1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
Commission File Number: 0-25062
ENVOY CORPORATION
(Exact Name of Registrant as Specified in its Charter)
TENNESSEE
(State or Other Jurisdiction of Incorporation or Organization)
62-1575729
(I.R.S. Employer Identification Number)
TWO LAKEVIEW PLACE, 15 CENTURY BLVD.
SUITE 600, NASHVILLE, TN 37214
(Address of Principal Executive Offices)
(615) 885-3700
(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
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practible date.
SHARES OUTSTANDING AS OF JULY 31, 1996:
11,733,571
CLASS:
COMMON STOCK, NO PAR VALUE PER SHARE
2
ENVOY CORPORATION
Condensed Consolidated Balance Sheets
(unaudited)
(In thousands, except share data)
June 30, December 31,
1996 1995
-----------------------
ASSETS:
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $ 1,907 $ 222
SHORT TERM INVESTMENTS 2,472 5,103
ACCOUNTS RECEIVABLE-NET 14,645 7,610
INVENTORIES 1,723 2,092
DEFERRED INCOME TAXES 300 300
OTHER CURRENT ASSETS 631 465
--------------------
TOTAL CURRENT ASSETS 21,678 15,792
PROPERTY AND EQUIPMENT, NET 15,540 12,768
OTHER ASSETS 52,662 1,590
--------------------
TOTAL ASSETS $89,880 $30,150
====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
CURRENT LIABILITIES:
ACCOUNTS PAYABLE $ 4,200 $ 388
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES 7,788 4,127
REDEEMABLE PREFERRED STOCK 2,200 -
CURRENT PORTION OF LONG-TERM DEBT 2,174 -
--------------------
TOTAL CURRENT LIABILITIES 16,362 4,515
LONG-TERM DEBT, LESS CURRENT PORTION 44,036 10,000
DEFERRED INCOME TAXES 2,745 300
SHAREHOLDERS' EQUITY:
PREFERRED STOCK-No par value;
authorized, 12,000,000 shares;
issued, 3,730,233 in 1996 40,100 -
COMMON STOCK-No par value; authorized,
48,000,000 shares; issued, 11,733,471 and
11,289,421 in 1996 and 1995, respectively 17,918 11,289
ADDITIONAL PAID-IN CAPITAL 7,155 7,155
ACCUMULATED DEFICIT (38,436) (3,109)
--------------------
TOTAL SHAREHOLDERS' EQUITY 26,737 15,335
--------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $89,880 $30,150
====================
See accompanying notes to unaudited condensed consolidated financial
statements.
3
ENVOY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1996 1995 1996 1995
----------------- ------------------
REVENUES $19,590 $ 6,155 $29,920 $13,078
OPERATING COSTS AND EXPENSES:
COST OF REVENUES 9,748 3,548 15,051 7,817
SELLING, GENERAL AND ADMINISTRATIVE 4,906 2,069 7,903 4,195
DEPRECIATION AND AMORTIZATION 5,315 572 7,370 1,132
MERGER AND FACILITY INTEGRATION COSTS 282 - 32,866 -
EMC LOSSES 105 - 540 -
------- ------- ------- -------
OPERATING LOSS (766) (34) (33,810) (66)
OTHER INCOME (EXPENSE):
INTEREST INCOME 69 66 167 76
INTEREST EXPENSE (1,130) (72) (1,634) (72)
------- ------- ------- -------
(1,061) (6) (1,467) 4
------- ------- ------- -------
LOSS FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES AND LOSS IN INVESTEE (1,827) (40) (35,277) (62)
INCOME TAX BENEFIT (PROVISION) 410 (30) (50) -
LOSS IN INVESTEE - 100 - 375
------- ------- ------- -------
LOSS FROM CONTINUING OPERATIONS (1,417) (170) (35,327) (437)
DISCONTINUED OPERATIONS:
LOSS FROM DISCONTINUED OPERATIONS,
NET OF INCOME TAXES - (2,443) - (2,274)
------- ------- ------- -------
LOSS FROM DISCONTINUED OPERATIONS - (2,443) - (2,274)
------- ------- ------- -------
NET LOSS ($1,417) ($2,613) ($35,327) ($2,711)
======= ======= ======= =======
NET LOSS PER COMMON SHARE:
CONTINUING OPERATIONS ($0.12) ($0.02) ($3.05) ($0.04)
DISCONTINUED OPERATIONS - (0.22) - (0.21)
------- ------- ------- -------
NET LOSS PER COMMON SHARE ($0.12) ($0.24) ($3.05) ($0.25)
======= ======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING 11,720 11,025 11,568 11,025
======= ======= ======= =======
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS.
4
ENVOY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In Thousands)
SIX MONTHS ENDED
JUNE 30,
1996 1995
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES: $ 893 $ 2,181
INVESTING ACTIVITIES:
NET (INCREASE) DECREASE IN INVESTMENTS 5,370 (377)
PURCHASES OF PROPERTY AND EQUIPMENT (2,383) (5,155)
PAYMENTS RECEIVED ON NOTES RECEIVABLE 334 1,814
DECREASE IN OTHER ASSETS 731 1,430
PAYMENTS FOR BUSINESSES ACQUIRED, NET OF
$4784 CASH ACQUIRED AND INCLUDING OTHER
CASH PAYMENTS ASSOCIATED WITH THE (83,147) -
ACQUISITION
SETTLEMENT OF DISCONTINUED OPERATIONS - (12,395)
------- -------
NET CASH USED IN INVESTING ACTIVITIES (79,095) (14,683)
FINANCING ACTIVITIES:
PROCEEDS FROM ISSUANCE OF PREFERRED STOCK 40,100 -
PROCEEDS FROM ISSUANCE OF COMMON STOCK 5,132 15
PROCEEDS FROM DEBT 43,900 10,000
PAYMENTS OF DEBT (8,045) (1,120)
PAYMENT OF DEFERRED FINANCING COSTS (1,200) -
------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 79,887 8,895
------- -------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 1,685 (3,607)
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF
THE YEAR 222 4,270
------- -------
CASH AND CASH EQUIVALENTS AT THE END OF THE
PERIOD $ 1,907 $ 663
======= =======
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS.
5
ENVOY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1996
A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of ENVOY
Corporation (the "Company" or "ENVOY") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments consisting of normal recurring accruals
considered necessary for a fair presentation have been included (See Notes C
and D). Operating results for the three- and six-month periods ended June 30,
1996 are not necessarily indicative of the results that may be expected for the
year ended December 31, 1996.
These financial statements, footnote disclosures and other information should
be read in conjunction with the audited financial statements and the
accompanying notes thereto in the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
Certain reclassifications have been made in the 1995 financial statements to
conform to the classifications in 1996.
B. NET LOSS PER COMMON SHARE
Net loss per common share has been computed by dividing net loss by the
weighted average number of shares of common stock and common stock equivalents,
when dilutive, using the treasury stock and modified treasury stock methods, as
appropriate.
C. ACQUISITIONS
NATIONAL ELECTRONIC INFORMATION CORPORATION ("NEIC")
On March 6, 1996, the Company's shareholders approved the acquisition of NEIC
for an aggregate purchase price of approximately $94,301,000, consisting of (i)
$86,154,000 paid to the NEIC stockholders, (ii) $2,200,000 paid to certain NEIC
stockholders on August 1, 1996 and (iii) certain other transaction and
acquisition costs of $5,947,000. The NEIC business combination was accounted
for under the purchase method of accounting, applying the provisions of
Accounting Principles Board Opinion No. 16 ("APB 16") and, as a result, the
Company recorded the assets and liabilities of NEIC at their estimated fair
values with the excess of the purchase price over these amounts being recorded
as goodwill. Based upon management's preliminary estimates, the Company has
recorded $35,328,000 in goodwill and $19,600,000 of identifiable intangible
assets related to the NEIC acquisition. The actual allocations will be based
on further studies and may change during the allocation period. The operations
of NEIC are included in the statement of operations from the date of
acquisition.
In connection with the NEIC acquisition, the Company also incurred a one time
write-off of acquired in-process technology of $30,000,000 and such amount was
charged to expense in the three months ended March 31, 1996, because this
amount relates to research and development that has not reached technological
feasibility and for which there is no alternative future use. The $30,000,000
is classified as merger and facility integration costs in the statement of
operations (See Note D).
6
The NEIC acquisition was financed through equity and debt financing. An
aggregate of 3,730,233 shares of the Company's Series B Convertible Preferred
Stock were issued to three investors for a total purchase price of $40,100,000.
Additionally, the Company issued 333,333 shares of the Company's Common Stock
to various investors for an aggregate purchase price of $5,000,000. The
Company also entered into a credit agreement, whereby the Company obtained
$50,000,000 in bank financing in the form of a $25,000,000 revolving credit
facility and a $25,000,000 term loan. An additional 840 shares of NEIC
cumulative redeemable preferred stock, $10.00 par value per share, remain
outstanding. The NEIC preferred stock was redeemed by the Company on August 1,
1996 at a redemption price of approximately $2,200,000.
TELECLAIMS, INC. ("TELECLAIMS")
On March 1, 1996, the Company acquired all the issued and outstanding capital
stock of Teleclaims in exchange for 73,242 shares of the Company's Common Stock
for a purchase price of approximately $1,500,000. The Teleclaims business
combination was accounted for under the purchase method of accounting applying
the provisions of APB 16 and, as a result, the Company recorded the assets and
liabilities at their estimated fair values with the excess of the purchase
price over these amounts being recorded as goodwill. Goodwill in the amount of
$278,000 was recorded in connection with the acquisition of Teleclaims. Also
recorded as part of the Teleclaims acquisition was a one time write-off of
acquired in-process technology of $700,000 in the three months ended March 31,
1996, because this amount relates to research and development that has not
reached technological feasibility and for which there is no alternative future
use. The $700,000 is classified as merger and facility integration costs in
the statement of operations. The allocation is based on management's
preliminary estimates. The actual allocations will be based upon further
studies and may change during the allocation period. The operations of
Teleclaims are included in the statement of operations from the date of
acquisition (See Note D).
The Company concluded that the electronic health claim transaction processing
industry is relatively new, subject to uncertainty, including regulatory
influences, and characterized by high levels of ongoing technological
innovation and rapidly changing technology. The Company operates in an
environment with high levels of price competition in a highly fragmented market
and faces significant competition from companies that have greater financial,
technological and other resources. The Company's operating history is
relatively limited and its ability to integrate acquisitions into the Company's
operations and business strategies is unproven. Accordingly, the Company
concluded that a three-year amortization period on a straight-line basis of the
excess cost over fair value of assets acquired in the NEIC and Teleclaims
acquisitions is appropriate based on current evidence.
Identifiable intangible assets acquired in the NEIC and Teleclaims acquisitions
are amortized on a straight-line basis over a period of two to nine years
depending upon the estimated remaining useful life of such assets.
The following presents unaudited pro forma results of operations (including the
one-time write-off of acquired in-process technology) for the six month period
ended June 30, 1996 and 1995 assuming the NEIC and Teleclaims acquisitions had
been consummated at the beginning of the periods presented (in thousands,
except per share data):
SIX MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1996 1995
-------------- --------------
Revenues $ 38,107 $ 31,712
Loss from continuing operations $(36,346) $(41,059)
Net loss $(36,346) $(43,333)
Loss per common share:
Continuing operations $ (3.07) $ (3.60)
Discontinued operations 0.00 (0.19)
-------- --------
Net loss $ (3.07) $ (3.79)
======== ========
7
D. CHANGE IN ACCOUNTING PRINCIPLE
At the consummation dates of the acquisitions of NEIC and Teleclaims, the
Company provided $11,400,000 and $266,000 of deferred income taxes related to
the write-off of acquired in-process technology for NEIC and Teleclaims,
respectively. However, subsequent to these acquisitions, at the May 23, 1996
Financial Accounting Standards Board ("FASB") Emerging Issues Task Force
("EITF") meeting, the EITF reached a consensus that the write-off of amounts
assigned for financial reporting purposes to acquired in-process research and
development occurs prior to the measurement of deferred income taxes in a
purchase business combination. Accordingly, the EITF concluded that deferred
income taxes are not provided on the initial differences between the amounts
assigned for financial reporting and tax purposes, and the in-process research
and development should be charged to expense on a gross basis at acquisition.
The Company has decided to make a change in accounting principle to conform
with the consensus of the EITF. Since the consensus does not specify the
manner of reporting a change in accounting principle, the Company accounted for
such change in accordance with Statement of Financial Accounting Standards No.
111, "Rescission of FASB Statement No. 32 and Technical Corrections," and
reported the change as specified by APB Opinion No. 20. The application of
this accounting change is reflected as a charge in the statements of operations
as a cumulative effect type accounting change. In accordance with FASB
Statement No. 3 "Reporting Accounting Changes in Interim Financial Statements"
the effect of the accounting principle change is reported as a restatement of
the first quarter of 1996 as if the change were made in the first quarter of
1996. With respect to originally reported amounts, this restatement is
reflected as an increase in income tax expense of $11,666,000, a decrease in
amortization expense of $264,000, an increase in loss from continuing
operations of $11,402,000 and an increase in net loss of $11,402,000 or $1.00
per share. The changed amounts are included in the statement of operations for
the six month period ended June 30, 1996. The effect of the change on the
three-month period ended June 30, 1996 was to reduce net loss approximately
$972,000 ($.08 per share) as a result of the reduced amount of goodwill being
amortized.
The effect of the change on the first quarter of 1996 is as follows (in
thousands):
THREE MONTHS ENDED MARCH 31, 1996
---------------------------------
Net loss as originally reported $(22,508)
Effect of change in accounting principle to
amortization expense 264
Effect of change in accounting principle to
income tax expense (11,666)
--------
Net loss as restated $(33,910)
========
Per Share Amounts:
Net loss as originally reported $ (1.97)
Effect of change in accounting principle (1.00)
--------
Net loss as restated $ (2.97)
========
E. MERGER AND FACILITY INTEGRATION COSTS
As a result of the acquisitions of NEIC and Teleclaims in March 1996, the
Company approved a plan that reorganized certain of its operations, personnel
and facilities to gain the effects of potential cost savings and operating
synergies. The cost of this plan to integrate the acquired companies is being
recognized as incurred in accordance with the guidance set forth in Emerging
Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" and are not part of the purchase price
allocation. The costs incurred in the three-and six-month periods ended June
30, 1996 associated with this plan of $282,000 and $1,884,000, respectively,
represents exit costs associated with lease terminations, personnel costs,
writedowns of impaired assets and other related costs that will be incurred as
a direct result of the plan and are classified as merger and facility
integration costs in the statements of operations. The employee groups to be
terminated are accounting, marketing and certain areas of the
8
systems and operations departments. The number of employees to be terminated is
approximately 100, of which 37 employees had been terminated as of June 30,
1996. Adjustments made to the liability as of June 30, 1996 were
approximately $615,000. The Company estimates that future costs to be charged
to expense as incurred during fiscal year 1996 to approximate $1,100,000 to
$2,100,000.
Merger and facility integration costs consist of the following (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1996 JUNE 30, 1996
------------------ ----------------
Acquired in process technology charge-off $ 0 $30,700
Facility integration costs 282 2,166
---- -------
Total merger and facility integration costs $282 $32,866
==== =======
F. EMC LOSSES
On January 28, 1995, the Company purchased 17.5% of the common stock of
EMC*Express, Inc. ("EMC"), a corporation that transmits billing information
from hospitals and doctors to third party payors. The remaining stock in EMC
is held by StellarNet, Inc., a California corporation ("StellarNet"), an
unrelated party, which previously owned all of the business of EMC directly.
The total purchase price for the 17.5% interest in EMC was $570,000.
In connection with the closing, the Company paid $250,000 for an option to
purchase the remainder of the capital stock of EMC for $2,680,000, subject to
increase upon the achievement of certain performance objectives, and also
entered into a management agreement to provide management services to EMC (the
"Management Agreement"). Under the terms of the Management Agreement, the
Company agreed to fund certain operating costs of EMC in the form of advances.
The Management Agreement could be terminated by the Company at any time on 60
days written notice, at which time the option would be terminated. The Company
gave notice to terminate the Management Agreement on January 31, 1996. The
Company was committed through March 31, 1996 to continue to fund certain
operating costs of EMC. The loss in EMC for the three-and six-month periods
ended June 30 was $105,000 and $540,000, respectively, for 1996 and $100,000
and $375,000, respectively, for 1995. The loss for the three-and six-month
periods ended June 30, 1996 is classified as an operating expense because the
Company now accounts for the EMC investment on the cost method of accounting
and has discontinued accounting for such investment on the equity method as it
had done previously.
In March 1996, StellarNet filed a lawsuit in the Superior Court of the State of
California for the City and County of San Francisco against the Company. This
lawsuit asserts claims for breach of contract and negligent conduct.
StellarNet seeks unspecified compensatory damages, plus attorneys fees and
court costs. The Company has denied each of StellarNet's claims and has filed
counterclaims for fraudulent inducement and misrepresentation against
StellarNet. The Company believes these claims of StellarNet are without merit
and intends to vigorously defend itself. No estimate of a possible loss or
range of loss can be estimated.
With the exception of the ongoing litigation expenses associated with the
defense of the lawsuit filed by StellarNet, Inc., the majority stockholder of
EMC, over the termination of the management agreement, the Company does not
anticipate additional losses from the EMC management agreement or investment
which would be material to its operations.
G. DISCONTINUED OPERATIONS
On June 6, 1995, the Company completed the merger between the Company and First
Data Corporation ("FDC"). Pursuant to a management services agreement entered
into in connection with the merger, the Company is receiving a fee from FDC of
$1,500,000 per annum, payable in quarterly installments of $375,000, during the
first two years following the merger, after which period such fees are
anticipated to end. Management fees of $375,000 and $750,000 for the three-
and six- month periods ended June 30, 1996 are classified in the revenues
caption in the statements of operations.
The net assets of the financial services electronic transaction processing
business was merged with and into FDC under the terms of the merger agreement
and were accounted for as discontinued operations. Certain reclassifications
were made to the statements of operations for the three- and six-month periods
ended June 30, 1995 to reflect such operations as discontinued operations.
9
H. SUBSEQUENT EVENT
On August 13, 1996, the Company completed the sale of 3,320,000 shares of
common stock at $26.50 per share in an underwritten public offering. The net
proceeds to the Company of approximately $83,064,000 have been used to retire
its $25,000,000 term loan and repay all amounts outstanding under its
$25,000,000 revolving credit facility. The remaining proceeds will be used for
general corporate purposes, including funding the increased working capital
requirements of the Company generated by growth and for possible strategic
acquisitions.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
ENVOY provides electronic processing services primarily for the health care
market. This includes submission for adjudication of insurance and other
third-party reimbursement claims for pharmacies, physicians, hospitals and
dentists, and, since 1994, providing clearinghouse services for batch
processing of medical and dental reimbursement claims.
On June 6, 1995, the Company completed the sale through a merger of its
financial transaction processing business to First Data Corporation ("First
Data"). For accounting purposes, the health care transaction processing
business is treated as continuing operations, while the financial transaction
processing business is treated as discontinued operations.
In March 1996, the Company acquired Teleclaims, Inc. ("Teleclaims") and
National Electronic Information Corporation ("NEIC") (the "Acquired
Businesses"). Both of these acquisitions were accounted for under the purchase
method of accounting and, as a result, the Company has recorded the assets and
liabilities of both companies at their estimated fair values with the excess of
the purchase price over these amounts being recorded as goodwill. The
financial statements presented herein reflect the operations of the Acquired
Businesses for the period after their respective dates of acquisition.
Revenues are principally derived from (i) transaction processing services to
the health care market which are generally paid for by the health care
providers and (ii) commercial claim processing services provided to third-party
payors which are usually paid for by the payors. Revenues are generally earned
on a per transaction basis and are generally based upon the number of
transactions processed, rather than the transaction volume per customer.
A small portion of ENVOY's revenues are derived from the sale and lease of
point-of-sale devices, customer support, on-site training and installation, and
annual participation fees.
The table below shows transactions processed by ENVOY for the periods
represented (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1996 1995 1996 1995
------- ------ -------- -------
Pharmacy 111,753 85,803 219,354 175,484
Non-pharmacy 36,570 3,766 49,722 6,176
------- ------ ------- -------
Transactions 148,323 89,569 269,076 181,660
======= ====== ======= =======
The total transactions reflected above include the transactions of the Acquired
Businesses from the date of acquisition through the end of the second quarter
of 1996. Had the acquisitions of the Acquired Businesses occurred as of
January 1, 1995, total transactions for the six-month period ended June 30,
1996 would have been 289.1 million compared to 221.5 million for the
comparable 1995 period.
RESULTS OF OPERATIONS
Revenues: Revenues for the three- and six- month periods ended June 30, 1996
were $19,590,000 and $29,920,000 respectively. Reported revenues for the same
periods in 1995 were $6,155,000 and $13,078,000. The increase is primarily
attributable to revenues from the Acquired Businesses, which contributed
$12,221,000 and $15,535,000 to revenues in the three- and six-month periods
ended June 30, 1996, respectively. Contributing to the revenue growth in the
second quarter was a 19.9% increase in ENVOY's pre-acquisition revenue over the
second quarter of 1995. This is attributable to the 24.1% increase in total
transactions (not including the Acquired Businesses) in the second quarter of
1996 over the second quarter of 1995. Hardware sales for the second quarter
of 1996 were $266,000 vs. $143,000 in the same period of 1995. Hardware sales
for the six month period ended June 30, 1996 and 1995 were $444,000 and
11
$1,130,000, respectively. The decrease for the six month period is
attributable to a large one-time hardware sale in the prior year.
Cost of Revenues: Cost of revenues includes the cost of communications,
computer operations, product development and customer support as well as the
cost of hardware sales. In addition, the Acquired Businesses' cost of revenues
includes payments to third parties for transaction processing volume. Cost of
revenues in the second quarter of 1996 was $9,748,000 compared to $3,548,000 in
the same quarter last year. As a percent of revenue, cost of revenue was 49.8%
for the quarter ended June 30, 1996 compared to 57.6% for the quarter ended
June 30, 1995. Cost of revenues for the six-month period ended June 30, 1996
and 1995 were $15,051,000 or 50.3% of revenue and $7,817,000 or 59.8% of
revenue, respectively. The improvement is almost exclusively attributable to
the inclusion of the Acquired Businesses' results which historically have
experienced higher profit margins than those of ENVOY's pre-acquisition
business.
Selling, General and Administrative Expenses: Selling, general and
administrative expenses include marketing, finance, accounting and
administrative costs. Selling, general, and administrative expenses for the
second quarter of 1996 were $4,906,000 compared to $2,069,000 for the second
quarter of 1995, an increase of 137%. Selling, general and administrative
expense for the six months ended June 30, 1996 were $7,903,000 compared to
$4,195,000 for the same period in 1995, an increase of 88%. Selling, general
and administrative expenses increased as a result of the inclusion of the
Acquired Businesses and the additional costs incurred by ENVOY in anticipation
of the merging of NEIC's corporate functions into ENVOY. As a percentage of
revenues, selling, general and administrative expenses were 25.0% and 33.6% for
the second quarter ended June 30, 1996 and 1995, respectively, and 26.4% and
32.1% for the six-month period ended June 30, 1996 and 1995, respectively.
Depreciation and Amortization: Depreciation and amortization expense relates
primarily to host computers, communications equipment, goodwill and other
identifiable intangible assets. Depreciation and amortization expense for the
second quarter of 1996 was $5,315,000 compared to $572,000 for the same period
in 1995. Depreciation and amortization expense for the six-month period ended
June 30, 1996 and 1995 was $7,370,000 and $1,132,000, respectively. The
increase is primarily the result of the amortization of goodwill and other
intangibles of $4,136,000 and $5,251,000 related to the Acquired Businesses for
the three- and six-month periods ended June 30, 1996, respectively.
Depreciation and amortization increased further as the result of the addition
of host computer systems in connection with the expansion of the Company's
transaction processing capabilities. The Company will amortize goodwill of
$35.6 million associated with the Acquired Businesses over the three year
period following the acquisitions. In addition, ENVOY will amortize
identifiable intangibles of $19.9 million over two to nine year time periods,
as applicable.
Merger and Facility Integration Costs: ENVOY recognized merger and facility
integration costs in the three- and six-month periods ended June 30, 1996 of
$282,000 and $32,866,000, respectively. This represents $282,000 of facility
integration costs for the second quarter of 1996 and a one-time charge of
acquired in process technology of $30,700,000 and facility integration costs of
$2,166,000 in the six-month period ended June 30, 1996. The Company
anticipates it will incur additional facility integration costs of up to
$2,100,000 over the remaining two quarters of 1996.
EMC Losses: The Company acquired 17.5% of the Common Stock of EMC* Express,
Inc. ("EMC") in January 1995. In conjunction with the purchase of the stock of
EMC, the Company entered into a management agreement which required ENVOY to
fund certain operating costs of EMC. Notice was given to terminate this
management agreement on January 31, 1996. During the second quarter of 1996,
the Company recognized losses of $105,000 for funding certain of EMC operations
and $540,000 of losses for the six-month period ended June 30, 1996. Such
losses are recorded as an operating expense because the Company now accounts
for its investment in EMC on the cost method of accounting and has discontinued
accounting for such investment on the equity method as it had done previously.
Except for ongoing litigation expenses associated with the defense of the
lawsuit filed by StellarNet, Inc., the majority stockholder of EMC, over the
termination of the management agreement, the Company does not anticipate
additional losses from the EMC management agreement or investment which would
be material to its operations. The loss in investee in the second quarter of
1995 was $100,000 and $375,000 for the six-month period ended June 30, 1995.
See Note F to the June 30, 1996 Unaudited Condensed Consolidated Financial
Statements.
12
Net Interest Expense: ENVOY recorded net interest expense for the quarter
ended June 30, 1996 of $1,061,000 compared to $6,000 of net interest expense
for the second quarter of 1995. Net interest expense for the six-month period
ended June 30, 1996 and 1995 was $1,467,000 and $4,000 of net interest income,
respectively. The increase in net interest expense is the result of the
borrowings under the Company's credit facilities used to finance the purchase
of the Acquired Businesses as well as interest associated with the 9%
$10,000,000 principal amount of convertible subordinated notes issued in June
1995 (the "Convertible Notes").
Income Tax Benefit (Provision): The Company's income tax benefit in the second
quarter of 1996 was $410,000 compared to an income tax expense of $30,000 in
the same period last year. The income tax expense for the six months ended
June 30, 1996 was $50,000 compared to zero for the six-month period ended June
30, 1995. The tax benefit recorded in the second quarter was a change in the
annual estimated tax rate and a reversal of the provision previously booked.
The tax provision booked in the six-month period ended June 30, 1996 is a
provision related to certain state income taxes.
Change in Accounting Principle: At the consummation dates of the acquisitions
of NEIC and Teleclaims, the Company provided $11,400,000 and $266,000 of
deferred income taxes related to the write-off of acquired in-process
technology for NEIC and Teleclaims, respectively. However, subsequent to these
acquisitions, at the May 23, 1996 FASB Emerging Issues Task Force ("EITF")
meeting, the EITF reached a consensus that the write-off of amounts assigned
for financial reporting purposes to acquired in-process research and
development occurs prior to the measurement of deferred income taxes in a
purchase business combination. Accordingly, the EITF concluded that deferred
income taxes are not provided on the initial differences between the amounts
assigned for financial reporting and tax purposes, and the in-process research
and development is charged to expense on a gross basis at the time of
acquisition.
The Company has decided to make a change in accounting principle to conform with
the consensus of the EITF. Since the consensus does not specify the manner of
reporting a change in accounting principle, the Company accounted for such
change in accordance with Statement of Financial Accounting Standards No. 111,
"Rescission of FASB Statement No. 32 and Technical Corrections," and reported
the change as specified by APB Opinion No. 20. The application of this
accounting change is reflected as a charge in the statements of operations as a
cumulative effect type accounting change. In accordance with FASB Statement No.
3 "Reporting Accounting Changes in Interim Financial Statements" the effect of
the accounting principle change is reported as a restatement of the first
quarter of 1996 as if the change were made in the first quarter of 1996. With
respect to originally reported amounts, this restatement is reflected as an
increase in income tax expense of $11,666,000, a decrease in amortization
expense of $264,000, an increase in loss from continuing operations of
$11,402,000 and an increase in net loss of $11,402,000 or $1.00 per share. The
changed amounts are included in the statement of operations for the six month
period ended June 30, 1996. The effect of the change on the three month period
ended June 30, 1996 was to reduce net loss approximately $972,000 ($0.08 per
share) as a result of the reduced amount of goodwill being amortized.
LIQUIDITY AND CAPITAL RESOURCES
ENVOY has incurred operating losses since its health care transaction
processing business commenced operations in 1989. The operating losses have
resulted from ENVOY's substantial investment in its health care transaction
processing business coupled with a disproportionate amount of overhead and
fixed costs. Historically, health care losses have been funded by earnings
from the Company's more mature financial business, which had a substantially
higher transaction volume and revenue base. The viability of ENVOY requires
continued expansion of the number of transactions processed to generate greater
revenue. While ENVOY believes that it is beginning to generate sufficient
revenues to cover operating expenses and the costs of planned expansion, there
can be no assurance that sufficient income will be generated from operations to
cover such costs and expenses. ENVOY believes that the additional transaction
volume from the Acquired Businesses, coupled with potential costs savings and
operating synergies that ENVOY believes it may realize from the integration of
the Acquired Businesses, will result in improved operating results; however,
there are no assurances that such cost savings or synergies will be realized or
that profitability can be obtained or maintained.
In June 1995, the Company issued the $10,000,000 Convertible Notes to First
Data. The entire $10,000,000 principal amount of the Convertible Notes remains
outstanding and is due in June 2000. The Convertible Notes are convertible at
the election of the holders into shares of Common Stock. The current
conversion price is equal to $10.52 per share.
13
In March 1996, the Company completed the purchase of the Acquired Businesses.
Teleclaims was acquired by the Company on March 1, 1996, for 73,242 shares of
Common Stock. On March 6, 1996 ENVOY acquired NEIC for $94,301,000 consisting
of $86,154,000 that was paid at closing to the stockholders of NEIC, $2,200,000
paid to certain stockholders of NEIC on August 1, 1996 and certain other
transaction and acquisition expenses of $5,947,000. The NEIC acquisition was
financed through equity issuances of 333,333 shares of Common Stock for
$5,000,000, 3,730,233 shares of Series B Preferred Stock for $40,100,000 and a
new credit facility of $50,000,000. The new credit facility provides financing
through a $25,000,000 term loan and a $25,000,000 revolving line of credit. In
addition to funding the merger consideration, the proceeds of the credit
facilities were used to fund capital expenditures, merger expenses and working
capital requirements.
Loans made pursuant to the credit facilities bear interest at varying rates
based on an index to the lender's prime rate or the 30, 60 or 90 day LIBOR.
The borrowings under the revolving credit facility of $5.9 million and $5.0
million currently bear interest at 9.25% (the lenders' "Base Rate" as defined
in the Credit Facilities plus 1.50%) and 7.98% (LIBOR as defined in the credit
facilities plus 3%), respectively. The borrowings under the term loan bear
interest at 7.98% (LIBOR as defined plus 3.0%). The credit facilities were
subject to a one-time facility fee of $1.0 million and an annual administrative
fee of $20,000. The revolving credit facility requires an annualized
commitment fee of 0.375% of its average daily unused portion. The term loan is
payable in quarterly installments varying in amount from $1,000,000 to
$2,250,000. The term loan is required to be prepaid with 100% of the net
proceeds from any sales of assets in excess of $500,000 per year and 50% of the
net proceeds of the issuance of any equity securities. The total amount
outstanding under the Credit Facilities is due and payable in full on March 31,
2000. The credit facilities contain financial covenants applicable to ENVOY
and its subsidiaries including the debt/cash flow ratio, ratios of debt to
capital and cash flow to interest expense and certain restrictions on capital
expenditures.
The credit facilities are secured by guarantees from all existing and future
ENVOY subsidiaries and by security interests in all of the stock, promissory
notes and other assets of ENVOY. ENVOY and its subsidiaries are subject to
certain restrictions relating to payment of dividends and other distributions,
asset acquisitions, incurrence of debt, investments, consolidations and mergers
and other restrictive provisions. On June 30, 1996 the Company had a balance
of $25,000,000 outstanding under the term loan and $10,900,000 outstanding
under the revolving line of credit.
On August 13, 1996, the Company completed the sale of 3,320,000 shares of
common stock at $26.50 per share in an underwritten public offering. The net
proceeds to the Company of approximately $83,064,000 have been used to retire
its $25,000,000 term loan and repay all amounts outstanding under its
$25,000,000 revolving credit facility. The Company is currently negotiating an
amended credit agreement to provide up to $100,000,000 of available credit.
The remaining net proceeds from the offering will be used for general corporate
purposes, including funding the increased working capital requirements of the
Company generated by growth and for possible strategic acquisitions.
ENVOY purchases additional computer hardware and software products from time to
time as required by the growth of its customer base. ENVOY incurred capital
expenditures of approximately $916,000 and $2,383,000 in the three-and
six-month periods ending June 30, 1996, respectively, primarily for computer
hardware and software products used for the expansion of the health care
transaction processing function. The Company anticipates that its total
capital expenditures for 1996, including amounts expended in the first half of
the year, will be approximately $5,000,000 to $6,000,000 and will be incurred
primarily for data processing equipment considered necessary because of
anticipated increased transaction volumes and to upgrade network technology.
In connection with the Acquired Businesses, ENVOY identified five projects
aggregating $30,700,000 that were classified as in-process technology for which
technological feasibility had not been established and alternative future use
did not exist. The cost to complete these projects into commercially viable
products is estimated at $2,200,000 and is expected to be incurred during the
next two fiscal years. There can be no assurance that these projects can be
completed during this time frame or for such amounts.
ENVOY has executed a non-binding letter of intent dated June 13, 1996, to
acquire substantially all of the assets of a small hospital-based software
company for an aggregate purchase price of $2,100,000 in cash. The transaction
is not expected to be material to ENVOY's financial condition or results of
operation and is subject to, among other things, completion of due diligence,
execution of a definitive acquisition agreement and receipt of all necessary
consents and approvals. From time to time, the Company has engaged and will
continue to engage in acquisition discussions with other health care
information businesses and other companies complimentary to its business. In
the event the Company engages in such other acquisitions in the future, its
currently available capital resources may not be sufficient for such purposes
and the Company may be required to incur additional indebtedness or issue
additional capital stock, which could result in dilution to existing investors.
14
Based on current operations, anticipated capital needs to fund known
expenditures and the pending acquisition, the Company believes its current
liquidity position coupled with the proceeds of the offering, cash flow from
operations and a revised credit facility of up to $50.0 million of available
credit will provide the capital resources necessary to meet its liquidity and
cash flow requirements over the next twelve months, including the Company's
current short-term obligations. The Company believes that present funding
sources will provide the ability to meet long-term obligations as they mature.
15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. - In March 1996, StellarNet, Inc. filed a lawsuit in
the Superior Court of the State of California for the City and County of San
Francisco against the Company. This lawsuit asserts claims for breach of
contract and negligent conduct. StellarNet seeks unspecified compensatory
damages, plus attorneys fees and court costs. The Company has denied each of
Stellar Net's claims and has filed counterclaims for fraudulent inducement and
misrepresentation against Stellar Net. The Company believes these claims of
StellarNet are without merit and intends to vigorously defend itself. No
estimate of a possible loss or range of loss can be estimated.
Item 2. Changes in Securities. - Not Applicable
Item 3. Defaults Upon Senior Securities. - Not Applicable
Item 4. Submission of Matter to a Vote of Security Holders. - The Company held
its Annual Meeting of Shareholders on June 11, 1996 (the "Annual Meeting"). At
the annual meeting the shareholders of the Company voted to elect three (3)
Directors, Jim D. Kever, Laurence E. Hirsch and William E. Ford, for three-year
terms and until their successors are duly elected and qualified. The following
table sets forth the number of votes cast for, against and withheld/abstained
with respect to each of the nominees:
Nominee For Against Abstained
------- --- ------- ---------
Jim D. Kever 10,085,804 0 70,281
Laurence E. Hirsch 9,338,549 0 817,536
William E. Ford 10,065,004 0 91,081
In addition, the shareholders of the Company voted to ratify the appointment of
Ernst & Young LLP as the independent public accountants for the Company in
1996. There were 10,117,464 votes cast for such proposal, 15,229 votes cast
against such proposal and 23,392 abstaining with respect to such proposal.
16
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENVOY CORPORATION
Date: August 14, 1996 By: /s/ Fred C. Goad
-----------------------------------------
Fred C. Goad
President and Co-Chief Executive Officer
Date: August 14, 1996 By: /s/ Kevin M. McNamara
-----------------------------------------
Kevin M. McNamara
Vice President and Chief Financial Officer
17
Exhibit Index
Exhibit 27 Financial Data Schedule (for SEC use only)