SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period Commission file number
ended June 30, 2003 0-19941
MedQuist Inc.
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(Exact name of registrant as specified in its charter)
New Jersey 22-2531298
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
Five Greentree Centre, Suite 311, Marlton, NJ 08053
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(Address of principal executive offices) (Zip Code)
(856) 810-8000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No___
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Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act) Yes X No___
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Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 37,208,555 shares of
common stock, no par value, as of August 8, 2003.
MEDQUIST INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at June 30, 2003 (Unaudited) and December 31, 2002 1
Consolidated Statements of Income for the Six Months Ended June 30, 2003 and
2002 (Unaudited) 2
Consolidated Statements of Income for the Three Months Ended June 30, 2003
and 2002 (Unaudited) 3
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003
and 2002 (Unaudited) 4
Notes to Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 17
Item 4. Controls and Procedures 17
Special Note Concerning Forward Looking Statements 17
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form S-K 19
SIGNATURE 19
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Part I. Financial Information
-----------------------------
Item 1. Consolidated Financial Statements
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, December 31,
2003 2002
---- ----
(Unaudited) Audited
Assets
Current assets:
Cash and cash equivalents $132,730 $103,392
Accounts receivable, net of allowance of $5,559 and
$5,606 77,505 86,465
Inventories 5,332 4,563
Prepaid expenses and other current assets 3,051 3,673
Deferred income taxes 6,238 6,238
-------- --------
Total current assets 224,856 204,331
Property and equipment, net 37,150 37,804
Goodwill, net 136,376 136,127
Other intangible assets, net 73,135 73,798
Deferred income taxes 13,980 15,524
Other assets 8,096 7,287
-------- --------
$493,593 $474,871
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of long-term debt $ 31 $ 31
Accounts payable 9,291 9,908
Accrued expenses 30,098 33,701
Deferred revenue 18,413 18,789
-------- --------
Total current liabilities 57,833 62,429
-------- --------
Long-term debt 26 54
-------- --------
Other liabilities 1,904 1,427
-------- --------
Commitments and contingencies (Note 7)
Shareholders' equity:
Common stock, no par value, 60,000 shares authorized,
37,120 and 37,091 issued and outstanding 230,251 229,149
Retained earnings 202,553 181,216
Accumulated other comprehensive income 1,026 596
-------- --------
Total shareholders' equity 433,830 410,961
-------- --------
$493,593 $474,871
======== ========
See Accompanying Notes to Consolidated Financial Statements.
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
Six Months Ended
June 30,
2003 2002
-------- --------
Revenues -
Services $212,090 $227,605
Solutions 36,016 ---
-------- --------
Total revenues 248,106 227,605
-------- --------
Cost of revenues, excluding depreciation -
Services 158,950 169,264
Solutions 24,168 ---
-------- --------
Total cost of revenues, excluding depreciation 183,118 169,264
Selling, general and administrative 15,394 7,183
Research and development 2,747 ---
Depreciation 9,381 8,583
Amortization of intangible assets 3,744 3,314
Gain on sale of building (814) ---
-------- --------
Total costs and expenses 213,570 188,344
-------- --------
Operating income 34,536 39,261
Equity in losses of investee (316) (431)
Interest income, net 474 689
-------- --------
Income before income taxes 34,694 39,519
Income taxes 13,357 15,215
-------- --------
Net income $21,337 $24,304
======== ========
Basic net income per common share $ 0.58 $ 0.66
======== ========
Diluted net income per common share $ 0.57 $ 0.64
======== ========
See Accompanying Notes to Consolidated Financial Statements.
2
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended
June 30,
2003 2002
-------- --------
Revenues -
Services $105,274 $113,631
Solutions 18,170 ---
-------- --------
Total revenues 123,444 113,631
-------- --------
Cost of revenues, excluding depreciation -
Services 78,466 84,254
Solutions 11,850 ---
-------- --------
Total cost of revenues, excluding depreciation 90,316 84,254
Selling, general and administrative 7,551 3,483
Research and development 1,390 ---
Depreciation 4,745 4,349
Amortization of intangible assets 1,985 1,613
-------- --------
Total costs and expenses 105,987 93,699
-------- --------
Operating income 17,457 19,932
Equity in losses of investee (132) (247)
Interest income, net 254 376
-------- --------
Income before income taxes 17,579 20,061
Income taxes 6,767 7,723
-------- --------
Net income $10,812 $12,338
======== ========
Basic net income per common share $ 0.29 $ 0.33
======== ========
Diluted net income per common share $ 0.29 $ 0.33
======== ========
See Accompanying Notes to Consolidated Financial Statements.
3
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Six Months Ended
June 30,
2003 2002
-------- --------
Operating activities:
Net income $ 21,337 $ 24,304
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 13,125 11,897
Gain on sale of building (814) ---
Equity in losses of investee 316 431
Pension contributions payable in Common Stock --- 277
Amortization of deferred compensation --- 14
Tax benefit for exercise of employee stock options 428 450
Changes in assets and liabilities, excluding effects of acquisitions
Accounts receivable, net 8,960 1,597
Inventories (769) ---
Prepaid expenses and other current assets 625 (989)
Other assets (1,125) (87)
Accounts payable (617) 2,997
Accrued expenses (1,696) (3,299)
Deferred revenue (983) ---
Other long-term liabilities 477 219
-------- --------
Net cash provided by operating activities 39,264 37,811
-------- --------
Investing activities:
Purchases of property and equipment (8,690) (8,193)
Investment in A-Life Medical, Inc. --- (892)
Proceeds from sale of property 814 ---
Acquisitions, net of cash acquired (2,848) (7,742)
-------- --------
Net cash used in investing activities (10,724) (16,827)
-------- --------
Financing activities:
Repayments of long-term debt (28) (1,131)
Proceeds from exercise of Common Stock options 446 232
Proceeds from issuance of Common Stock 228 1,047
-------- --------
Net cash provided by financing activities 646 148
-------- --------
Effect of exchange rate changes 152 (18)
-------- --------
Net increase in cash and cash equivalents 29,338 21,114
Cash and cash equivalents, beginning of period 103,392 86,334
-------- --------
Cash and cash equivalents, end of period $132,730 $107,448
======== ========
Supplemental disclosure of cash flow information:
Cash paid during period for -
Interest expense $ 5 $ 140
======== ========
Income taxes $ 13,258 $ 14,213
======== ========
See Accompanying Notes to Consolidated Financial Statements.
4
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2003
(Unaudited - amounts in thousands, except per share amounts)
Note 1. Business and Basis of Presentation
- ------------------------------------------
MedQuist Inc. is a comprehensive provider of health information
solutions and services, which offerings meet the medical document management
needs of the Company's clients. Medical document management includes medical
transcription plus other services and products related to health care
information management such as coding, digital dictation systems, handheld units
and speech recognition.
MedQuist Inc. is a majority owned subsidiary of Koninklijke Philips
Electronics N.V. (Philips).
The information set forth in these statements is unaudited, unless
otherwise indicated. The information reflects all adjustments that, in the
opinion of management, are necessary to present a fair statement of the
financial position, results operations and cash flows of MedQuist Inc. and its
consolidated subsidiaries for the periods indicated. Results of operations and
cash flow for the interim period ended June 30, 2003 are not necessarily
indicative of the results of operations for the full year. Certain information
in footnote disclosures normally included in financial statements have been
condensed or omitted in accordance with the rules and regulations of the
Securities and Exchange Commission.
Note 2. Stock Based Compensation
- ---------------------------------
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations, to account for its
fixed-plan stock options. Under this method, compensation expense is recorded on
the date of grant only if the current market price of the underlying stock
exceeds the exercise price. SFAS No. 123, "Accounting for Stock-Based
Compensation", established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123, as amended in SFAS No. 148, "Accounting for
Stock-Based Compensation", the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of SFAS No. 123 and SFAS No. 148.
Had compensation cost for the Company's common stock options been
determined based upon the fair value of the options at the date of grant, as
prescribed under SFAS No. 123, as amended by SFAS No. 148, the Company's net
income and net income per share would have been reduced to the following pro
forma amounts:
5
Six months ended June 30, Three months ended June 30,
------------------------- ---------------------------
2003 2002 2003 2002
------- ------- ------- -------
Net income: $21,337 $24,304 $10,812 $12,338
As reported
Add stock-based employee
compensation expense included
in reported net income, net of tax --- 10 --- 5
Impact of total stock-based
compensation expense determined
under fair-value based method for
all rewards, net of tax (3,865) (4,171) (1,933) (2,086)
------- ------- ------- -------
Pro forma net income $17,472 $20,143 $ 8,879 $10,257
======= ======= ======= =======
Basic net income per share:
As reported $ 0.58 $ 0.66 $ 0.29 $ 0.33
======= ======= ======= =======
Pro forma $ 0.47 $ 0.55 $ 0.24 $ 0.28
======= ======= ======= =======
Diluted net income per share:
As reported $ 0.57 $ 0.64 $ 0.29 $ 0.33
======= ======= ======= =======
Pro forma $ 0.46 $ 0.53 $ 0.24 $ 0.27
======= ======= ======= =======
The above pro forma amounts may not be indicative of future amounts
because option grants prior to January 1, 1995 have not been included and
because future option grants are expected.
The fair value of the options granted is estimated using the
Black-Scholes option-pricing model.
Note 3. Acquisitions
- --------------------
We completed an acquisition in March 2003. A summary of the allocation
of the purchase price to net assets acquired is as follows:
Prepaid and other $ 3
Property and equipment 37
Noncompete agreements 250
Other intangible assets 2,826
Accrued expenses (27)
Deferred revenue (607)
------
Purchase price for 2003 acquisition 2,482
Refund of escrow from 2002 acquisition (244)
Earnout payment on 2001 acquisition 610
------
Net cash paid for acquisition
including transaction costs $2,848
======
6
During the six months ended June 30, 2003, we negotiated the return of
an escrow related to an acquisition completed in 2002. This escrow refund was
applied as a reduction to the goodwill created by the acquisition (See note 4).
In addition, we made an earnout payment on an acquisition completed in 2001 as
certain established goals were achieved. There are no additional potential
earnout payments required on any other completed acquisition transactions.
During 2002, we completed five acquisitions. A summary of the
allocation of the purchase price to net assets acquired is as follows:
Accounts receivable $16,863
Inventories 3,750
Prepaid and other 2,685
Property and equipment 6,016
Deposits 5
Goodwill 22,774
Other intangible assets 23,406
Accounts payable (4,275)
Deferred revenue (16,520)
Accrued expenses (5,975)
Debt (72)
-------
Cash paid for acquisition
including transaction costs $48,657
=======
Included in the 2002 acquisitions was the acquisition of Lanier
Healthcare, LLC ("Lanier") on July 1, 2002, for $38.0 million in cash. The
following unaudited proforma information is presented as if the Lanier
acquisition had been completed on January 1, 2002. All other acquisitions in
2003 and 2002 were not material to the Company.
Six Months Ended Three Months Ended
June 30, 2002 June 30, 2002
------------- -------------
Revenue $268,389 $134,325
Net Income 24,224 12,700
Basic net income
per common share $0.66 $0.34
Diluted net income
per common share $0.64 $0.33
Note 4. Goodwill and Other Intangible Assets
- --------------------------------------------
The changes in the carrying amount of goodwill for the period ended
June 30, 2003 are as follows:
Balance at December 31, 2002 $136,127
Earnout payment on 2001 acquisition 610
Refund of escrow from 2002 acquisition (244)
Other adjustments (117)
--------
Balance at June 30, 2003 $136,376
========
7
The carrying amount of acquired other intangible assets as of June 30,
2003 is as follows:
Weighted Average
Amortization Gross Carrying Accumulated Net Book
Period Amount Amortization Value
------ -------- ------------ -------
Customer Lists 21 years $ 76,960 $15,139 $61,821
Noncompete Agreements 4 years 11,468 8,608 2,860
Other 4 years 13,630 7,876 5,754
-------- -------- ------- -------
17 years 102,058 31,623 70,435
Nonamortizable intangible asset:
Tradename --- 2,700 --- 2,700
-------- ------- -------
Total $104,758 $31,623 $73,135
======== ======= =======
Note 5. Investment in A-Life Medical, Inc.
- ------------------------------------------
In January 2002, the Company increased its ownership in A-Life Medical,
Inc. (A-Life) to 28.1% of the outstanding voting shares of A-Life. As such,
effective January 2002, the Company began accounting for the investment under
the equity method of accounting. Because A-Life had negative book value at the
time of the change to the equity basis of accounting, the entire investment was
allocated to intangible assets, of which $1 million was allocated to acquired
software. The acquired software is being amortized over three years. The
remaining amount was recorded as goodwill. In 2002, the Company's ownership was
further increased to 33.6%. Throughout this period, A-Life has operated at a
loss and the Company has recognized its portion of this loss, along with the
amortization of the software, as equity in losses of investee on the income
statement, with a corresponding reduction in the investment.
Note 6. Restructuring Charges
- -----------------------------
In 1998 and 2001, we approved various restructuring plans related to
closure of facilities, the rollout of our new transcription platform and the
rationalization of several operating facilities. During the six month period
ended June 30, 2003, we made payments of $451 on remaining obligations for
non-cancelable leases and $38 in severance payments. There were no other changes
to the accrual during the period. The accrual balance at June 30, 2003 is $676,
which amount is included in accrued expenses in the accompanying consolidated
balance sheet.
Note 7. Commitments and Contingencies
- -------------------------------------
During the six months ended June 30, 2003, there have been no items
that significantly impact the Company's commitments and contingencies as
disclosed in the notes to the 2002 annual financial statements as filed on Form
10-K.
Note 8. Net Income Per Common Share
- -----------------------------------
Basic net income per share is calculated by dividing net income by the
weighted average number of shares of Common Stock outstanding for the period.
Diluted net income per share is calculated by dividing net income by the
weighted average number of shares of Common Stock outstanding for the period,
adjusted for the dilutive effective of Common Stock equivalents, which consist
of stock options, using the treasury stock method.
The table below sets forth the reconciliation of the numerators and
denominators of the basic and diluted net income per share computations:
8
Six Months Ended June 30,
--------------------------------------------------------------------------------
2002 2003
----------------------------------- ------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------- ------ ------- ------- ------- -----
Basic $21,337 37,103 $ 0.58 $24,304 36,955 $0.66
Effect of dilutive securities --- 596 --- 999
------- ------ ------- ------
Diluted $21,337 37,699 $ 0.57 $24,304 37,954 $0.64
======= ====== ======= ======= ====== =====
For the six months ended June 30, 2003 and 2002, options to acquire
3,984 and 3,207 shares of Common Stock, respectively, were outstanding but were
not included in the computation of diluted net income per share. These shares
were not included in the computation because the exercise prices of the options
were greater than the average market prices for Common Stock during the periods.
Three Months Ended June 30,
--------------------------------------------------------------------------------
2003 2002
------------------------------------ ------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------- ------ --------- ------- ------ ------
Basic $10,812 37,120 $0.29 $12,338 36,976 $0.33
Effect of dilutive securities --- 648 --- 973
------- ------ ------ ------
Diluted $10,812 37,768 $0.29 $12,338 37,949 $0.33
======= ====== ===== ======= ====== =====
For the three months ended June 30, 2003 and 2002, options to acquire
3,984 and 3,207 shares of Common Stock, respectively, were outstanding but were
not included in the computation of diluted net income per share. These shares
were not included in the computation because the exercise prices of the options
were greater than the average market prices for Common Stock during the periods.
Note 9. Related Party Transactions
- ----------------------------------
In March 2003, the Company agreed to amend a licensing agreement with
Philips Speech Processing. This amendment adjusts the fees to be charged to the
Company for the use of the Philips speech product, defines the terms for paying
Philips for further development of the product through the consulting work which
Philips is providing, and provides an exclusivity right, when the product is
developed to be reviewed annually. Through June 30, 2003, the Company paid $110
related to the consulting work to Philips, and $420 toward the exclusivity
right.
Presently, all business insurance coverages, with the exception of
worker's compensation, are provided by Philips. For the six months ended June
30, 2003, the Company paid $2 in premiums to Philips for these policies.
Philips also sells dictation related equipment to MedQuist and for the
six months ended June 30, 2003, the Company paid $334 in costs for such
equipment.
9
There are several other transactions with Philips which total $18 for
the six months ended June 30, 2003.
Management believes that the transactions with Philips are on an
arms-length basis.
Note 10. Segment Information
- ----------------------------
MedQuist manages its business in two segments; services and solutions.
While the two segments are closely related, the services segment is largely
comprised of transcription and coding services, while the solution segment is
comprised of sales and service of voice products.
Segment information is presented in accordance with SFAS 131,
"Disclosure about Segments of an Enterprise and Related Information". This
Statement is based on a management approach, which requires segmentation based
on the Company's internal organization and disclosure of revenue and operating
income based on internal accounting methods. The Company's financial reporting
systems present various data for management to run the business, including
profit and loss statements. However, this Statement does not require an
enterprise to report information that is not prepared for internal use, if
reporting it would be impractical.
Six Months Ended June 30,
- -------------------------
Intersegment
2003 Services Solutions Items Consolidated
- ---- -------- --------- ----- ------------
Revenue $212,090 $36,297 $(281) $248,106
Cost of revenue,
excluding depreciation 158,950 24,303 (135) 183,118
-------- ------- ----- --------
Gross profit $ 53,140 $11,994 $(146) $ 64,988
======== ======= ===== ========
2002
- ----
Revenue $227,605 -- -- $227,605
Cost of revenue,
excluding depreciation 169,264 -- -- 169,264
-------- ------- ----- --------
Gross profit $ 58,341 -- -- $ 58,341
======== ======= ===== ========
Three Months Ended June 30,
- --------------------------
Intersegment
2003 Services Solutions Items Consolidated
- ---- -------- --------- ----- ------------
Revenue $105,274 $18,351 $(181) $123,444
Cost of revenue,
excluding depreciation 78,466 11,949 (99) 90,316
------ ------ ---- ------
Gross profit $ 26,808 $ 6,402 $ (82) $ 33,128
========= ======== ====== =========
10
2002
- ----
Revenue $113,631 -- -- $113,631
Cost of revenue,
excluding depreciation 84,254 -- -- 84,254
-------- ------- ----- --------
Gross profit $ 29,377 -- -- $ 29,377
======== ======= ===== ========
A reconciliation of MedQuist's consolidated segment gross profit to
operating income is as follows:
Six Months Ended Three Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- ------- ------- -------
Consolidated segment gross profit $ 64,988 $58,341 $33,128 29,377
Selling, general and administrative (15,394) (7,183) (7,551) (3,483)
Research and development (2,747) --- (1,390) ---
Depreciation (9,381) (8,583) (4,745) (4,349)
Amortization of intangible assets (3,744) (3,314) (1,985) (1,613)
Gain on sale of building 814 --- --- ---
-------- ------- ------- -------
Operating income $ 34,536 $39,261 $17,457 $19,932
======== ======= ======= =======
Note 11. New Accounting Pronouncements
- --------------------------------------
In November 2002, the Emerging Issues Task Force ("EITF") finalized its
tentative consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple
Deliverables", which provides guidance on the timing and method of revenue
recognition for sales arrangements that include the delivery of more than one
product or service. EITF 00-21 is effective prospectively for arrangements
entered into in fiscal periods beginning after June 15, 2003. Management has
evaluated the impact of this consensus and does not believe it will have a
material impact on the Consolidated Financial Statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003 and to variable interests in variable interest entities
obtained after January 31, 2003. Management does not believe the adoption of
this Interpretation will have an impact on the Company's Consolidated Financial
Statements.
The FASB has recently issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" and SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." The adoption of these accounting pronouncements is not expected to have
a material impact on the Company's Consolidated Financial Statements.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
- -------
Critical Accounting Policies and Estimates
- ------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results
of Operations is based on our Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions which affect the reported amounts
of assets, liabilities, revenue, expense, and related disclosures. Management
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities.
Management believes the following critical accounting policies affect
its more significant estimates and assumptions used in the preparation of its
consolidated financial statements. These critical accounting policies and
estimates have been discussed with the Company's audit committee.
Revenue Recognition
- -------------------
A substantial portion of our revenue is derived from providing medical
transcription services, which we recognize when services are rendered. These
services are based primarily on contracted rates. A portion of our revenue is
derived from the sale and implementation of voice-capture and document
management solutions, and maintenance service of these products. We recognize
revenue and profit on sales and implementation utilizing the percentage of
completion method. With regard to service contracts, which is arranged separate
from the product sale, the typical arrangement spans 12 months. We recognize
revenue on the service contracts on a straight line method over the term of the
underlying service contract. Deferred revenues represent cash received from
customers in advance of revenues being recognized for the related payment.
Bad Debt
- --------
We estimate an allowance for doubtful accounts receivables based on
historical experience and evaluation of the financial condition of our clients.
Historically, our estimates have been adequate to cover accounts receivable
exposure. If circumstances related to our estimates change, we may need to
record increases to the allowance.
Valuation of Goodwill, Other Intangible Assets and Other Long-Lived Assets
- --------------------------------------------------------------------------
In accordance with SFAS No. 144, "Accounting for Impairment or Disposal
of Long-Lived Assets", we assess long-lived assets, such as property, plant, and
equipment, and purchased intangibles subject to amortization, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.
12
We measure recoverability of assets to be held and used by comparing
the carrying amount of an asset to estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. Assets to be disposed of would be separately presented in the balance
sheet and reported at the lower of the carrying amount or fair value less costs
to sell, and would no longer be depreciated. The assets and liabilities of a
disposed group classified as held for sale would be presented separately in the
appropriate asset and liability sections of the balance sheet.
We test goodwill and intangible assets not subject to amortization
annually for impairment. Should events and circumstances indicate that the asset
might be impaired at some time prior to the annual test, we will test more
frequently. An impairment loss is recognized to the extent that the carrying
amount exceeds the asset's fair value. In May 2003, we performed this test and
determined there has been no impairment.
Deferred Taxes
- --------------
We record a valuation allowance to reduce our deferred tax assets to
the amount that is more likely than not to be realized. We have considered
future taxable income and prudent and feasible tax planning strategies in
determining the need for a valuation allowance. In the event we were to
determine that we could not realize all or part of our net deferred tax assets
in the future, an adjustment to the deferred tax assets would be charged to
earnings in the period such determination is made. Likewise, if we later
determine that it is more likely than not that the net deferred tax assets would
be realized, the previously provided valuation reserve would be reversed.
Results of Operations
- ---------------------
The following table sets forth for the periods indicated certain financial data
in the Company's Unaudited Consolidated Statements of Income as a percentage of
net revenue:
Six Months Ended Three Months Ended
June 30, June 30,
--------- ----------
2003 2002 2003 2002
----- ----- ----- ----
Revenue 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue, excluding depreciation 73.8 74.4 73.2 74.1
Selling, general and administrative 6.2 3.1 6.1 3.1
Research and development 1.1 -- 1.1 --
Depreciation 3.8 3.8 3.9 3.8
Amortization of intangible assets 1.5 1.4 1.6 1.4
Gain on sale of building (0.3) -- -- --
----- ----- ----- -----
Operating income 13.9 17.3 14.1 17.6
Equity in losses of investee (0.1) (0.2) (0.1) (0.2)
Interest income, net 0.2 0.3 0.2 0.3
----- ----- ----- -----
Income before income taxes 14.0 17.4 14.2 17.7
Income taxes 5.4 6.7 5.4 6.8
----- ----- ----- -----
Net income 8.6% 10.7% 8.8% 10.9%
===== ===== ===== =====
13
Six Months Ended June 30, 2003
- ------------------------------
Revenues. Revenues increased 9.0% from $227.6 million for the six months ended
June 30, 2002 to $248.1 million for the comparable 2003 period with the overall
revenue increase resulting from the acquisition of Lanier Healthcare, LLC on
July 1, 2002. Revenues for the services segment decreased 6.8% from $227.6
million for the six months ended June 30, 2002 to $212.1 million for the
comparable 2003 period. The decrease is largely the result of reductions in
contracted service rates and attrition due to competitive pricing pressure.
Revenues for the solutions segment were $36.0 million for the six months ended
June 30, 2003 and were the result of the acquisition of Lanier Healthcare, LLC.
There were $281 thousand in revenues between the two segments, which have been
eliminated in consolidation.
Cost of Revenues, excluding depreciation. Cost of revenues increased 8.2% from
$169.3 million for the six months ended June 30, 2002 to $183.1 million for the
comparable 2003 period. Cost of revenues for the services segment was $169.3
million, or 74.4% of revenues, and $159.0 million, or 74.9% of revenues, for the
six month periods ended June 30, 2002 and June 30, 2003, respectively. The
decrease in actual costs was due to a large portion of the costs of this segment
being variable and declining as revenues declined. Cost of revenue for the
solutions segment was $24.2 million, or 67.1% of revenues, for the six months
ended June 30, 2003, and was the result of the acquisition of Lanier Healthcare,
LLC.
Selling, general and administrative. Selling, general and administrative
expenses increased 114.3% from $7.2 million for the six months ended June 30,
2002 to $15.4 million for the comparable 2003 period. As a percentage of
revenues, selling, general and administrative expenses increased from 3.1% for
the six months ended June 30, 2002 to 6.2% for the comparable 2003 period. Of
the increase in expenses between comparable periods, $7.0 million was the result
of the Lanier acquisition and largely relates to the cost of the sales force.
The remaining $1.2 million increase was the result of increased costs to support
operations.
Research and development. Research and development costs were $2.7 million for
the six months ended June 30, 2003. These costs relate entirely to Lanier, which
was acquired on July 1, 2002.
Depreciation. Depreciation expense increased 9.3% from $8.6 million for the six
months ended June 30, 2002 to $9.4 million for the comparable 2003 period. As a
percentage of revenues, depreciation was consistent at 3.8% of revenues for both
periods.
Amortization of intangible assets. Amortization of intangible assets increased
from $3.3 million for the six months ended June 30, 2002 to $3.7 million for the
comparable 2003 period. The increase is attributable to the Company's
acquisitions in 2002 and 2003.
Equity in losses of investee. We reflect our investment in A-Life Medical, Inc.
under the equity method of accounting. As such, we have recognized $431 thousand
and $316 thousand in a loss in investment for the six month periods ended June
30, 2002 and June 30, 2003, respectively. These losses were the result of
amortization of $166 thousand related to $1 million of the investment being
allocated to acquired software and the remainder related to our share of
A-Life's operating loss in both periods.
14
Interest income, net. We had net interest income of $689 thousand for the six
months ended June 30, 2002 and net interest income of $474 thousand for the
comparable 2003 period. The decrease was due to decreased rates of return on
liquid investments.
Income taxes. Income taxes decreased from $15.2 million for the six months ended
June 30, 2002 to $13.4 million for the comparable 2003 period. The decrease in
income taxes resulted from decreased pre-tax earnings; the effective rate
remained constant at 38.5%.
Three Months Ended June 30, 2003
- --------------------------------
Revenues. Revenues increased 8.6% from $113.6 million for the three months ended
June 30, 2002 to $123.4 million for the comparable 2003 period, with the overall
revenue increase resulting from the acquisition of Lanier Healthcare, LLC on
July 1, 2002. Revenues for the services segment decreased 7.4% from $113.6
million for the three months ended June 30, 2002 to $105.3 million for the
comparable 2003 period. The decrease is largely the result of reduction in
contract service rates and attrition due to competitive pricing pressure.
Revenues for the solutions segment were $18.2 million for the three months ended
June 30, 2003 and were the result of the acquisition of Lanier Healthcare, LLC.
There were $181 thousand in revenues between the two segments, which have been
eliminated in consolidation.
Cost of Revenues, excluding depreciation. Cost of revenues increased 7.2% from
$84.3 million for the three months ended June 30, 2002 to $90.3 million for the
comparable 2003 period. Cost of revenue for the services segment was $84.3
million, or 74.1% of revenue, and $78.5 million, or 74.5% of revenue, for the
three month periods ended June 30, 2002 and June 30, 2003, respectively. The
decrease in actual costs was due to a large portion of the costs of this segment
being variable and declining as revenues declined. Cost of revenues for the
solutions segment was $11.9 million, or 65.2% of revenues, for the three months
ended June 30, 2003, and was the result of the acquisition of Lanier Healthcare,
LLC.
Selling, general and administrative. Selling, general and administrative
expenses increased 116.8% from $3.5 million for the three months ended June 30,
2002 to $7.6 million for the comparable 2003 period. As a percentage of
revenues, selling, general and administrative expenses increased from 3.1% for
the three months ended June 30, 2002 to 6.1% for the comparable 2003 period. Of
the increase in expenses between comparable periods, $3.6 million was the result
of the Lanier acquisition and largely relates to the cost of the sales force.
The remaining $500 thousand increase was the result of increased costs to
support operations.
Research and development. Research and development costs were $1.4 million for
the three months ended June 30, 2003. These costs relate entirely to Lanier,
which was acquired on July 1, 2002.
Depreciation. Depreciation expense increased 9.1% from $4.3 million for the
three months ended June 30, 2002 to $4.7 million for the comparable 2003 period.
As a percentage of revenues, depreciation increased slightly as the result of
capital purchases.
Amortization of intangible assets. Amortization of intangible assets increased
from $1.6 million for the three months ended June 30, 2002 to $2.0 million for
the comparable 2003 period. The increase is attributable to the Company's
acquisitions in 2002 and 2003.
15
Equity in losses of investee. We reflect our investment in A-Life Medical, Inc.
under the equity method of accounting. As such, we have recognized $247 thousand
and $132 thousand in a loss in investment for the periods ended June 30, 2002
and June 30, 2003, respectively. These losses were the result of amortization of
$83 thousand related to $1 million of the investment being allocated to acquired
software and the remainder related to our share of A-Life's operating loss in
both periods.
Interest income, net. We had net interest income of $376 thousand for the three
months ended June 30, 2002 and net interest income of $254 thousand for the
comparable 2003 period. The decrease was due to decreased rates of return on
liquid investments.
Income taxes. Income taxes decreased from $7.7 million for the three months
ended June 30, 2002 to $6.8 million for the comparable 2003 period. The decrease
in income taxes resulted from decreased pre-tax earnings; the effective tax rate
remained constant at 38.5%.
Liquidity and Capital Resources
- -------------------------------
At June 30, 2003, we had working capital of $167.0 million, including
$132.7 million of cash and cash equivalents. During the six months ended June
30, 2003, our operating activities provided cash of $39.3 million and during the
six months ended June 30, 2002 our operating activities provided cash of $37.8
million. The increase is primarily due to increased collections of accounts
receivable and a decrease in prepaid expenses, partially offset by increases in
inventories and decreases in accounts payable, deferred revenue and accrued
expenses.
During the six months ended June 30, 2003, we used cash in investing
activities of $10.7 million, consisting of $8.7 million of capital expenditures
and $2.8 million for acquisitions, partially offset by $814 thousand in proceeds
from the sale of a building. During the six months ended June 30, 2002, we used
cash for investing activities of $16.8 million, consisting of $8.2 million of
capital expenditures, $7.7 million for acquisitions and $892 thousand of
additional investment in A-Life Medical.
During the six months ended June 30, 2003, net cash provided by
financing activities was $646 thousand. During the six months ended June 30,
2002, cash provided by financing activities was $148 thousand.
We believe that our cash and cash equivalents generated from operations
and our borrowing capacity will be sufficient to meet our current working
capital and capital expenditure requirements.
During the six months ended June 30, 2003, there have been no items
that significantly impact our commitments and contingencies as discussed in the
notes to the 2002 Annual Financial Statements as filed on Form 10-K. In
addition, we have no significant off balance sheet arrangements.
New Accounting Pronouncements
- -----------------------------
In November 2002, the EITF finalized its tentative consensus on EITF
Issue 00-21, "Revenue Arrangements with Multiple Deliverables", which provides
guidance on the timing and method of revenue recognition for sales arrangements
that include the delivery of more than one product or service. EITF 00-21 is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. Management has evaluated the impact of this
consensus and does not believe it will have a material impact on the
Consolidated Financial Statements.
16
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities after January
31, 2003 and to variable interests in variable interest entities obtained after
January 31, 2003. Management does not believe the adoption of this
Interpretation will have an impact on the Company's Consolidated Financial
Statements.
The FASB has recently issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" and SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." The adoption of these accounting pronouncements is not expected to have
a material impact on the Company's Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We generally do not use derivative financial instruments. We make
investments in instruments that meet credit quality standards, as specified in
our investment policy guidelines; the policy also limits the amount of credit
exposure to any one issue, and type of instrument. We do not expect any material
loss with respect to our investments.
Item 4. Controls and Procedures
The Company's management, with the participation of the Company's
Principal Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures as of June 30,
2003. Based on this evaluation, the Company's Principal Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective for gathering, analyzing and disclosing the information
the Company is required to disclose in the reports it files under the Securities
Exchange Act of 1934, within the time periods specified in the SEC's rules and
forms. Such evaluation did not identify any change in the Company's internal
control over financial reporting that occurred during the quarter ended June 30,
2003 that materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
Changes in internal controls. There have been no changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of the Disclosure Controls evaluation.
Special Note Concerning Forward Looking Statements
- --------------------------------------------------
Some of the information in this Form 10-Q contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Securities Exchange Act. We also may have referred you to this note
in other written or oral disclosures we have made. These statements include
forward-looking language such as "will likely result," "may," "are expected to,"
"is anticipated," "estimated," "projected," "intends to," or other similar
17
words. Our actual results are likely to differ, and could differ materially,
from the results expressed in, or implied by, these forward-looking statements.
There are many factors that could cause these forward-looking statements to be
incorrect, including but not limited to the following risks: risks associated
with (1) our ability to recruit and retain qualified transcriptionists and other
employees; (2) inability to complete and assimilate acquisitions of businesses
especially acquisitions of non-medical transcription businesses, because we have
no prior experience in such businesses; (3) dependence on our senior management
team and new senior management from non-medical transcription acquisitions; (4)
the impact of new services or products on the demand for our existing services;
(5) our current dependence on medical transcription for a majority of our
business; (6) our ability to expand our customer base; (7) our ability to
maintain our current growth rate in revenue and earnings; (8) the volatility of
our stock price; (9) our ability to compete with others; (10) changes in law,
including without limitation, the impact of the Health Information Portability
and Accountability Act ("HIPAA") will have on our business; (11) infringement on
the proprietary rights of others; (12) our failure to comply with
confidentiality requirements; (13) the inability to predict future economic or
market conditions; and (14) risks inherent in diversifying into other
businesses, such as from the acquisitions of Lanier Healthcare (digital
dictation equipment), and entering into the medical record coding reimbursement
business. When considering these forward-looking statements, you should keep in
mind these risk factors and other cautionary statements we make in connection
with such statements, and you should recognize that those forward-looking
statements speak only as of the date made. MedQuist does not undertake any
obligation to update any forward-looking statement included in this Form 10-Q or
elsewhere. Other risk factors and cautionary statements are set forth in our
other filings with the SEC, and you are encouraged to read those.
Part II. Other Information
--------------------------
Item 1. - Legal Proceedings - None
Item 2. - Changes in Securities and Use of Proceeds - None
Item 3. - Defaults upon Senior Securities - None
Item 4. - Submission of Matters to a Vote of Security Holders
On May 28, 2003, the Company held its Annual Meeting of
Shareholders. At that meeting all of the persons nominated as
directors by the Board of Directors were elected.
The number of votes cast for, against, as well as abstentions
and broker non-votes, including a separate tabulation with
respect to each director nominee was as follows:
Director Votes For Votes Against
-------- --------- -------------
Hans M. Barella 34,464,736 55,787
Belinda W. Chew 34,464,736 55,787
David A. Cohen 33,583,730 936,793
William E. Curran 33,583,730 936,793
Stephen H. Rusckowski 34,464,736 55,787
A. Fred Ruttenberg 33,587,746 932,777
Richard H. Stowe 34,464,736 55,787
John H. Underwood 34,464,736 55,787
Scott M. Weisenhoff 34,464,736 55,787
Erik J. Westerink 34,464,736 55,787
18
There were no abstentions or broker non-votes with respect to
this matter.
Item 5. - Other Information
Item 6. - Exhibits and Reports on Form 8-K
a) Exhibits:
Exhibit 10.31 - Separation Agreement, dated April 2, 2003,
by and between MedQuist Inc. and David A. Cohen, filed
herewith.
Exhibit 31.1 - Certification of the Principal Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 31.2 - Certification of the Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32.1 - Certification of the Principal Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
Exhibit 32.2 - Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b) The Company filed the following Reports on Form 8-K
File Date Item Reported
--------- -------------
April 24, 2003 Regulation FD Disclosure in
connection with earnings
release and conference call
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MedQuist Inc.
Registrant
Date: August 12, 2003 By: Brian J. Kearns
--------------------
Brian J. Kearns
Chief Financial Officer
19