terms will be as favorable to
MECON as existing terms.
INTEGRITY AND RELIABILITY OF DATABASE
MECON's success depends significantly on the integrity of its database.
Although MECON tests data for completeness and consistency, it does not conduct
independent audits of the information provided by its customers. Moreover, while
MECON believes that the benchmarking information contained in its database is
representative of the operational aspects of various types of hospitals, MECON
cannot assure that such information is appropriate for comparative analysis in
all cases or that the database accurately reflects general or specific trends in
the hospital market. If the information contained in the database were
11
found, or were perceived, to be inaccurate, or if such information were
generally perceived to be unreliable, MECON could be materially and adversely
affected.
COMPETITION
The market for healthcare information systems and services is intensely
competitive and rapidly changing. MECON's competitors include other providers of
operations and financial benchmarking data and services, providers of decision
support software systems and management and healthcare consulting firms.
Furthermore, other major healthcare information companies not presently offering
cost management solutions may enter the markets in which MECON competes. Many of
its competitors and potential competitors have significantly greater financial,
technical, product development and marketing resources than MECON's, and
currently have, or may develop or acquire, substantial installed customer bases
in the healthcare industry. MECON also faces significant competition from
internal management information services departments of large hospital alliances
or for-profit hospital chains, many of which have developed or may develop
benchmarking information and other cost control solutions. In addition,
increased competitive pressures, among other factors, could lead to lower prices
for MECON's products and services, thereby materially adversely affecting
MECON's operating results. Accordingly, MECON cannot assure that it will be able
to compete successfully in the future.
MANAGEMENT OF GROWTH
MECON is currently experiencing a period of growth and expansion, which has
placed a significant strain on its personnel and resources. Its growth has
resulted in an increase in the level of responsibility for its key personnel,
several of whom were only recently hired. Failure to manage growth effectively,
or to develop, maintain or upgrade management information and other systems and
controls, could have a material adverse effect on MECON.
DEPENDENCE ON STRATEGIC RELATIONSHIPS
A key element of MECON's business strategy is to develop relationships with
leading industry organizations in order to increase its market presence, expand
distribution channels and broaden its product line. MECON believes that its
success in penetrating new markets for its products and services depends in
large part on its ability to maintain this relationship and cultivate additional
relationships. MECON cannot assure that its existing or future strategic
partners will not develop and market products in competition with it or
otherwise discontinue their relationships with it, or that it will be able to
successfully develop additional strategic relationships.
CONSOLIDATION AND UNCERTAINTY IN THE HEALTHCARE INDUSTRY
Many healthcare providers are consolidating to create larger healthcare
delivery enterprises with greater regional market power. Such consolidation
could erode MECON's existing customer base and reduce the size of its target
market. In addition, the resulting enterprises could have greater bargaining
power, which may lead to price erosion of its products and services. The
reduction in the size of MECON's target market or its failure to maintain
adequate price levels could have a material adverse effect on MECON.
The healthcare industry is subject to changing political, economic and
regulatory influences that may affect the procurement practices and operation of
healthcare industry participants. During the past several years, the U.S.
healthcare industry has been subject to an increase in governmental regulation
of, among other things, reimbursement rates and certain capital expenditures.
Several lawmakers have announced that they intend to propose programs to reform
the U.S. healthcare system. These programs may contain proposals to increase
governmental involvement in healthcare, lower reimbursement rates and otherwise
change the operating environment for MECON's customers. Healthcare industry
participants may react to
12
these proposals and the uncertainty surrounding such proposals by curtailing or
deferring investments, including those for MECON's products and services. MECON
cannot predict what impact, if any, such factors might have on its business,
financial condition and results of operations.
UNCERTAINTY OF ENTRANCE INTO NEW MARKETS
A substantial majority of MECON's revenues to date have been derived from
sales to large hospitals in urban areas. MECON's future success depends in part
upon its ability to market its products and services to other healthcare
providers, including small and rural hospitals, long-term care facilities, large
group medical practices, rehabilitation hospitals and surgical centers. In order
to develop the subscriber base necessary for the accumulation of meaningful
operations benchmarking data for such new markets, MECON may be required to
offer significant price discounts to prospective customers in such markets. In
addition, because such providers typically have smaller budgets than MECON's
existing customers, entry into new markets may require it to offer lower priced
versions of its products. Sales of such new products may result in lower gross
margins than sales to MECON's existing customer base. Moreover, the entry into
such new markets may require MECON to increase substantially its product
development, marketing and other expenses. MECON cannot assure that it will be
successful in entering new markets.
NEW PRODUCT DEVELOPMENT
MECON's future success and financial performance will depend in large part
on its ability to continue to meet the increasingly sophisticated needs of its
customers through the timely development and successful introduction of new and
enhanced versions of its database and other complementary products and services.
Product development has been focused on enhancing existing products or
introducing new products and has inherent risks, and MECON cannot assure that it
will be successful in its product development efforts or that the market will
continue to accept its existing or new products and services. MECON believes
that significant continuing product enhancement and development efforts will be
required to sustain its growth. MECON cannot assure that it will successfully
develop, introduce and market new products or product enhancements, or that
products or product enhancements it develops will meet requirements of
healthcare providers and achieve market acceptance.
POTENTIAL ACQUISITIONS
MECON may expand its product line through the acquisition of complementary
businesses, products and technologies. Acquisitions involve numerous risks,
including difficulties in the assimilation of operations and products, the
ability to manage geographically remote units, the diversion of management's
attention from other business concerns, the risks of entering markets in which
MECON has limited or no direct expertise and the potential loss of key employees
of the acquired companies. In addition, acquisitions may involve the expenditure
of significant funds. MECON cannot assure that any acquisition will result in
long-term benefits to it or that management will be able to manage effectively
the resulting business. In addition, such acquisitions may involve the issuance
of additional equity securities, which may be dilutive to existing stockholders.
DEPENDENCE ON KEY PERSONNEL
The success of MECON and of its business strategy is dependent in large part
on its key management and operating personnel. MECON believes that its future
success will also depend upon its ability to attract and retain highly skilled
technical, managerial and marketing personnel. Such individuals are in high
demand and often attract competing offers. In particular, MECON's success will
depend on its ability to retain the services of its executive officers. MECON
will also have an ongoing need to expand its management personnel and support
staff. The loss of the services of one or more members of management or key
employees, or the inability to hire additional personnel as needed, may have a
material adverse effect on MECON.
13
YEAR 2000
MECON has completed the evaluation of its internal systems and has also
completed implementation of systems and programming changes necessary to address
Year 2000 issues on an enterprise-wide basis. During the second quarter of
fiscal 2000 this remediation plan (consisting of upgrading and replacement of
certain product versions) has been implemented and tested for compliance.
MECON has evaluated the status of its products and implemented programming
changes necessary to address Year 2000 issues. With modifications to existing
software or converting to new software, the Year 2000 issue has not posed
significant operational problems for its computer systems; however, MECON cannot
assure that there will not be increased costs associated with, the
implementation of such changes, and its inability to implement such changes
could have a material adverse effect on MECON.
MECON has not fully determined the extent to which it may be impacted by
third parties' systems, which may not be Year 2000 compliant. The Year 2000
computer issue creates risk for MECON from customers' financial information
gathering systems and other third parties with which MECON deals on financial
transactions. While MECON expects to complete its efforts to seek assurance from
its suppliers, service providers and customers by the end of 1999, MECON cannot
assure that the systems of other companies that it deals with or on which its
systems rely will be timely converted, or that any such failure to convert by
another company could not have a material adverse effect on MECON. If MECON
determines that a material number of customers cannot collect their data because
of Year 2000 issues, as a contingency plan, MECON currently intends to staff
accordingly to collect the data manually.
MECON relies on third parties for services such as telecommunications,
Internet service, utilities and other key services and supplies. MECON is
seeking confirmation from such service providers that their systems are Year
2000 compliant. Interruption of those services or supplies due to Year 2000
issues could adversely affect MECON's operations. MECON is also subject to
external forces that might generally affect industry and commerce, such as
utility or transportation company Year 2000 compliance failures. MECON has
completed the process of updating and upgrading its internal information
systems. Although the replacement of information systems is not in direct
response to Year 2000 concerns, MECON expects that all new internal information
systems implemented in 1999 will be Year 2000 compliant.
Known or unknown Year 2000 errors or defects in MECON's internal systems and
products, lack of Year 2000 compliance by third party software incorporated in
its products and/or interruption of services from its external service providers
due to Year 2000 problems could result in failure or disruption of its products
and operations, delay or loss of revenue, diversion of development resources,
damage to its reputation, or claims or litigation, any of which could adversely
affect MECON. Some commentators have predicted significant litigation regarding
Year 2000 compliance issues, MECON is aware of such lawsuits against other
software vendors. Because of the unprecedented nature of such litigation, it is
uncertain whether or to what extent MECON may be affected by it.
MECON currently responds to customer concerns about its products on a
case-by-case basis. MECON believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways,
including the decision to delay purchasing MECON products until the Year 2000.
MECON believes that it is not possible to predict the overall impact of these
decisions.
At this stage in MECON's analysis and remediation process, it is difficult
to specifically identify the cause and the magnitude of any adverse economic
impact of the most reasonably likely worst case Year 2000 scenario. MECON's
reasonably likely worst case scenario would include the unavailability of its
major internal systems to its employees and the failure of its products to
operate properly, causing customers' systems and/or operations to fail or be
disrupted. Such worst case scenario also would include the failure of key
vendors and/or suppliers to correct their own Year 2000 issues, which failures
could cause failure or disruption of MECON's operations or products. If a worst
case scenario occurs, MECON may incur expenses to repair its systems or upgrade
its products, face interruptions in the work of its employees, lose
14
service and product license revenue, not be able to deliver downloads of its
products, incur service expenses and suffer damage to its reputation. Any or all
of the above events could have an adverse economic impact on MECON.
MECON has developed a comprehensive contingency plan to address situations
that may result if it is unable to achieve Year 2000 readiness of its critical
operations. The cost of developing and implementing such a plan may itself be
material. To date, MECON has not incurred significant expenditures for its Year
2000 remediation efforts as it has deployed existing resources to address Year
2000 issues noted. Although MECON does not anticipate the costs to address its
Year 2000 issues to be material, the costs of Year 2000 remediation work and the
date on which it plans to complete such work is based on management's best
estimates, which are derived from assumptions about future events, including the
availability of certain resources, third-party remediation plans and other
factors. In addition, undetected errors or the failure of such systems to be
Year 2000 compliant could create significant record-keeping and operational
deficiencies. Accordingly, if Year 2000 modifications, evaluations, assessments
and conversions are not made, or are not completed in time, the Year 2000
problem could have an adverse impact on MECON.
15
ITEM 7. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
The Board of Directors
MECON, Inc.
We have audited the accompanying consolidated balance sheets of MECON, Inc.
and subsidiaries as of March 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended March 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MECON, Inc.
and subsidiaries as of March 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended March 31, 1999, in conformity with generally accepted accounting
principles.
KPMG LLP
San Francisco, California
December 14, 1999
16
MECON, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
1999 1998
-------- --------
Current assets:
Cash and cash equivalents................................. $ 7,182 $12,812
Securities available-for-sale, at market.................. 2,789 3,844
Accounts receivable, net of allowances of $1,703 and $308,
respectively............................................ 5,517 2,882
Unbilled accounts receivable.............................. 745 522
Prepaid expenses and other current assets................. 327 385
Employee receivables...................................... 106 73
------- -------
Total current assets................................ 16,666 20,518
Property and equipment, net................................. 2,106 1,527
Software development costs, net............................. 2,414 1,776
Goodwill, net............................................... 8,577 --
Other assets................................................ 9 9
------- -------
$29,772 $23,830
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 573 $ 317
Accrued salaries and benefits............................. 899 848
Deferred revenue.......................................... 2,281 1,969
Other accrued liabilities................................. 2,063 906
------- -------
Total current liabilities........................... 5,816 4,040
Long-term obligations, less current portion................. - 20
------- -------
Total liabilities................................... 5,816 4,060
------- -------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value; 5,000,000 authorized;
none issued and outstanding............................. -- --
Common stock, $.001 par value; 50,000,000 shares
authorized; 7,111,319 and 6,975,068 issued and
outstanding in 1999 and 1998, respectively.............. 7 7
Additional paid-in capital................................ 27,051 25,655
Accumulated deficit....................................... (3,102) (5,892)
------- -------
Total stockholders' equity.......................... 23,956 19,770
------- -------
$29,772 $23,830
======= =======
See accompanying notes to consolidated financial statements.
17
MECON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1999 1998 1997
-------- -------- --------
Revenue:
Data products............................................. $14,107 $11,930 $ 9,934
Consulting................................................ 4,386 3,523 3,661
------- ------- --------
Net revenue......................................... 18,493 15,453 13,595
Cost of revenue............................................. 5,964 5,571 5,959
------- ------- --------
Gross profit........................................ 12,529 9,882 7,636
------- ------- --------
Operating costs:
Research and development.................................. 3,127 2,602 2,336
Sales and marketing....................................... 3,049 2,667 3,651
General and administrative................................ 3,028 3,305 3,172
Reorganization and other special charges.................. 419 749 1,706
------- ------- --------
Total operating costs............................... 9,623 9,323 10,865
------- ------- --------
Operating income (loss)..................................... 2,906 559 (3,229)
Interest and other income, net.............................. 908 738 808
------- ------- --------
Income (loss) before provision for taxes.................... 3,814 1,297 (2,421)
Provision for income taxes.................................. 1,024 102 40
------- ------- --------
Net income (loss)................................... $ 2,790 $ 1,195 $ (2,461)
======= ======= ========
Basic earnings (loss) per share............................. $ 0.40 $ 0.17 $ (0.37)
======= ======= ========
Weighted average common stock outstanding................... 7,029 6,860 6,710
======= ======= ========
Diluted earnings (loss) per share........................... $ 0.37 $ 0.17 $ (0.37)
======= ======= ========
Weighted average common and dilutive potential common stock
outstanding............................................... 7,523 7,195 6,710
======= ======= ========
See accompanying notes to consolidated financial statements.
18
MECON, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
MARCH 31, 1999, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
COMMON STOCK ADDITIONAL TOTAL
-------------------- PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
--------- -------- ---------- ----------- -------------
Balances as of March 31, 1996............ 6,650,947 $ 7 $24,520 $ (4,626) $19,901
Exercise of common stock options......... 102,968 -- 398 -- 398
Employee stock purchase plan purchases... 20,382 -- 144 -- 144
Other.................................... -- -- (20) -- (20)
Net loss................................. -- -- -- (2,461) (2,461)
--------- ---- ------- -------- -------
Balances as of March 31, 1997............ 6,774,297 7 25,042 (7,087) 17,962
Exercise of common stock options......... 162,487 -- 462 -- 462
Employee stock purchase plan purchases... 38,284 -- 103 -- 103
Contribution of services by executive
officer of "pooled" company............ -- -- 48 -- 48
Net income............................... -- -- -- 1,195 1,195
--------- ---- ------- -------- -------
Balances as of March 31, 1998............ 6,975,068 7 25,655 (5,892) 19,770
Exercise of common stock options......... 110,442 -- 354 -- 354
Employee stock purchase plan purchases... 25,809 -- 161 -- 161
Tax benefit of employee stock
transactions........................... -- -- 814 -- 814
Contribution of services by executive
officer of "pooled" company............ -- -- 67 -- 67
Net income............................... -- -- -- 2,790 2,790
--------- ---- ------- -------- -------
Balances as of March 31, 1999............ 7,111,319 $ 7 $27,051 $ (3,102) $23,956
========= ==== ======= ======== =======
See accompanying notes to consolidated financial statements.
19
MECON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
(IN THOUSANDS)
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net income (loss)......................................... $ 2,790 $ 1,195 $ (2,461)
Adjustments to reconcile income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization......................... 1,548 1,202 622
Loss on write off of fixed assets..................... -- -- 328
Bad debt and sales discount provisions................ 91 370 472
Noncash compensation.................................. 67 48 --
Tax benefit of employee stock transactions............ 814 -- --
Changes in operating assets and liabilities:
Accounts receivable................................. (1,711) (710) (245)
Unbilled accounts receivable........................ (223) 364 (360)
Prepaid expenses and other current and noncurrent
assets and employee receivables................... 53 (40) (54)
Accounts payable.................................... 256 (284) 421
Deferred revenue.................................... (715) 911 (275)
Accrued and other liabilities....................... (112) 764 (1,217)
------- ------- --------
Net cash provided by (used in) operating
activities...................................... 2,858 3,820 (2,769)
------- ------- --------
Cash flows from investing activities:
Purchases of securities available-for-sale................ (2,920) (6,826) (8,117)
Proceeds from sales or maturities of securities
available-for-sale...................................... 3,975 7,449 8,425
Acquisitions of property and equipment.................... (1,106) (503) (1,301)
Cash paid for acquisition................................. (7,500) -- --
Computer software development costs....................... (1,452) (904) (814)
------- ------- --------
Net cash used in investing activities............. (9,003) (784) (1,807)
------- ------- --------
Cash flows from financing activities:
Repayment of bank borrowings.............................. -- -- (1,940)
Proceeds from exercise of stock options and employee stock
purchases............................................... 515 565 542
Other..................................................... -- -- (20)
------- ------- --------
Net cash provided by (used in) financing
activities...................................... 515 565 (1,418)
------- ------- --------
Net (decrease) increase in cash and cash equivalents........ (5,630) 3,601 (5,994)
Cash and cash equivalents at beginning of year.............. 12,812 9,211 15,205
------- ------- --------
Cash and cash equivalents at end of year.................... $ 7,182 $12,812 $ 9,211
======= ======= ========
Supplemental information:
Cash paid for taxes....................................... $ 63 $ 40 $ --
======= ======= ========
Supplemental disclosure of noncash investing and financing
activities:
Acquisition (see note 3):
Fair value of assets acquired......................... $ 9,827 $ -- $ --
Less:
Cash paid........................................... (7,500) -- --
Deferred revenue.................................... (1,027) -- --
------- ------- --------
Liabilities assumed and acquisition costs accrued......... $ 1,300 $ -- $ --
======= ======= ========
See accompanying notes to consolidated financial statements.
20
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999, 1998 AND 1997
(1) BUSINESS OF THE COMPANY
MECON, Inc. is a leading provider of benchmarking solutions to the
healthcare industry. The benchmarking solutions offered by MECON consist of
data/information products, decision support software and value-added services.
The principal focus of MECON's products and services is to reduce costs and
improve efficiency and effectiveness of healthcare delivery systems. MECON's
main product line is based upon a proprietary operations benchmarking database
containing cost and key performance information from hospitals nationwide. In
addition to statistical data, the database incorporates qualitative data derived
from operational profiles provided by hospitals that utilize our
database-related products. MECON's customers use the information provided by the
operations benchmarking database to quantify, develop and implement strategies
to reduce costs and to periodically measure actual performance to maintain the
cost reductions achieved. The acquisition in March, 1999 of the Implementation
Consulting Group of HCIA Inc. (HCIA), formerly known as LBA Healthcare, a
leading provider of benchmarking-based consulting services for clinical service
lines, enables MECON to offer a benchmarking-based healthcare cost management
solution that encompasses both clinical and operational requirements. The
acquisition of Clinical Dynamics, Inc. (CDI) in September 1999 has enabled MECON
to provide software reporting tools that analyze clinical process and outcomes
metrics of care for clinicians and administrators. The consolidated financial
statements have been restated to include the financial position and results of
operations of CDI for all periods presented.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All intercompany balances and transactions
have been eliminated in consolidation.
CASH EQUIVALENTS
All highly liquid investments with a maturity of three months or less at the
date of purchase are considered to be cash equivalents. Cash equivalents consist
principally of money market instruments which include: corporate notes,
corporate bonds, certificates of deposits, commercial paper and government
agency securities.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the estimated useful lives of the respective
assets which are generally three to five years.
SOFTWARE DEVELOPMENT COSTS
MECON capitalizes internally generated software development costs for
external use in accordance with Statement of Financial Accounting Standards
(SFAS) No. 86, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR
OTHERWISE MARKETED. Capitalization of software development costs begins upon the
establishment of technological feasibility for the product. MECON amortizes such
capitalized amounts upon commencement of product introduction at the greater of
the straight-line basis using estimated economic lives of two to three years or
the ratio of actual revenues achieved to total anticipated revenues over the
lives of the products. The realizability of unamortized capitalized costs is
periodically
21
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reviewed relative to the estimated future revenues of the related products.
Under SFAS No. 86, MECON capitalized $1,309,000, $740,000 and $754,000 of
software development costs for the years ended March 31, 1999, 1998 and 1997,
respectively.
MECON capitalizes software development costs for internal use in accordance
with Statement of Position (SOP) 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER
SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. Capitalization of software
development costs begins in the application development stage of the product.
MECON amortizes such capitalized amounts using the straight-line basis over
estimated economic lives of up to three years. Under SOP 98-1, MECON capitalized
$143,000 and $92,000 of software development costs related to internal databases
supporting company products for the years ended March 31, 1999 and 1998,
respectively, and no such costs for prior periods.
RESEARCH AND DEVELOPMENT
Research and development expenditures are charged to expense in the period
incurred.
ADVERTISING COSTS
All costs associated with advertising and promoting products are expensed in
the period incurred. Costs to date have been insignificant.
REVENUE RECOGNITION
Beginning April 1, 1998, MECON has accounted for the sale of software and
related revenues in accordance with SOP 97-2, SOFTWARE REVENUE RECOGNITION. SOP
97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements.
Revenue generated from the initial year of a MECON-PEERx-TM-subscription and
related MECON-PEERview-TM- license and services contract is recognized ratably
from the date of contract signing over the estimated time to complete
acquisition of data into the database, which is generally four to five months in
duration. Revenue generated from a subsequent year subscription contract is
recognized ratably over the estimated time to complete the acquisition of data
into the database, which generally takes four to five months beginning in the
second or third year of the contract. Revenue generated from the initial year of
a PEER Overview Assessment contract is recognized ratably from the date of
contract signing over the estimated time to the complete acquisition of data
into the database, the overview assessment, and the executive briefing, which is
generally five to six months in duration. Costs to deliver the MECON-PEERx-TM-
products are estimated to be incurred evenly throughout the period beginning
with the signing of a contract and ending with the delivery of a report. Revenue
earned and unbilled is recorded as unbilled accounts receivable and amounts
billed and unearned are recorded as deferred revenue.
Revenue from MECON-OPTIMIS-TM- and MECON-Action*Point-SM- license and
implementation services are recorded as deferred revenue and recognized upon
completion of implementation. MECON offers post-contract customer support to its
MECON-OPTIMIS-TM- and MECON-Action*Point-SM- customers. Revenue from maintenance
services, including amounts bundled with the initial license fee, is recorded as
deferred revenue and recognized ratably over the period the post-contract
customer support services are provided.
22
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MECON-Advisory-TM- revenue is recognized as the services are performed or as
the customer's specific project is completed.
Revenue from fees paid for access to our DYNAMO-TM- Web-based clinical
performance tool are earned and are recognized ratably over the access period.
MECON's adoption of SOP 97-2 did not have a material effect on revenue
recognition or the results of operations. Prior to adoption of SOP 97-2, MECON
accounted for software and related revenues in accordance with SOP 91-1,
SOFTWARE REVENUE RECOGNITION.
In December 1998, the AICPA issued SOP 98-9, MODIFICATION OF SOP 97-2,
SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which amends
SOP 97-2 regarding how to account for multiple-element arrangements and how
vendor-specific evidence is defined. SOP 98-9 is effective for fiscal years
beginning after March 15, 1999. MECON believes that the adoption of SOP 98-9
will not have a material effect on its results of operations or financial
position.
INCOME TAXES
MECON accounts for income taxes in accordance with SFAS No. 109, ACCOUNTING
FOR INCOME TAXES. Under SFAS No. 109 deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
COMPREHENSIVE INCOME (LOSS)
Beginning April 1, 1998, we adopted SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, which establishes standards for reporting and display of comprehensive
income and its components in a full set of general purpose financial statements.
MECON has no components of other comprehensive income (loss) and, accordingly,
the comprehensive income (loss) is the same as net income (loss) for all periods
presented.
EARNINGS (LOSS) PER SHARE
SFAS No. 128, EARNINGS PER SHARE, requires the presentation of basic
earnings per share (EPS) and, for companies with complex capital structures,
diluted EPS. Basic earnings (loss) per share is calculated using the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share is calculated using the weighted average number of common and
dilutive potential common stock outstanding during the period. Dilutive
potential common stock represents outstanding options which are calculated using
the treasury stock method.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject us to concentrations of
credit risk, consist principally of cash and cash equivalents, securities
available-for-sale and trade receivables. MECON has investment
23
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
policies that limit investments to short-term low risk investments. MECON
performs ongoing credit evaluations of its customers' financial condition and
generally does not require collateral. MECON maintains an allowance for doubtful
accounts to cover potential credit losses.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the recorded amounts of assets and liabilities at the
date of the consolidated financial statements and of revenues and expenses
during the reporting period, as well as the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements. A change in
the facts and circumstances surrounding these estimates could result in a change
to the estimates and impact future operating results.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
MECON reviews its long-lived assets, including goodwill, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets held and used,
including goodwill, is measured by a comparison of the carrying amount of an
asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets.
STOCK-BASED COMPENSATION
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, establishes financial
accounting and reporting standards for stock-based compensation, including
employee stock purchase plans and stock option plans. As allowed by SFAS No.
123, MECON continues to measure compensation expense for awards granted to
employees under the provisions of Accounting Principles Board (APB) No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1998 and 1997 consolidated
financial statements to conform to the 1999 presentation. Such reclassifications
had no effect on previously reported results of operations.
(3) ACQUISITION
On March 31, 1999, MECON completed the acquisition of certain assets and
liabilities of the Implementation Consulting Group (ICG) of HCIA Inc. (HCIA),
formerly known as LBA Healthcare, for $7.5 million in cash. Upon acquisition,
MECON renamed the acquired division LBA Healthcare (LBA). LBA, based in Denver,
Colorado, is a leading provider of benchmarking-based consulting services for
clinical service lines. The acquisition was accounted for using the purchase
method of accounting and, accordingly, the results of LBA's operations will be
included in MECON's consolidated financial statements from the date of
acquisition of March 31, 1999. Through the date of acquisition, the historical
24
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(3) ACQUISITION (CONTINUED)
revenues earned by ICG were related to the Clinical Value Enhancement (CVE) and
Strategic Business Development (SBD) business lines.
A summary of the purchase price for the acquisition is as follows (in
thousands):
Cash........................................................ $7,500
Termination benefits accrual................................ 539
Accrued closure costs....................................... 111
Accrued vacation, accounts payable, and other accrued
liabilities assumed....................................... 329
Direct acquisition costs (primarily legal, accounting and
travel expenses).......................................... 321
Deferred revenue............................................ 1,027
------
Total............................................. $9,827
======
The termination benefits accrual pertains to thirteen (13) LBA employees who
will be terminated in accordance with an exit plan developed by MECON. Included
in the accrual are costs associated with certain employees in accordance with
the purchase agreement, who have been retained solely to develop certain
technology for HCIA. MECON will not derive any on-going future benefit from the
services of these specified employees or the technology under development, and
these employees will be terminated in 1999 once the technology is completed for
HCIA.
In conjunction with the transaction, MECON signed separate license
agreements with HCIA allowing HCIA's use of LBA data and MECON's use of HCIA
risk adjustment methodologies. Such license agreements became effective on April
1, 1999 and no payments were due as of March 31, 1999.
In connection with the purchase of LBA, MECON entered into an agreement with
HCIA whereby MECON would act as HCIA's agent and/or subcontractor for certain
contracts not assigned by HCIA. MECON will be fully responsible for performance
of the non-assigned contracts and will be compensated accordingly as services
are performed. For two certain non-assigned contracts, MECON will be reimbursed
for services performed based on amounts set forth in the agreement. For all
other non-assigned contracts, MECON will receive all amounts paid to HCIA for
the services performed by MECON pursuant to the contracts. In connection with
the agreement, MECON and HCIA agreed to appoint certain representatives of their
respective companies to resolve any disputes related to service obligations or
compensation matters in good faith.
Accrued closure costs pertain to excess leased space at LBA's facilities in
Colorado. The space is vacant and expected to be disposed of within twelve
months.
The purchase price was allocated as follows (in thousands):
Accounts receivable, net.................................... $1,015
Property and equipment...................................... 207
Other current assets........................................ 28
Goodwill.................................................... 8,577
------
Total........................................... $9,827
======
25
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(3) ACQUISITION (CONTINUED)
Goodwill represents the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired and is amortized using the
straight-line method over its estimated life of fifteen years.
The following table represents pro forma results of operations as if the
acquisition had occurred on April 1, 1997. The pro forma information is not
necessarily indicative of the combined results that would have occurred had the
acquisition taken place on April 1, 1997, nor is it necessarily indicative of
results that may occur in the future (in thousands).
FISCAL FISCAL
1999 1998
-------- --------
PRO FORMA BASIS
Total net revenues....................................... $ 27,296 $ 31,513
Net loss................................................. (19,445) (36,744)
Net loss per share--basic and diluted.................... (2.77) (5.36)
(4) REORGANIZATION AND OTHER SPECIAL CHARGES
During fiscal 1999, MECON incurred $419,000 special charges related to
recruiting a senior vice president of product integration and management and
write-off of marketing materials which were obsolete given MECON's acquisition
of LBA.
During fiscal 1998, MECON took action to reduce its ongoing quarterly
operating expense base. As a part of the expense reduction effort, it decreased
its workforce by 38 employees on April 17, 1997 and incurred a $749,000
reorganization charge during the first quarter of fiscal 1998. This charge was
primarily comprised of employee severance and related benefits and additional
costs associated with facility shutdowns. The following table sets forth a
description of the reorganization charge for the year ended March 31, 1998:
ACCRUAL
TOTAL USED OR AT
REORGANIZATION COST EXPENSE PAID 3/31/98
- ------------------- -------- -------- --------
Salaries and termination benefits.............. $634,000 $599,000 $35,000
Facilities shutdown............................ 38,000 38,000 --
Professional fees.............................. 77,000 77,000 --
-------- -------- -------
$749,000 $714,000 $35,000
======== ======== =======
At March 31, 1999, $35,000 remains accrued related to employee termination
matters.
During fiscal 1997, MECON implemented a plan to reorganize its operations by
centralizing the management of its product development, sales and product
support organizations to better achieve its strategic growth objectives. In
connection with the implementation of this new corporate structure, MECON
recorded a pretax charge of $1,337,000 for costs associated with employee
severance and related benefits; asset writedowns; expansion of the corporate
headquarters; and a provision for accounts receivable that management believed
would not be collectible. This reserve was established because MECON believed
its commitment to the development of new products would change the strategic
26
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(4) REORGANIZATION AND OTHER SPECIAL CHARGES (CONTINUED)
direction of its product lines. The following table sets forth a description of
the type and amount of reorganization costs recognized as expense for the year
ended March 31, 1997:
USED ACCRUAL
TOTAL OR AT
REORGANIZATION COST EXPENSE PAID 3/31/97
- ------------------- ---------- ---------- --------
Salaries and termination benefits.......... $ 529,000 $ 529,000 $ --
Facilities shutdown........................ 285,000 285,000 --
Professional fees.......................... 5,000 5,000 --
Asset writedowns........................... 218,000 218,000 --
Provision for doubtful accounts............ 300,000 51,325 248,675
---------- ---------- --------
$1,337,000 $1,088,325 $248,675
========== ========== ========
During fiscal 1998, MECON utilized for bad debt write-offs the remaining
balance of $248,675 that was identified at the time of the restructuring.
Other special charges of $369,000 were incurred during fiscal 1997 related
to additional acquisition costs from a prior year merger and costs associated
with aborted acquisitions.
(5) FAIR VALUE OF FINANCIAL INSTRUMENTS
In accordance with the requirements of SFAS No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES, MECON has classified its investments
in certain debt securities as "available-for-sale." Such investments are
recorded at fair value based on quoted market prices, with unrealized gains and
losses, deemed by MECON as temporary in nature, reported as a separate component
of other comprehensive income (loss). At March 31, 1999 and 1998, cost of
available-for-sale securities approximated fair value of such securities.
At March 31, 1999 and 1998, available-for-sale securities consisted of the
following (in thousands):
1999 1998
-------- --------
Government securities...................................... $ -- $ 522
Corporate debt securities.................................. 9,050 13,484
------ -------
$9,050 $14,006
====== =======
At March 31, 1999 and 1998, these securities were classified in the Consolidated
Balance Sheet as follows (in thousands):
1999 1998
-------- --------
Cash equivalents........................................... $6,261 $10,162
Securities available-for-sale.............................. 2,789 3,844
------ -------
$9,050 $14,006
====== =======
The contractual maturity of all available-for-sale securities as of March
31, 1999 was one year or less.
27
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(5) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
During fiscal 1999, 1998 and 1997, there were no gross realized gains or
losses on sales of securities held as available-for-sale.
The carrying amounts of all other financial instruments approximate fair
value because of their short maturity.
(6) PROPERTY AND EQUIPMENT AND SOFTWARE DEVELOPMENT COSTS
The following is a summary of property and equipment at March 31, 1999 and
1998 (in thousands):
1999 1998
-------- --------
Office furniture and equipment............................ $ 701 $ 535
Computers................................................. 2,875 2,237
Leasehold improvements.................................... 698 191
------- -------
$ 4,274 $ 2,963
Less accumulated depreciation............................. (2,168) (1,436)
------- -------
$ 2,106 $ 1,527
======= =======
Depreciation expense was $732,000, $564,000 and $395,000 for the years ended
March 31, 1999, 1998 and 1997, respectively.
The following is a summary of software development costs at March 31, 1999
and 1998 (in thousands):
1999 1998
-------- --------
Purchased software........................................ $ 373 $ 230
Internally developed software for internal use............ 290 92
Internally developed software held for sale, license, or
lease................................................... 4,182 3,071
------- -------
4,845 3,393
Less accumulated amortization............................. (2,431) (1,617)
------- -------
$ 2,414 $ 1,776
======= =======
Amortization expense was $816,000, $638,000 and $227,000 for the years ended
March 31, 1999, 1998 and 1997, respectively.
(7) COMMITMENTS AND CONTINGENCIES
MECON is involved in certain legal matters which are normal for the industry
in which MECON operates. Management believes that these matters, both
individually and in the aggregate, will not have a material adverse impact on
MECON's financial position or results of operations.
MECON leases office space under operating leases with terms of 29 and 60
months. Certain office equipment is leased under operating leases with terms of
approximately 36 months.
28
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(7) COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease commitments under operating leases are as follows (in
thousands):
YEAR ENDING MARCH 31,
- ---------------------
2000........................................................ $ 750
2001........................................................ 779
2002........................................................ 565
2003........................................................ 409
2004 and thereafter......................................... 347
------
Total................................................... $2,850
======
In conjunction with the purchase of LBA, Mecon entered into a sub-lease
agreement, which is included in lease commitments above, with HCIA to lease
certain office space through August 2001.
Rent expense under operating leases for the years ended March 31, 1999, 1998
and 1997 was $372,000, $408,000 and $520,000, respectively.
(8) RELATED PARTY TRANSACTIONS
IT Solutions, Inc. (ITS) is partially owned by certain of our stockholders.
MECON purchased contract software programming services from ITS totaling
approximately $0, $3,000 and $500,000, capitalized as software development costs
or expensed as research and development costs, during the years ended March 31,
1999, 1998 and 1997, respectively.
(9) INCOME TAXES
Income tax expense for the years ended March 31, 1999, 1998 and 1997
consists of the following (in thousands):
1999 1998 1997
-------- -------- --------
Current:
Federal.............................................. $ 757 $ 118 $ 3
State................................................ 304 83 16
------ ----- ---
1,061 201 19
Deferred:
Federal.............................................. (28) (79) 16
State................................................ (9) (20) 5
------ ----- ---
(37) (99) 21
------ ----- ---
Total tax expense.................................. $1,024 $ 102 $40
====== ===== ===
29
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(9) INCOME TAXES (CONTINUED)
Income tax expense for the years ended March 31, 1999, 1998 and 1997
differed from the amounts computed by applying the U.S. Federal income tax rate
of 34% of pretax income (losses) as a result of the following (in thousands):
1999 1998 1997
-------- -------- --------
Computed "expected" tax expense (benefit)............ $ 1,297 $ 441 $(823)
Nondeductible expenses and merger costs.............. 29 26 87
Research credits..................................... -- -- (196)
State taxes.......................................... 192 41 15
Utilization of net operating loss and research credit
carryforwards...................................... -- (464) --
Change in beginning of year valuation allowance...... (1,147) -- --
Losses and credits for which no benefit was taken.... 653 -- 953
Other................................................ -- 58 4
------- ----- -----
$ 1,024 $ 102 $ 40
======= ===== =====
The tax effects of temporary differences that gave rise to significant
portions of deferred income tax assets and liabilities as of March 31, 1999 and
1998 are as follows (in thousands):
1999 1998
-------- --------
Deferred tax assets:
Net operating losses...................................... $ -- $ 790
Compensated absences...................................... 246 153
Research credit carryforwards............................. -- 438
Research expenses capitalized for state tax purposes...... 126 143
Capital loss carryforward................................. 5 259
Allowance for bad debts................................... 73 122
Depreciation.............................................. 2 70
MCIS tax accounting method change......................... 109 173
Other accrued liabilities................................. 979 144
----- -------
Total gross deferred tax assets......................... 1,540 2,292
Less valuation allowance.................................... (631) (1,778)
----- -------
Net deferred tax assets................................. 909 514
Deferred tax liabilities:
Software costs............................................ (774) (416)
----- -------
Total gross deferred tax liabilities.................... (774) (416)
----- -------
Net deferred tax asset.................................. $ 135 $ 98
===== =======
MECON has certain acquired deferred tax assets from the LBA acquisition of
$631,000 that, when realized, will reduce the carrying value of goodwill and
create no income tax benefit.
30
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(9) INCOME TAXES (CONTINUED)
The (decrease) increase in the valuation allowance of approximately
$(1,147,000), $(298,000) and $1,733,000 for the years ended March 31, 1999, 1998
and 1997, respectively, was primarily due to a change in deferred tax assets for
which there was an uncertainty regarding the ultimate realization of the gross
deferred asset.
A portion of the net operating loss carryforward utilized in the current
year is attributable to the exercise of stock options which resulted in
approximately $814,000 of deferred tax assets being credited to additional
paid-in capital.
(10) EMPLOYEE RETIREMENT AND SAVINGS PLAN
MECON has a qualified 401(k) savings plan. All full-time employees with one
year of service may defer a portion of their salary. At the discretion of the
Board of Directors, MECON may also make a matching contribution for all eligible
employees. MECON's contributions to the plan were approximately $57,000, $49,000
and $26,000 for the years ended March 31, 1999, 1998 and 1997, respectively.
(11) PREFERRED SHARE PURCHASE RIGHTS PLAN
Pursuant to the Preferred Shares Rights Agreement (the Rights Agreement)
dated April 9, 1997, the Company's Board of Directors declared a dividend of one
right (the Rights) on each outstanding share of the Company's common stock
payable to stockholders of record as of March 14, 1997 and payable in the same
ratio as each future common share is issued. The exercise price of the Right
shall be $55 per right, and the redemption price shall be $0.01 per right. The
Rights are exercisable upon certain events as defined in the Rights Agreement
and expire on the earlier of (i) February 26, 2007 or (ii) exchange or
redemption of the Rights.
Series A Preferred Stock purchasable upon exercise of the Rights will not be
redeemable. Each share of Series A Preferred Stock will be entitled to an
aggregate dividend of 1,000 times the dividend declared per common share. In the
event of liquidation, the holders of the Series A Preferred Stock will be
entitled to a minimum preferential liquidation payment equal to 1,000 times the
aggregate amount to be distributed per share to holders of common shares plus an
amount equal to any accrued and unpaid dividends on the Series A Preferred
Stock. Each share of Series A Preferred Stock will have 1,000 votes, and will
vote together with the common shares. In the event of any merger, consolidation
or other transaction in which the common shares are changed or exchanged, each
share of Series A Preferred Stock will be entitled to receive 1,000 times the
amount received per common share. These rights are protected by certain
anti-dilution provisions.
31
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(12) EARNINGS (LOSS) PER SHARE
The following table sets forth a reconciliation of the numerators and
denominators of the basic and diluted EPS computations under SFAS No. 128 (in
thousands, except per share amounts):
YEAR ENDED MARCH 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net income (loss)................................. $2,790 $1,195 $ (2,461)
====== ====== ========
Denominator for basic earnings (loss) per share--
weighted average common shares.................. 7,029 6,860 6,710
Dilutive stock options............................ 494 335 --
------ ------ --------
Denominator for diluted earnings (loss) per
share........................................... 7,523 7,195 6,710
====== ====== ========
Basic earnings (loss) per share................... $ 0.40 $ 0.17 $ (0.37)
====== ====== ========
Diluted earnings (loss) per share................. $ 0.37 $ 0.17 $ (0.37)
====== ====== ========
Options to purchase 238,235 and 421,638 shares of MECON's common stock at
March 31, 1999 and 1998, respectively, were not included in the computation of
diluted earnings per share because their exercise prices, which ranged from
$9.50 to $23.79 and $6.00 to $23.79, respectively, were greater than the average
market price of our common stock of $8.90 and $5.75 per share, respectively. All
options to purchase shares of MECON's common stock at March 31, 1997 were not
included in the computation of diluted loss per share as their effect would have
been antidilutive.
(13) STOCK-BASED COMPENSATION PLANS
1994 INCENTIVE STOCK OPTION PLAN
MECON's 1994 Incentive Stock Option Plan (the 1994 Plan) provides for the
grant of incentive stock options to its employees. The Board of Directors has
determined that no further options will be granted under the 1994 Plan.
Outstanding options granted under the 1994 Plan generally become exercisable at
a rate of 1/5 of the shares subject to the option at a specified date after the
date of grant and an additional 1/5 of the shares at the end of each subsequent
anniversary of the initial vesting date, subject to continued service as an
employee, consultant or director. The term of each outstanding stock option is
seven years. The exercise price of all options granted under the 1994 Plan was
at least equal to the fair market value of MECON's common stock on the date of
grant. Payment of the exercise price may be made in cash, promissory notes or
other shares of MECON's common stock.
1995 STOCK PLAN
MECON's 1995 Stock Plan (the 1995 Plan) was adopted in October 1995 and
became effective in December 1995. The 1995 Plan provides for the grant of
incentive stock options to employees, officers, consultants and directors and
for the grant of nonstatutory stock options and stock purchase rights (Rights)
to MECON's employees and consultants. A total of 1,700,000 shares of common
stock has been reserved for future issuance under the 1995 Plan. The exercise
price of options granted under the 1995 Plan is generally at least equal to the
fair market value of MECON's common stock on the date of grant. However, with
respect to any participant who owns stock possessing more than 10% of the voting
power of
32
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(13) STOCK-BASED COMPENSATION PLANS (CONTINUED)
all classes of MECON's stock, the exercise price of any incentive stock option
granted must equal at least 110% of fair market value on the grant date and the
maximum term of the option must not exceed five years. The term of all other
options granted under the 1995 Plan may not exceed ten years. Generally, options
vest 20% on the date of grant, and 20% each year thereafter for four years. As
of March 31, 1999, there were 522,779 shares available for future grant under
the 1995 Plan.
1995 DIRECTOR OPTION PLAN
MECON's 1995 Director Option Plan (the Director Plan) was adopted in October
1995 and became effective in December 1995. In August 1998, the Director Plan
was amended to increase the number of shares of MECON's common stock reserved
for issuance under the Director Plan to 200,000 shares. The Director Plan, as
amended in January 1997, provides for the grant of nonstatutory stock options to
certain of MECON's non-employee directors (Outside Directors) pursuant to an
automatic, nondiscretionary grant mechanism. The Director Plan provides that
each new Outside Director shall be granted a nonstatutory stock option to
purchase 15,000 shares of common stock (10,000 shares prior to the January 1997
amendment) upon the date which such person first becomes an Outside Director.
Thereafter, each Outside Director shall be automatically granted an option to
purchase 5,000 shares of common stock on January 16 of each year (a Subsequent
Option), if on such date, such Outside Director shall have served on our Board
of Directors for at least six (6) months. The Director Plan provides that each
initial grant to new Directors will be exercisable three years from the date of
grant and the subsequent options will vest immediately. The exercise price per
share of all options granted under the Director Plan shall be equal to the fair
market value of a share of common stock on the date of grant. Options granted to
Outside Directors under the Director Plan have a ten year term, but will expire
unless exercised within three months following the termination of an Outside
Director's status as a director. If not terminated earlier, the Director Plan
will have a term of ten years. As of March 31, 1999, there were 115,000 shares
available for future grant under the Director Plan. In addition, the Director
Plan was amended in January 1997 to include an annual retainer of $10,000 for
Outside Directors, a per meeting fee of $1,000 for Board meetings, and $750 for
separately held committee meetings.
1995 EMPLOYEE STOCK PURCHASE PLAN
MECON's 1995 Employee Stock Purchase Plan (the Purchase Plan) was adopted in
October 1995 and became effective in December 1995. A total of 250,000 shares of
common stock has been reserved for issuance under the Purchase Plan.
The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions, which may not exceed 7 1/2% of an employee's base
compensation, including commissions, bonuses and overtime, at a price equal to
85% of the fair market value of the common stock at the beginning of each
offering period or the end of a six month purchase period, whichever is lower.
Unless terminated sooner, the Purchase Plan will terminate ten years after its
effective date. The Board of Directors has authority to amend or terminate the
Purchase Plan provided no such action may adversely affect the rights of any
participant. MECON sold 25,809, 38,284 and 20,382 shares to employees under the
Purchase Plan for the years ended March 31, 1999, 1998 and 1997, respectively.
No shares were sold under the Purchase Plan in prior years. As of March 31,
1999, there were 165,525 shares available for future grant under the Purchase
Plan.
33
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(13) STOCK-BASED COMPENSATION PLANS (CONTINUED)
CDI INCENTIVE STOCK OPTION PLAN
In conjunction with the acquisition of Clinical Dynamics, Inc. (CDI) on
September 30, 1999 (note 16), MECON assumed all stock options outstanding as of
that date under CDI's stock option plan (CDI Plan). Based on the acquisition
agreement, no further options will be granted under CDI's Plan. Outstanding
options granted under the CDI Plan generally become exercisable at a rate of at
least 20% per year over 5 years from the date the option is granted, subject to
continued service as an employee or consultant. The term of each outstanding
option is generally 10 years from the date of grant.
OPTION PLAN ACTIVITY
The following table summarizes option activity for the three years ended
March 31, 1999:
INCENTIVE STOCK WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
--------------- --------------
Balance at March 31, 1996......................... 698,072 $ 7.36
Options granted................................... 1,086,565 10.29
Options canceled.................................. (541,450) 14.52
Options exercised................................. (102,968) 3.86
--------- ------
Balance at March 31, 1997......................... 1,140,219 7.05
Options granted................................... 564,888 4.07
Options canceled.................................. (546,581) 6.26
Options exercised................................. (162,487) 2.84
--------- ------
Balance at March 31, 1998......................... 996,039 6.47
Options granted................................... 526,160 7.06
Options canceled.................................. (105,814) 8.42
Options exercised................................. (110,442) 3.20
--------- ------
Balance at March 31, 1999......................... 1,305,943 $ 6.82
========= ======
The weighted average fair value of options granted was $5.80, $3.11 and
$7.59 per share for the years ended March 31, 1999, 1998 and 1997, respectively.
34
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(13) STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following table summarizes information about stock options outstanding
at March 31, 1999:
OPTIONS OUTSTANDING
----------------------- OPTIONS EXERCISABLE
WEIGHTED- -----------------------
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
- --------------- ----------- ----------- --------- ----------- ---------
$ 0.13 - 2.37 272,507 7.1 $ 1.17 169,620 $ 1.00
2.38 - 4.75 163,368 8.2 3.06 105,329 3.11
4.76 - 7.13 309,169 8.6 6.18 101,351 6.11
7.14 - 9.51 337,664 8.2 7.99 98,450 8.09
9.52 - 11.89 81,500 9.4 10.25 19,889 10.16
11.90 - 14.27 33,000 6.1 13.00 23,155 13.00
14.28 - 16.65 8,735 6.8 15.02 6,910 15.02
16.66 - 19.03 50,000 7.3 17.88 30,000 17.88
21.42 - 23.78 50,000 7.5 23.78 30,000 23.78
--------- --- ------ ------- ------
$ 0.57 - 23.78 1,305,943 8.0 $ 6.82 584,704 $ 6.45
========= === ====== ======= ======
PRO FORMA INFORMATION
MECON continues to apply APB No. 25 in accounting for its employee
stock-based compensation plans. Accordingly, no compensation cost has been
recognized in the accompanying consolidated statements of operations for MECON's
fixed stock option plans and its stock purchase plan. Had compensation cost for
MECON's stock-based compensation plans been determined in accordance with the
fair value method prescribed in SFAS No. 123, MECON's net income (loss) and
earnings (loss) per share would have been changed to the pro forma amounts
indicated below:
1999 1998 1997
-------- -------- --------
Net income (loss) (IN THOUSANDS)..................... As reported $ 2,790 $ 1,195 $(2,461)
Pro forma (736) (1,567) (4,083)
Basic earnings (loss) per share...................... As reported 0.40 0.17 (0.37)
Pro forma (0.10) (0.25) (0.61)
Diluted earnings (loss) per share.................... As reported 0.37 0.17 (0.37)
Pro forma (0.10) (0.23) (0.61)
The fair value of each option granted under the option plans and purchase
rights granted under the Purchase Plan are estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in fiscal 1999, 1998 and 1997:
STOCK OPTION PLANS EMPLOYEE STOCK PURCHASE PLAN
----------------------------------- ---------------------------------
1999 1998 1997 1999 1998 1997
---------- ---------- --------- --------- --------- ---------
Expected volatility......... 96% 98% 95% 96% 98% 95%
Expected life............... 6.78 years 6.38 years 4.5 years 6 months 6 months 6 months
Risk-free interest rate..... 4.74% 6.21% 6.32% 4.57% 5.45% 5.05%
35
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(13) STOCK-BASED COMPENSATION PLANS (CONTINUED)
A dividend yield of zero was used for each year. The weighted-average fair
value of purchase rights granted under the Purchase Plan in fiscal 1999, 1998
and 1997 was $3.36, $1.79 and $2.57 per share, respectively.
OPTION REPRICING
On January 16, 1997, MECON offered certain key employees holding options
with exercise prices in excess of $12.00 per share the opportunity to exchange
such options for options with an exercise price of $5.625 per share, the fair
market value of the Company's stock on that date, provided that such options be
subject to a revised four-year vesting schedule beginning on the new grant date.
Options to purchase 412,176 shares were so exchanged and are included in fiscal
1997 options granted and canceled.
(14) MAJOR CUSTOMERS
For the year ended March 31, 1999, one significant customer accounted for
25% of MECON's fiscal 1999 revenues and 15% of total receivables at March 31,
1999. At March 31, 1999, receivables from a different customer constituted 10%
of total accounts receivable and 27% of total unbilled accounts receivables.
For the year ended March 31, 1998, one significant customer accounted for
21% of MECON's fiscal 1998 revenues. At March 31, 1998, receivables from two
different customers constituted 26% of total accounts receivable. At March 31,
1998, unbilled receivables from two other customers constituted 34% of total
unbilled accounts receivables.
For the year ended March 31, 1997, MECON had a different significant
customer which covered approximately 50 academic hospitals. This contract
totaled 11% of 1997 revenues and 15% of total unbilled receivables at March 31,
1997.
(15) SEGMENT INFORMATION
During fiscal year 1999, MECON adopted the provisions of SFAS 131,
DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within MECON
for making operational decisions and assessments of financial performance.
For the years presented, MECON operated in one business segment, operational
benchmarking solutions, for which it received revenues from its customers.
MECON's Chief Operating Decision Maker is considered to be the Company's
Operating Committee (COC) which is comprised of MECON's Chief Executive Officer
and its Senior Vice Presidents. The COC reviews financial information presented
on a consolidated basis accompanied by disaggregated information on revenues by
products and services for purposes of making decisions and assessing financial
performance. Through March 31, 1999, the COC has not reviewed discrete financial
information regarding profitability of its different products or services and
therefore, MECON does not have operating segments as defined by SFAS 131.
Effective April 1, 1999, subsequent to the acquisition of LBA, MECON will
operate in two business segments, consulting services and data products.
Financial reporting systems will be implemented that will enable the COC to
review segment data based on discrete financial information.
36
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(15) SEGMENT INFORMATION (CONTINUED)
MECON's customers consist 100% of end users in the United States.
1999 1998 1997
-------- -------- --------
Data Products............................................... $14,107 $11,930 $ 9,934
Consulting.................................................. 4,386 3,523 3,661
------- ------- -------
Total net revenues.......................................... $18,493 $15,453 $13,595
(16) SUBSEQUENT EVENT--POOLING OF INTEREST BUSINESS COMBINATION
On September 30, 1999, MECON issued 774,000 shares of MECON's common stock
and assumed all outstanding options in exchange for all the outstanding shares
of common stock of Clinical Dynamics, Inc. (CDI), a provider of Web-based
software reporting tools that analyze clinical process and outcome metrics of
care for clinicians and administrators. The merger was accounted for as a
pooling of interests, and accordingly, our consolidated financial statements
have been restated to include the financial position and results of operations
of CDI for all periods presented.
The results of operations previously reported by the separate enterprises
and the combined amounts presented in the accompanying consolidated financial
statements are summarized below (in thousands):
YEARS ENDED MARCH 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net revenues:
Mecon.......................................... $17,807 $15,073 $13,595
CDI............................................ 686 380 --
------- ------- -------
Combined....................................... $18,493 $15,453 $13,595
======= ======= =======
Net income (loss):
Mecon.......................................... $ 2,779 $ 1,061 $(2,461)
CDI............................................ 11 134 --
------- ------- -------
Combined....................................... $ 2,790 $ 1,195 $(2,461)
======= ======= =======
Transaction and acquisition costs were approximately $638,000 and consisted
principally of transaction fees for attorneys, accountants and other related
charges. There were no conforming accounting changes or intercompany
transactions related to this merger. Prior to the combination, CDI's fiscal year
ended December 31. In recording the pooling-of-interests combination, CDI's
financial statements were recast to conform to our March 31 year end.
(17) OTHER SUBSEQUENT EVENTS
PROGRESSIVE DEVELOPMENT, INC. ACQUISITION
On July 14, 1999, MECON acquired Progressive Development, Inc. (PDI), a
provider of a Web-based supply cost comparison database. MECON issued 75,000
shares of MECON common stock at $8.125 per share, which was the value of MECON's
stock on July 14, 1999, and paid $275,000 in cash in a transaction
37
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(17) OTHER SUBSEQUENT EVENTS (CONTINUED)
accounted for using the purchase method of accounting. In accordance with the
purchase, MECON received a client server software product, the services of the
founder, and a royalty stream. PDI did not have any assets and liabilities,
employees, or customers at the time of our purchase. The entire purchase price
of $884,000 has been allocated to goodwill that will be amortized over its
estimated benefit period of five years.
LINE OF CREDIT
On September 7, 1999, MECON entered into a $100,000 revolving line of credit
with Coast Commercial Bank, which bears interest at a rate of 2.0% above the
Coast Commercial Bank's Reference Rate. MECON is required to make regular
monthly payments of accrued interest. The line of credit matures on
September 7, 2000, and is secured by all inventory, accounts receivable,
equipment, furniture of CDI, and all products or proceeds from the disposition
of any of the above. In addition, an officer of CDI has provided a guaranty in
connection with this line of credit.
IBUSINESSHUB INVESTMENTS
On September 28, 1999, MECON invested $500,000 in iBusinessHub (IBH) for
2,000,000 shares of IBH Series A Preferred stock. IBH is a development stage
company focused on building business-to-business e-commerce procurement engines
for various vertical markets. In addition to the common shares, MECON also
received a warrant to purchase 2,000,000 shares of IBH common stock, which may
be exercised at any time. IBH has the right to cause MECON to exercise up to
800,000 warrants at a price of $0.25 per share. Since MECON's investment
constituted a 36% interest in the outstanding shares of IBH, the investment will
be accounted for using the equity method of accounting.
GOODWILL IMPAIRMENT
In August, 1999, MECON noted that the revenue being generated by LBA's CVE
business line was not meeting its expectations, which were based on the
projections MECON received at the time of the acquisition. Based on this
information, MECON concluded that it could better utilize its resources in other
areas of the Company and decided to exit the CVE business line. In accordance
with an exit plan MECON developed, MECON notified fourteen (14) LBA employees of
their termination. These individuals were responsible for maintaining the VETCAR
database which supported the consulting being performed as part of the CVE
business line. MECON accrued $773,000 for severance costs to be paid to those
employees as of September 30, 1999.
In consideration of SFAS No. 121, "ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF", and MECON's
decisions to exit the business, MECON reviewed the goodwill associated with the
LBA acquisition for impairment. MECON performed an undiscounted cashflow
analysis based on revenue projections expected to be received from future
operations of LBA which revealed that the goodwill was impaired. MECON estimated
the fair market value of the goodwill using a discounted cash flow model and
recognized an impairment charge of $5,555,000, based on a 15 year cash flow
projection, assuming a growth rate commensurate with Mecon's overall growth rate
and a 5% discount rate. MECON also wrote off certain other capitalized software
costs associated with the CVE business in the amount of $119,000.
38
MECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, 1998 AND 1997
(17) OTHER SUBSEQUENT EVENTS (CONTINUED)
MERGER WITH GENERAL ELECTRIC COMPANY
On November 29, 1999, MECON announced that it had signed a definitive
agreement to merge its operations with General Electric Company. In this
transaction, MECON's stockholders will receive $11.25 per share payable in
General Electric Company stock. The transaction is subject to approval by our
stockholders, and other governmental agencies as required.
39