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 SEPTEMBER 30, 1998
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 practicable date.
SHARES OUTSTANDING AS OF NOVEMBER 9, 1998:
21,559,504
CLASS:
COMMON STOCK, NO PAR VALUE PER SHARE
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENVOY CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------- ---------
ASSETS
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $ 22,095 $ 8,598
ACCOUNTS RECEIVABLE - NET 44,429 33,510
INVENTORIES 2,225 2,585
DEFERRED INCOME TAXES 1,369 1,797
OTHER 2,628 1,811
--------- ---------
TOTAL CURRENT ASSETS 72,746 48,301
PROPERTY AND EQUIPMENT, NET 18,898 19,508
OTHER ASSETS 87,406 98,816
--------- ---------
TOTAL ASSETS $ 179,050 $ 166,625
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER
CURRENT LIABILITIES $ 39,441 $ 30,011
CURRENT PORTION OF LONG-TERM DEBT 84 263
--------- ---------
TOTAL CURRENT LIABILITIES 39,525 30,274
LONG-TERM DEBT, LESS CURRENT PORTION 561 527
OTHER NON-CURRENT LIABILITIES 8,558 9,163
DEFERRED INCOME TAXES 573 1,579
SHAREHOLDERS' EQUITY:
PREFERRED STOCK -- No par value; authorized, 12,000,000 shares;
issued 2,800,000 and 3,730,233 in 1998 and in 1997, respectively 41,300 55,021
COMMON STOCK -- No par value; authorized, 48,000,000 shares;
issued, 21,559,504 and 20,075,822 in 1998 and 1997,
respectively 126,773 114,652
ADDITIONAL PAID-IN CAPITAL 8,485 7,208
RETAINED DEFICIT (46,725) (51,799)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 129,833 125,082
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 179,050 $ 166,625
========= =========
See accompanying notes to unaudited consolidated financial statements.
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ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
-------- -------- --------- --------
REVENUES $ 47,290 $ 34,693 $ 132,763 $ 97,625
OPERATING COSTS AND EXPENSES:
COST OF REVENUES 19,669 16,321 58,875 45,852
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 10,443 7,657 29,728 23,175
RESEARCH AND DEVELOPMENT
EXPENSES 690 452 1,963 1,689
DEPRECIATION AND AMORTIZATION
EXPENSES 8,890 8,938 26,948 25,013
WRITE OFF OF ACQUIRED IN-PROCESS
TECHNOLOGY 0 6,000 0 6,600
-------- -------- --------- --------
OPERATING INCOME (LOSS) 7,598 (4,675) 15,249 (4,704)
OTHER INCOME (EXPENSE):
INTEREST INCOME 256 282 589 1,219
INTEREST EXPENSE (401) (470) (1,226) (1,076)
-------- -------- --------- --------
(145) (188) (637) 143
-------- -------- --------- --------
INCOME (LOSS) BEFORE INCOME TAXES 7,453 (4,863) 14,612 (4,561)
INCOME TAX PROVISION (BENEFIT) 5,180 (228) 11,653 3,327
-------- -------- --------- --------
NET INCOME (LOSS) $ 2,273 $ (4,635) $ 2,959 $ (7,888)
======== ======== ========= ========
NET INCOME (LOSS) PER COMMON SHARE
BASIC $ 0.11 $ (0.23) $ 0.14 $ (0.40)
======== ======== ========= ========
DILUTED $ 0.09 $ (0.23) $ 0.12 $ (0.40)
======== ======== ========= ========
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC 21,316 20,014 21,048 19,556
======== ======== ========= ========
DILUTED 25,315 20,014 25,029 19,556
======== ======== ========= ========
See accompanying notes to unaudited consolidated financial statements.
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ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1997
-------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES $ 27,236 $ 16,504
INVESTING ACTIVITIES:
PURCHASES OF PROPERTY AND EQUIPMENT (4,360) (6,903)
INCREASE IN OTHER ASSETS (162) (3,294)
PAYMENTS FOR BUSINESSES ACQUIRED LESS CASH
ACQUIRED OF $550 IN 1998 (9,419) (40,412)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (13,941) (50,609)
FINANCING ACTIVITIES:
PROCEEDS FROM ISSUANCE OF COMMON
STOCK 2,119 1,813
CAPITAL DISTRIBUTIONS OF EXPRESSBILL COMPANIES (318) (779)
PROCEEDS FROM SHORT-TERM AND LONG-TERM DEBT 0 880
PAYMENTS ON SHORT-TERM AND LONG-TERM DEBT (1,599) (718)
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 202 1,196
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 13,497 (32,909)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 8,598 36,737
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 22,095 $ 3,828
======== ========
See accompanying notes to unaudited consolidated financial statements.
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ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1998
A. BASIS OF PRESENTATION
The accompanying unaudited 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. Operating
results for the three-month and nine-month periods ended September 30, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998.
As more fully discussed in Note C, on February 27, 1998, the Company
completed business combinations with Professional Office Services, Inc. ("POS"),
XpiData, Inc. ("XpiData") and Automated Revenue Management, Inc. ("ARM")
(collectively referred to as the "ExpressBill Companies"). These transactions
have been accounted for as poolings of interests and the Company's historical
consolidated financial statements have been restated to include the accounts and
results of operations of the ExpressBill Companies.
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 Current Report on Form 8- K/A No. 2,
filed on November 16, 1998.
B. RESTATEMENT OF FINANCIAL STATEMENTS
The management of the Company and the staff of the Securities and Exchange
Commission (the "Commission") have had discussions with respect to the methods
used to value acquired in-process technology recorded and written off at the
date of acquisition. As a result of these discussions, the Company has modified
the methods used to value acquired in-process technology in connection with the
Company's 1996 acquisition of National Electronic Information Corporation
("NEIC") and 1997 acquisitions of Healthcare Data Interchange Corporation
("HDIC") and Diverse Software Solutions ("DSS"). Initial calculations of value
of the acquired in-process technology were based on the cost required to
complete each project, the after-tax cash flows attributable to each project,
and the selection of an appropriate rate of return to reflect the risk
associated with the stage of completion of each project. Revised calculations of
the value of the acquired in-process technology are based on adjusted after-tax
cash flows that give explicit consideration to the Staff's views on in-process
research and development as set forth in its September 15, 1998 letter to the
American Institute of Certified Public Accountants and the Staff's comments for
the Company to consider (i) the stage of completion of the in-process technology
at the dates of acquisition, (ii) contributions of the Company's own distinct
and unique proprietary advantages, and (iii) the estimated total project costs
of the in-process research and development in arriving at the valuation amount.
As a result of this modification, the Company has decreased the amount of the
purchase price allocated to acquired in-process technology in the NEIC
acquisition from $30 million to $8 million, in the HDIC acquisition from $35
million to $6 million, and in the DSS acquisition from $3 million to $600,000.
As a result, the Company increased other intangibles by $5 million (for a
customer contract) and goodwill by $48.4 million.
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The changes related to acquired in-process technology are reflected in the
accompanying financial statements. These changes reduced the amounts reported
for net income for the three month period ended September 30, 1998 by
$2,172,000, or $0.10 and $0.09 on a basic and diluted per share basis,
respectively.
The effects of the restatement resulted in the following impact on the
Company's previously reported results of operations for the first and second
quarters of 1998 and the first, second, and third quarters of 1997 (in
thousands).
1998
------------------------------------------------
THREE MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED
MARCH 31, JUNE 30, JUNE 30,
1998 1998 1998
-----------------------------------------------
Income before income taxes:
As previously reported $ 5,002 $ 6,956 $ 11,958
* Adjustment related to acquired in-process technology (2,398) (2,398) (4,797)
-----------------------------------------------
Restated $ 2,604 $ 4,558 $ 7,161
===============================================
Net income:
As previously reported $ 2,258 $ 2,786 $ 5,044
* Adjustment related to acquired in-process technology (2,184) (2,172) (4,356)
-----------------------------------------------
Restated $ 74 $ 614 $ 688
===============================================
Earnings per share - Basic:
As previously reported $ 0.11 $ 0.13 $ 0.24
* Adjustment related to acquired in-process technology (0.11) (0.10) (0.21)
-----------------------------------------------
Restated -- $ 0.03 $ 0.03
===============================================
Earnings per share - Diluted:
As previously reported $ 0.09 $ 0.11 $ 0.20
* Adjustment related to acquired in-process technology (0.09) (0.09) (0.17)
-----------------------------------------------
Restated -- $ 0.02 $ 0.03
===============================================
* The adjustment results from the decrease in the value assigned to acquired
in-process technology, the increased amortization of goodwill, and related tax
effects.
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1997
-------------------------------------------------------------------------
THREE THREE THREE SIX NINE
MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
MARCH 31, JUNE 30, SEPT. 30, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1997
-------------------------------------------------------------------------
Income before income taxes:
As previously reported $ (1,225) $ 2,843 $ (31,640) $ 1,618 $ (30,022)
* Adjustment related to acquired in-process technology 558 (1,873) 26,777 (1,315) 25,461
-------------------------------------------------------------------------
Restated $ (667) $ 970 $ (4,863) $ 303 $ (4,561)
=========================================================================
Net income:
As previously reported $ (1,964) $ 920 $ (20,540) $ (1,044) $ (21,584)
* Adjustment related to acquired in-process technology (351) (1,858) 15,905 (2,209) 13,696
-------------------------------------------------------------------------
Restated $ (2,315) $ (938) $ (4,635) $ (3,253) $ (7,888)
=========================================================================
Earnings per share - Basic:
As previously reported $ (0.10) $ 0.05 $ (1.03) $ (0.05) $ (1.10)
* Adjustment related to acquired in-process technology (0.02) (0.10) 0.80 (0.12) 0.70
-------------------------------------------------------------------------
Restated $ (0.12) $ (0.05) $ (0.23) $ (0.17) $ (0.40)
=========================================================================
Earnings per share - Diluted:
As previously reported $ (0.10) $ 0.04 $ (1.03) $ (0.05) $ (1.10)
* Adjustment related to acquired in-process technology (0.02) (0.09) 0.80 (0.12) 0.70
-------------------------------------------------------------------------
Restated $ (0.12) $ (0.05) $ (0.23) $ (0.17) $ (0.40)
=========================================================================
* The adjustment results from the decrease in the value assigned to acquired
in-process technology, the increased amortization of goodwill, and related tax
effects.
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C. POOLING WITH EXPRESSBILL COMPANIES
On February 27, 1998, the Company completed business combinations with the
three companies operating the ExpressBill patient statement processing and
printing services businesses, for an aggregate of 3,500,000 shares of ENVOY
Common Stock. Shareholders of XpiData, based in Scottsdale, Arizona, received
1,365,000 shares and shareholders of POS and its affiliated company, ARM, both
of which are based in Toledo, Ohio, received an aggregate of 2,135,000 shares.
The ExpressBill patient statement services include electronic data transmission
and formatting, statement printing and mailing services for health care
providers and practice management system vendors. These transactions have been
accounted for as poolings of interests. Accordingly, the Company's historical
consolidated financial statements have been restated to include the accounts and
results of operations of the ExpressBill Companies. A reconciliation of
previously reported revenues and earnings for the three-month and nine-month
periods ended September 30, 1997, restated to reflect the modifications referred
to in Note B above, appears below:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1997
(IN THOUSANDS, (IN THOUSANDS,
EXCEPT EXCEPT
PER SHARE DATA) PER SHARE DATA)
--------------- ---------------
Revenues:
ENVOY $ 28,590 $ 81,098
ExpressBill Companies 6,103 16,527
-------- --------
Combined $ 34,693 $ 97,625
======== ========
Net income (loss):
ENVOY $ (5,305) $ (9,912)
ExpressBill Companies 670 2,024
-------- --------
Combined $ (4,635) $ (7,888)
======== ========
Net (loss) per common share:
ENVOY $ (0.27) $ (0.51)
Combined $ (0.23) $ (0.40)
D. ACQUISITION
On May 6, 1998, the Company acquired all the issued and outstanding capital
stock of Synergy Health Care, Inc. ("Synergy"), which provides health care
information products and services to participants in the health care market, for
$10,200,000 in cash, including amounts paid to certain selling stockholders for
noncompete agreements. The acquisition was accounted for under the purchase
method of accounting, applying the provisions of APB Opinion No. 16. The
financial statements for the three- and nine-month periods ended September 30,
1998, reflect the operations of Synergy for the period after the date of
acquisition. The purchase price has been allocated based upon the Company's
preliminary estimates, and actual allocations will be based on further studies
and may change during the allocation period, generally one year following the
date of acquisition. Pro forma financial information for the nine months ended
September 30, 1998 has not been presented because the results of operations of
Synergy are not material to those of the Company.
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E. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income (loss) per common share (in thousands, except for per share data):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1998 1997 1998 1997
------- ---------- ------- --------
Numerator:
Numerator for basic and diluted
earnings per share - net income (loss)
available to common shares $ 2,273 $ (4,635) $ 2,959 $ (7,888)
======= ========== ======= ========
Denominator:
Denominator for basic earnings per share -
weighted average shares 21,316 20,014 21,048 19,556
Effect of dilutive securities:
Employee stock options 1,199 -(1) 1,078 -(1)
Convertible preferred stock 2,800 -(1) 2,903 -(1)
------- ---------- ------- --------
Denominator for diluted earnings per share -
adjusted weighted average shares 25,315 20,014 25,029 19,556
======= ========== ======= ========
Basic net income (loss) per common share $ 0.11 $ (0.23) $ 0.14 $ (0.40)
======= ========== ======= ========
Diluted net income (loss) per common share $ 0.09 $ (0.23) $ 0.12 $ (0.40)
======= ========== ======= ========
- ---------------
(1) Stock options to purchase 3,384,000 shares of Common Stock for the three-
month and nine-month periods ended September 30, 1997, and 3,730,233 shares
Series B Preferred Stock (convertible into 3,730,233 shares of common
stock) for the three-month and nine-month periods ended September 30, 1997
were the only securities issued which would have been included in the
diluted earnings per share calculation for the three-month and nine-month
periods ended September 30, 1997 had they not been antidilutive due to the
net loss reported by the Company.
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F. EFFECT OF NEW ACCOUNTING PRONOUNCEMENT
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 130, "Reporting Comprehensive Income," which establishes standards
for reporting and displaying comprehensive income and its components in a full
set of general purpose financial statements. FASB Statement 130 is effective for
interim and annual periods beginning after December 15, 1997. Comprehensive
income encompasses all changes in shareholders' equity (except those arising
from transactions with owners) and includes net income, net unrealized capital
gains or losses on available for sale securities and foreign currency
translation adjustments. Adoption of this pronouncement has not had a material
impact on the Company's results of operations, as comprehensive income for the
three months and nine months ended September 30, 1998 was the same as net income
for the Company.
G. CONTINGENCIES
Class action complaints were filed on each of August 20, 1998, August 21,
1998 and September 15, 1998 (the "Complaints"), in the United States District
Court, Middle District of Tennessee, Nashville Division, against the Company and
certain of its executive officers. The Court has ordered that the three
Complaints be consolidated into a single class action lawsuit in the United
States District Court, Middle District of Tennessee, Nashville Division. The
Complaints allege, among other things, that from February 12, 1997 to August 18,
1998 (the "Class Period") the defendants issued materially false and misleading
statements about the Company, its business, operations and financial position
and failed to disclose material facts necessary to make defendants' statements
not false and misleading in violation of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder. Plaintiffs allege that the Company failed to disclose that the
Company's financial statements were not prepared in accordance with generally
accepted accounting principles due to the improper write-off of certain acquired
in-process technology, resulting in the Company's stock trading at allegedly
artificially inflated prices during the Class Period. The Complaints seek
unspecified compensatory damages, attorney's fees and other relief. The Company
believes that these claims are without merit and intends to defend the
allegations vigorously.
H. SUBSEQUENT EVENT
On October 22, 1998, the Company completed the acquisition of substantially
all of the assets of Control-O-Fax Corporation and its wholly owned subsidiary
Control-O-Fax Systems, Inc. (collectively, "Control-O-Fax"), which provides EDI
patient statement and other printing and processing services to participants in
the health care market, for $8,250,000 in cash. This acquisition will be
accounted for under the purchase method of accounting, and, as a result, the
Company will record the net assets acquired at their estimated fair values with
the excess of the purchase price over these amounts being recorded as goodwill.
Pro forma financial information for the nine months ended September 30, 1998
will not be presented for this acquisition because the results of operations of
Control-O-Fax are not material to those of the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with,
and is qualified in its entirety by, the Company's consolidated financial
statements, including the notes thereto, included herein.
Except for historical information contained herein, this report contains
forward-looking statements as defined in Section 21E of the Securities Exchange
Act of 1934, as amended. Such forward-looking statements are subject to various
risks and uncertainties that could cause actual results to differ materially
from those projected in the forward- looking statements. These risks and
uncertainties are discussed in more detail in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1997, as such may be amended
from time to time, and Form 8-K/A No. 2, dated November 16, 1998, which amends
an earlier Form 8-K filed on March 9, 1998, as amended on May 5, 1998 (the "Form
8-K/A"). These forward-looking statements generally can be identified as such
because the content of the statements usually will contain such words as the
Company or management "believes," "anticipates," "expects," "hopes," and words
of similar import. Similarly, statements that describe the Company's future
plans, objectives, goals or strategies are forward-looking statements.
RECENT DEVELOPMENT
On October 22, 1998, the Company completed the acquisition of substantially
all the assets of Control-O-Fax Corporation and its wholly-owned subsidiary
Control-O-Fax Systems, Inc. (collectively, "Control-O-Fax"), which provides EDI
patient statement services and other printing and processing services to
participants in the health care market, for $8,250,000 in cash. This acquisition
will be accounted for under the purchase method of accounting, and, as a result,
the Company will record the net assets acquired at their estimated fair values
with the excess of the purchase price over these amounts being recorded as
goodwill.
OVERVIEW
The Company is a leading provider of EDI and transaction processing services
to participants in the health care market, including pharmacies, physicians,
hospitals, dentists, billing services, commercial insurance companies, managed
care organizations, state and federal government agencies and others.
On February 27, 1998, the Company completed business combinations with the
ExpressBill Companies pursuant to separate agreements and plans of merger for an
aggregate of 3.5 million shares of Common Stock. These combinations have been
accounted for as poolings of interests, and the historical financial statements
of the Company for all periods have been restated to include the accounts and
results of operations of the ExpressBill Companies.
The Company also has made several acquisitions since the beginning of 1996,
including the acquisitions of National Electronic Information Corporation
("NEIC") and several other businesses in 1996 (collectively, the "1996 Acquired
Businesses") and Healthcare Data Interchange Corporation ("HDIC") and Diverse
Software Solutions, Inc. ("DSS") in 1997 (collectively, the "1997 Acquired
Businesses"). The 1996 Acquired Businesses and 1997 Acquired Businesses are
sometimes collectively referred to herein as the "Acquired Businesses." These
acquisitions were accounted for under the purchase method of accounting and, as
a result, the Company recorded the assets and liabilities of the Acquired
Businesses at their estimated fair values, with the excess of the purchase price
over these amounts being recorded as goodwill. In connection with the allocation
of purchase price for these Acquired Businesses, valuations of all identified
intangible assets of these Acquired Businesses were made. The intangible assets
of the Acquired Businesses included in-process technology projects, among other
assets, which were related to research and development that had not reached
technological feasibility and for which there was no alternative future use.
Pursuant to applicable accounting pronouncements, the amounts of the purchase
price allocated to these projects were expensed. In previously issued financial
statements, the Company recorded write-offs for acquired in-process technology
of $30.7 million in 1996 and $38.0 million in 1997 in connection with certain of
the Acquired Businesses, including NEIC, DSS and HDIC. After discussions with
the Staff of the Securities and Exchange Commission (the "Commission"), the
Company has reduced the amount of the write-offs for acquired in-process
technology to $8.7 million in 1996 and $6.6 million in 1997. These reductions
have been reallocated to goodwill and to other intangible assets and the
Company's consolidated financial statements have been restated to reflect such
adjustments as described herein and in Note 2 of the Notes to Consolidated
Financial Statements of the Form 8-K/A. See also "--Acquired In-Process
Technology." The financial statements for all periods reflect the operations of
the Acquired Businesses for the periods after their respective dates of
acquisition.
On September 16, 1997, the Company completed the sale of substantially all
of the assets related to the Company's hunting and fishing licenses and
electronic benefit transfer business (collectively, "the Government Services
Business") for (i) $500,000 payable in the form of a promissory note due and
payable in full on August 31, 1999 and (ii) certain contingent payment amounts
based upon the achievement of specified future operating results of the
Government Services Business. The results of operations of the Government
Services Business are included in the Company's consolidated statements of
operations through the date of disposition, and includes revenues for 1997 of
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approximately $466,000. Accordingly, the sale of the Government Services
Business is not expected to have a material impact on the Company's future
results of operations.
The Company's revenues principally have been derived from EDI and
transaction processing services to the health care market which generally are
paid for by the health care providers or third-party payors. Revenues generally
are earned on a per transaction basis. In addition, total revenues include
non-transaction based revenues. These revenues include maintenance, licensing
and support activities, as well as the sale of ancillary software and hardware
products and, in the case of the ExpressBill Companies, certain printing
services.
The Company's revenues generally are comprised of the following types of EDI
and transaction processing services: (i) pharmacy EDI, (ii) medical and other
EDI and (iii) patient statements. The table below shows the number of
transactions processed by the Company for the periods presented:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
Pharmacy EDI 175,378 145,045 529,419 431,547
Medical and other EDI 74,585 55,425 215,131 150,952
Patient statements 41,915 26,784 114,407 69,498
------- ------- ------- -------
Totals 291,878 227,254 858,957 651,997
======= ======= ======= =======
The transactions reflected above include the transactions of the Acquired
Businesses from the date of acquisition, and include the transactions of the
ExpressBill Companies for all periods.
While pharmacy EDI transactions currently represent a majority of the
Company's total transactions, the fees associated with these transactions are
significantly less on a per transaction basis than those received for medical
EDI and patient statement transactions. As a result, pharmacy EDI revenue
constituted less than 20% of the Company's total revenues in the three-month and
nine-month periods ended September 30, 1998. For 1997, the pharmacy EDI business
grew at less than half the rate experienced in the Company's other businesses
based on the number of transactions processed. The Company believes the limited
growth in the Company's pharmacy EDI revenues as compared to the Company's
medical EDI and patient statement revenues primarily is the result of two
factors. First, the acquisitions of the Acquired Businesses have contributed
significantly to the growth of the medical EDI and patient statement business,
and the Company has not made any acquisitions in the pharmacy EDI business. In
addition, the Company believes that the growth in the pharmacy EDI business has
not been as great as in the medical EDI and patient statement business because
of the larger market penetration in the more mature pharmacy EDI business. As a
result, the Company expects its pharmacy EDI business as presently conducted to
represent a decreasing portion of the Company's total revenues in the future. As
the mix of the Company's business changes, a decline in the growth rates
associated with the Company's medical and other EDI and patient statement
business could have a material adverse effect on the financial condition and
operating results of the Company. There can be no assurance that the mix of the
Company's business or growth rates will continue at their current level.
The Company receives a large number of medical EDI transactions from PMS
vendors and other claims clearinghouses. These third parties aggregate medical
EDI transactions from health care providers, but require a clearinghouse (such
as ENVOY) with direct connections to payors in order to complete the processing
of the transactions. ENVOY typically receives revenue from payors on these
transactions, and pays rebates based on volume to exclusive and preferred
vendors as an inducement to use ENVOY as the clearinghouse for these
transactions. If the mix of transaction volume continues to shift to large PMS
vendors or claims clearinghouses, the Company's business may increasingly become
dependent on the Company's ability to maintain or establish successful
relationships with such third parties. In that regard, Medic Computer Systems, a
major PMS vendor which currently has an exclusive processing relationship for
batch transactions with the Company through June 1999 and represented
approximately 3.2% of the Company's total revenues for the nine months ended
September 30, 1998, recently announced that it has entered into a transaction
processing and development agreement with one of the Company's competitors. In
the event the Company is not able to maintain or establish relationships with
major third party PMS and claims clearinghouse vendors, including Medic, to
induce them to continue to send transactions to ENVOY, the Company's business,
operating results or financial condition may be adversely affected.
The Company continues to actively pursue the acquisition of health care
information businesses and other companies complementary to its business. The
Company's ability to successfully negotiate and close acquisitions will
materially impact the financial condition and operating results of the Company.
There can be no assurance that the Company will find attractive acquisition
candidates, be able to successfully finance and complete the acquisitions,
consolidate and integrate such businesses following the acquisition or
successfully operate them on a going forward basis.
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RESULTS OF OPERATIONS
The following table presents, for the periods indicated, the percentage
relationship certain statements of operations items bear to revenues.
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
----- ----- ----- -----
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 41.6 47.0 44.3 47.0
Selling, general and administrative expenses 22.1 22.1 22.4 23.7
Research and development expenses 1.5 1.3 1.5 1.7
Depreciation and amortization expenses 18.8 25.8 20.3 25.6
Write-off of acquired in-process technology 0 17.3 0 6.8
----- ----- ----- -----
Operating income (loss) 16.1 (13.5) 11.5 (4.8)
Interest income 0.5 0.8 0.5 1.2
Interest expense (0.8) (1.4) (0.9) (1.1)
----- ----- ----- -----
Income (loss) from continuing operations before income taxes
and loss in investee 15.8 (14.0) 11.0 (4.7)
Provision (benefit) for income taxes 11.0 (0.7) 8.8 3.4
----- ----- ----- -----
Income (loss) from continuing operations 4.8% (13.4)% 2.2% (8.1)%
===== ===== ===== =====
THREE MONTHS ENDED SEPTEMBER 30, 1998 AS COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1997
Revenues. Revenues for the quarter ended September 30, 1998 were $47.3
million compared to $34.7 million for the same period last year, an increase of
$12.6 million or 36.3%. The increase in revenue is primarily the result of
higher transaction volumes, which increased 28.4% in the three months ended
September 30, 1998, compared to the same period in 1997. The increases were
primarily the result of medical EDI and patient statement internal transaction
growth, and, to a lesser extent, the retroactive billing of approximately $1
million during the third quarter of 1998 for certain transactions processed in
the second quarter of 1998 following the resolution of a discussion regarding
pricing of the transactions.
Cost of Revenues. Cost of revenues includes the cost of communications,
computer operations, operating supplies, product development and customer
support, as well as the cost of hardware sales and rebates to third parties for
transaction processing volume. Cost of revenues in the third quarter of 1998 was
$19.7 million compared to $16.3 million for the third quarter of 1997, an
increase of $3.4 million or 20.5%. The dollar increase is attributable to the
additional costs associated with the increased transaction volume and, to a
lesser extent, increases in rebates paid to third parties in connection with
medical EDI transactions. As a percentage of revenues, cost of revenues
continued to improve to 41.6% in the third quarter of 1998 compared to 47.0% in
the third quarter of 1997. The improvement is primarily attributable to the
Company's ability to spread certain fixed costs of revenue over a larger base of
revenues, and, to a lesser extent, the retroactive billing of approximately $1
million during the third quarter of 1998 for certain transactions processed in
the second quarter of 1998 following the resolution of a dispute regarding
pricing of the transactions.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include marketing, finance, accounting and
administrative costs. Selling, general and administrative expenses for the three
months ended September 30, 1998 were $10.4 million compared to $7.7 million in
the same period in 1997, an increase of $2.7 million or 36.4%. As a percentage
of revenues, selling, general and administrative expenses were 22.1% for both
the third quarter of 1998 and 1997. Included in selling, general and
administrative expenses for the third quarter of 1998 are approximately $656,000
in legal, accounting and other professional fees incurred in connection with a
registration statement filed with the Commission by the Company in May 1998
relating to a proposed underwritten public offering by certain shareholders of
the Company and the related resolution of the Commission Staff's comments
regarding the Company's accounting for acquired in-process technology. See
"--Acquired In-Process Technology." Excluding these costs, selling, general and
administrative expenses as a percentage of revenue for the third quarter of 1998
would have been 20.7%. The improvement is attributable to the Company's ability
to spread its infrastructure costs over a larger base of revenues.
Research and Development Expenses. Expenses related to research and
development of new products are expensed as incurred until technological
feasibility is established for the product. Thereafter, all development costs
are capitalized until the products are available for general use by customers.
Research and development expenses for the three months ended September 30, 1998
were $690,000 compared to $452,000 for the comparable period in 1997.
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Depreciation and Amortization Expenses. Depreciation and amortization
expenses relate primarily to host computers, communications equipment and
goodwill and identifiable intangible assets related to acquisitions.
Depreciation and amortization expense for the third quarter of 1998 was $8.9
million, unchanged from the comparable period in 1997. At September 30, 1998,
the Company had net goodwill of $57.2 million remaining to be amortized over
periods of three to 15 years following the acquisitions. In addition, the
Company had net identifiable intangible assets of $25.3 million remaining to be
amortized over two- to ten-year periods, as applicable. See "Acquired In-Process
Technology."
Write-Off of Acquired In-Process Technology. The Company recorded a
write-off of acquired in-process technology of $6.0 million in the third quarter
of 1997 related to the acquisition of HDIC. This amount represents an allocation
of purchase price to projects that primarily included the development of new
transaction sets which would allow health care providers to submit additional
health care transactions electronically. See "Acquired In-Process Technology."
Net Interest Income (Expense). The Company recorded net interest expense of
$145,000 for the three months ended September 30, 1998 compared to $188,000 for
the third quarter in 1997. Interest expense resulted primarily from interest
expense that is required to be imputed in order to account for certain
unfavorable contracts assumed in the HDIC acquisition.
Income Tax Provision (Benefit). The Company's income tax provision for the
third quarter of 1998 was $5.2 million compared to an income tax benefit of
$228,000 for the comparable period in 1997. Income tax expense recorded is based
on estimated taxable income. Amortization of certain goodwill and identifiable
intangible assets is not deductible for income tax purposes.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AS COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1997
Revenues. Revenues for the nine-month period ended September 30, 1998 were
$132.8 million compared to $97.6 million for the same period in the prior year,
an increase of $35.1 million or 36.0%. The increase in revenue is primarily the
result of higher transaction volumes, which increased 31.7% in the nine months
ended September 30, 1998, compared to the same period in 1997. The increases
were primarily the result of medical EDI and patient statement internal
transaction growth, and, to a lesser extent, the acquisition of HDIC. Without
the increased transaction volume from HDIC, transaction volumes would have
increased 29.6% in the nine months ended September 30, 1998 compared to the same
period in 1997.
Cost of Revenue. Cost of revenues for the nine-month period ended September
30, 1998 was $58.9 million compared to $45.9 for the nine-month period ended
September 30, 1997, an increase of $13.0 million or 28.4%. The dollar increase
is attributable to the additional costs associated with the increased
transaction volume and increases in rebates paid to third parties in connection
with medical EDI transactions. The increase in rebates paid to third parties was
approximately $2.2 million and results primarily from an increase in the volume
of claims received from certain large third party vendors and claims
clearinghouses. As a percentage of revenues, cost of revenues improved to 44.3%
for the nine-month period ended September 30, 1998 compared to 47.0% in the same
period last year. The improvement is primarily attributable to the Company's
ability to spread certain fixed costs of revenue over a larger base of revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the nine-month period ended September 30, 1998 were
$29.7 million compared with $23.2 million for the same period last year, an
increase of $6.6 million or 28.3%. The dollar increase is a result of the
inclusion of the Acquired Businesses following the date of acquisition and the
required infrastructure to support the larger base of revenues. As a percentage
of revenues, selling, general and administrative expenses were 22.4% for the
nine-month period ended September 30, 1998 compared with 23.7% in the same
period last year. The improvement as a percentage of revenue is a result of a
larger revenue base to support these expenses, as well as the elimination of
certain duplicative costs realized in connection with the Acquired Businesses
following the date of acquisition. Transaction costs related to the business
combinations with the ExpressBill Companies totaled $796,000 in the nine months
ended September 30, 1998 and consisted of approximately $516,000 in legal and
accounting fees, $200,000 for financial advisory services and $80,000 in filing
fees and other transaction costs. Additionally, legal, accounting and other
professional fees incurred in connection with the registration statement filed
with the Commission in May 1998 relating to a proposed underwritten public
offering by certain shareholders of the Company and the related resolution of
the Commission Staff's comments regarding acquired in-process technology totaled
$986,000 during the nine months ended September 30, 1998. These amounts are
included in selling, general and administrative expenses. Excluding these costs,
selling, general and administrative expenses as a percentage of revenues for the
first nine months of 1998 would have been 21.2%.
Research and Development Expenses. Research and development expenses for the
nine months ended September 30, 1998 were $2.0 million compared to $1.7 million
for the first nine months of 1997.
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Depreciation and Amortization. Depreciation and amortization expenses for
the nine-month period ended September 30, 1998 were $26.9 million compared to
$25.0 million for the comparable period in 1997. See "Acquired In-Process
Technology."
Write-off of Acquired In-Process Technology. The Company recorded write-offs
of acquired in-process technology of $6.6 million in connection with the 1997
acquisitions of HDIC and DSS. These amounts represent an allocation of the
purchase price to projects that primarily included the development of: (i) new
transaction sets which would allow health care providers to submit additional
health care transactions electronically; and (ii) additional interfaces and
functionality for accounts receivable management service offerings provided by
DSS. Such amounts were charged to expense because the projects related to
research and development that had not reached technological feasibility and for
which there was no alternative future use. See "--Acquired In-Process
Technology."
Net Interest Income (Expense). The Company recorded net interest expense of
$637,000 for the nine-month period ended September 30, 1998 compared to net
interest income of $143,000 in the comparable period in 1997. Interest income
decreased to $589,000 in the nine months ended September 30, 1998 from $1.2
million in the same period of 1997. In August 1997, the Company acquired HDIC
for approximately $36.4 million in cash and the assumption of certain
liabilities associated with unfavorable contracts. Following this acquisition,
the Company had less cash available for investment, accounting for the reduction
in interest income in 1998.
Income Tax Provision (Benefit). The Company's income tax provision for the
nine-month period ended September 30, 1998 was $11.7 million compared to $3.3
million in the comparable period in 1997. Income tax expense recorded is based
upon estimated taxable income. Amortization of certain goodwill and identifiable
intangibles are not deductible for income tax purposes.
ACQUIRED IN-PROCESS TECHNOLOGY
In connection with the purchases of certain of the Acquired Businesses,
including NEIC, DSS and HDIC, the Company made allocations of the purchase price
to acquired in-process technology. These amounts were expensed as non-recurring
charges on the respective acquisition dates of the Acquired Businesses because
the acquired in-process technology had not yet reached technological feasibility
and had no future alternative uses. In previously issued financial statements,
the Company recorded write-offs for acquired in-process technology of $30.7
million in 1996 and $38.0 million in 1997 in connection with such acquisitions.
The Staff of the Commission, in its review of the registration statement filed
by the Company in May 1998 relating to a proposed underwritten public offering
by certain shareholders of the Company, commented on the valuation of the
in-process research and development costs for the NEIC, DSS and HDIC
acquisitions. After further discussions with the Staff of the Commission, the
Company has reduced the amount of the write-offs for acquired in-process
technology to $8.7 million in 1996 and $6.6 million in 1997. These reductions
have been reallocated to goodwill or other intangible assets to reflect such
adjustments as more particularly set forth below.
Since the respective dates of acquisition, the Company has used the acquired
in-process technology to develop new health care EDI and transaction processing
product and service offerings, which have or will become part of the Company's
suite of products when completed. The nature of the efforts required to develop
the acquired in-process technology into commercially viable products principally
relate to the completion of all planning, designing and testing activities that
are necessary to establish that the product or service can be produced to meet
its design requirements, including functions, features and technical performance
requirements. The Company currently expects that the acquired in-process
technology will be successfully developed, but there can be no assurance that
commercial viability of these products will be achieved. Furthermore, future
developments in the health care EDI and transaction processing industry, changes
in EDI and transaction processing technology, changes in other product and
service offerings or other developments may cause the Company to alter or
abandon these plans. Failure to complete the development of these projects in
their entirety, or in a timely manner, could have a material adverse impact on
the Company's operating results, financial condition and results of operations.
A description of the acquired in-process technology and the estimates made
by the Company for each of NEIC, DSS and HDIC is set forth below.
NEIC
The in-process technology acquired in the NEIC acquisition consisted of five
significant research and development projects. These projects were all aimed at
facilitating the ease of participation of health care providers into
clearinghouse technologies and ensuring compliance with regulatory and other
industry standards. After acquiring NEIC, the Company continued the development
of these in-process projects.
At the time of the NEIC acquisition, the Company assigned a value of $30.0
million to the NEIC in-process technology with the assistance of an independent
valuation prepared at such time. In an effort to facilitate the completion of
the Commission's review of its registration
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statement, the Company engaged a second appraisal firm to conduct additional
valuation analyses, which indicated a value of $28.9 million. Based on further
discussions with the Staff of the Commission, the Company has determined to
value the related in-process research and development projects at $8.0 million.
In arriving at this value, the Company considered the previously-obtained
independent appraisals, the Staff's views on in-process research and development
as set forth in its September 15, 1998 letter to the American Institute of
Certified Public Accountants ("AICPA Letter"), and the Staff's comments for the
Company to consider (i) the stage of completion of the in-process technology at
the date of acquisition, (ii) other contributions of the Company's own distinct
and unique proprietary advantages, and (iii) the estimated total project costs
of the in-process research and development in arriving at the valuation amount.
A brief description of the five in-process projects is set forth below:
- UniClaim. This product is a PC based claims processing system that
extracts Health Care Financing Administration 1500 claim formats from practice
management systems ("PMS"), performs edits and transports the file to a host
system where EDI formatting is completed for delivery to payors. The Company
estimates this project, which was completed in the second quarter of 1996, was
approximately 40% complete at the date of the NEIC acquisition.
- GTEDS. This product is a computerized system for the collection,
validation and distribution of claims from various sources to claims receivers.
The Company estimates this project, which was completed in the fourth quarter of
1996, was approximately 45% complete at the date of the NEIC acquisition.
- On-Line. This product is an application that performs "screen scraping"
(i.e., it captures data from a screen presentation and creates an American
National Standards Institute 270 eligibility request.) The Company estimates
this project, which was completed during the second quarter of 1998, was
approximately 35% complete at the date of the NEIC acquisition.
- SmartPost. This product is an application to populate a physician PMS with
remittance data for automatic posting to the PMS. In the first quarter of 1997,
the Company completed the acquisition of DSS, which already had a Receivables
Management product that included substantially the same functionality as the
SmartPost product, and determined to abandon further development of SmartPost.
The Company estimates this project was approximately 55% complete at the date of
the NEIC acquisition.
- Expect. This product is an application for screen scraping at payor
locations. In the first quarter of 1997, the Company identified an existing
software application with the same capabilities as Expect, and made a decision
to license that software and abandon the Expect project. The Company estimates
this project was approximately 35% complete at the date of the NEIC acquisition.
At the time of the NEIC valuation, the expected total costs of all such
projects were approximately $4.0 million. As of September 30, 1998,
approximately $1.8 million had been incurred since the date of the NEIC
acquisition for these projects, and there were no additional expected costs to
complete the research and development projects acquired from NEIC.
DSS
The in-process technology acquired in the DSS acquisition consisted
primarily of projects related to DSS's Receivables Management product line and
four peripheral products expected to be used as add-on features to the
Receivables Management product. DSS's Receivables Management product line works
with existing hospital information system ("HIS") and PMS software and provides
claims and receivables management, including billings, collections and cash
applications, among other functions. At the time of acquisition, DSS was selling
versions of the Receivables Management product to work with certain HIS and PMS
products; however, the Company noted that there was still substantial
development work required in order to complete versions which were adapted to
other major HIS and PMS products. The Company estimates this project, which was
completed during the fourth quarter of 1997, was approximately 35% complete at
the date of the DSS acquisition.
At the time of the DSS acquisition, the Company assigned a value of $3.0
million to the DSS in-process technology with the assistance of an independent
valuation prepared at such time. In an effort to facilitate the completion of
the Commission's review of its registration statement, the Company engaged a
second appraisal firm to conduct additional valuation analyses, which indicated
a value of $2.8 million. Based on further discussions with the Staff of the
Commission, the Company has determined to value the related in-process research
and development projects at $600,000. In arriving at this value, the Company
considered the previously-obtained independent appraisals, the Commission's
views on in-process research and development as set forth in the AICPA Letter,
and the Staff's comments for the Company to consider (i) the stage of completion
of the in-process technology at the date of acquisition, (ii) other
contributions of the Company's own distinct and unique proprietary advantages,
and (iii) the estimated total project costs of the in-process research and
development in arriving at the valuation amount.
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A brief description of each of the four add-on features is set forth below:
- Materials Management. This product incorporates certain customized
features into licensed software to allow for online transaction processing of
inventory data. The Company estimates this project, which was completed during
the third quarter of 1997, was approximately 50% complete at the date of the DSS
acquisition.
- Billing and 72-Hour Compliance. This product processes all emergency room
billings and collections, in addition to tracking patients throughout the
emergency/casualty process. The Company estimates this project, which was
completed during the first quarter of 1998, was approximately 50% complete at
the date of the DSS acquisition.
- Registration. This product facilitates access to patient records, as well
as providing basic patient information to payors. The Company estimates this
project was approximately 25% complete at the date of the DSS acquisition. The
Company estimates that this project was approximately 75% complete as of
September 30, 1998, and is expected to be completed during the fourth quarter of
1998.
- Collections. This product assists the health care provider's HIS or PMS
system in the management of receivables. In the fourth quarter of 1997,
management placed further development of this project on hold while it evaluates
alternative technologies and development strategies. The Company estimates this
project was approximately 20% complete at the date of the DSS acquisition. At
the time that the project was placed on hold, the Company estimates that this
project was approximately 60% complete.
At the time of the DSS valuation, the expected total costs of all such
projects totaled approximately $300,000. Approximately $160,000 has been
incurred since the date of the DSS acquisition for these projects through
September 30, 1998, and the Company estimates that approximately $40,000 will be
required to complete the remaining research and development projects. The
remaining efforts to complete the remaining DSS projects are primarily the
completion of the work necessary to develop and test the working prototypes.
HDIC
The in-process technology acquired in the HDIC acquisition consisted of
seven significant research and development projects associated with HDIC's
product line. At the time of acquisition, HDIC had developed on-line, real-time
claims transaction technology which permitted Aetna U.S. Healthcare Inc.
("AUSHC") to receive real-time EDI transactions, and was in the process of
developing new transaction sets which would allow health care providers to
submit additional health care transactions electronically. After acquiring HDIC,
the Company modified the Company's existing front-end transaction platforms to
accommodate HDIC's technology and continued the development of seven in-process
projects. The Company believes that the resulting technology has given, and will
continue to give, the Company a competitive advantage in the marketplace by
significantly enhancing the Company's existing EDI and transaction processing
capabilities with additional transaction sets.
At the time of the HDIC acquisition, the Company assigned a value of $35.0
million to the HDIC in-process technology with the assistance of an independent
valuation prepared at such time. In an effort to facilitate the completion of
the Commission's review of its registration statement, the Company engaged a
second appraisal firm to conduct additional valuation analyses, which indicated
a value of $32.9 million. Based on further discussions with the Staff of the
Commission, the Company has determined to value the related in-process research
and development projects at $6.0 million. In arriving at this value, the Company
considered the previously-obtained independent appraisals, the Commission's
views on in-process research and development as set forth in the AICPA Letter,
and the Staff's comments for the Company to consider (i) the stage of completion
of the in-process technology at the date of acquisition, (ii) other
contributions of the Company's own distinct and unique proprietary advantages,
and (iii) the estimated total project costs of the in-process research and
development in arriving at the valuation amount.
A brief description of each of the seven in-process projects is set forth
below:
- Real-time referrals. This product is designed to allow batch or on-line
real-time transaction processing for referral authorization and the ability to
receive or confirm acknowledgment through the Company's network that a valid
referral is on file with the primary care provider ("PCP"). The Company
estimates this project, which was completed during the second quarter of 1998,
was approximately 25% complete at the date of the HDIC acquisition.
- Vision claims. This product is designed to provide the capability for
health care providers to submit vision claims and vision related information
electronically. The Company estimates this project, which was completed during
the third quarter of 1998, was approximately 35% complete at the date of the
HDIC acquisition.
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- Lab utilization/results. This product is designed to allow electronic
transmission of lab testing requests and reporting of lab results. The Company
estimates this project, which was completed during the third quarter of 1998,
was approximately 50% complete at the date of the HDIC acquisition.
- Provider directories. This product is designed to allow for the
maintenance of reference information related to health care providers and
provider networks. The Company estimates this project was approximately 15%
complete at the date of the HDIC acquisition. The Company estimates that the
project was approximately 80% complete as of September 30, 1998, and is expected
to be completed in the fourth quarter of 1998.
- Real-time encounters/claims. This product is designed to allow batch or
on-line real-time transaction processing for the transmission of encounter data
from the PCP or a capitated specialist to the insurer, and the subsequent
acknowledgment of receipt. The Company estimates this project was approximately
45% complete at the date of the HDIC acquisition. The Company estimates that the
project was approximately 70% complete as of September 30, 1998, and is expected
to be completed during the first quarter of 1999.
- Electronic pre-certifications. This product is designed to allow batch or
real-time batch transaction processing for the request and authorization to
perform non-capitated procedures or hospital admissions. This transaction is
initiated from the PCP, specialist hospital or other delivery system. The
Company estimates this project was approximately 35% complete at the date of the
HDIC acquisition. The Company estimates that the project was approximately 40%
complete as of September 30, 1998, and is expected to be completed during the
second quarter of 1999.
- Rosters through the Internet. This product is designed to use the Internet
as a means to deliver to health care providers managed care program eligibility
status and capitated payment information. The Company estimates this project was
approximately 50% complete at the date of the HDIC acquisition. The Company
estimates that the project was approximately 80% complete as of September 30,
1998, and is expected to be completed during the third quarter of 1999.
At the time of the HDIC valuation, the expected total costs of all such
projects was approximately $3.0 million. Approximately $400,000 has been
incurred since the date of the HDIC acquisition for these projects through
September 30, 1998, and the Company estimates that approximately $1.4 million
will be required to complete the remaining research and development projects.
The remaining efforts to complete these projects include the processes of
planning and coding the primary applications and customer interfaces, testing
such coding and interfaces, and introducing such processes into production
environments at Company and customer locations.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred operating losses in recent years primarily as a
result of substantial non-cash depreciation and amortization charges related to
the Acquired Businesses, together with the write-off of acquired in-process
technology. During the nine months ended September 30, 1998, however, operations
generated positive cash flows of $27.3 million compared to $16.5 million for the
nine months ended September 30, 1997.
Investing activities consist primarily of payments for acquired businesses
and purchases of property and equipment. Investing activities used cash of $14.0
million in the nine months ended September 30, 1998 and used cash of $50.6
million in the nine months ended September 30, 1997.
Financing activities consist primarily of proceeds from the issuance of
capital stock, and proceeds from and payments on debt. Financing activities
provided cash of $202,000 in the nine months ended September 30, 1998 and
provided $1.2 million of cash in the nine months ended September 30, 1997.
On October 22, 1998, the Company completed the acquisition of substantially
all of the assets of Control-O-Fax for $8.25 million in cash. Following this
acquisition and as of November 10, 1998, the Company had available cash and cash
equivalents of approximately $21.6 million.
The Company purchases additional computer hardware and software products
from time to time as required to support the Company's business. The Company
incurred capital expenditures of $4.4 million and $6.9 million for the
nine-month periods ended September 30, 1998 and 1997, respectively, primarily
for computer hardware and software products. The Company currently estimates
that total capital expenditures for 1998 will be approximately $6 to $8 million.
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The Company is expensing as incurred all costs associated with system
changes related to its Year 2000 compliance project. The Company estimates that
the total cost of the Year 2000 expenses will be approximately $4.0 million, of
which approximately $1.2 million will be incurred during 1998. These costs are
being funded with available cash. See "--Year 2000 Compliance."
At September 30, 1998, the Company had no amounts outstanding under its $50
million revolving credit facility. Any future borrowings made under the credit
facility would bear interest at a rate equal to the Base Rate (as defined in
the credit facility) or an index tied to LIBOR. Any future borrowings under the
credit facility would be due and payable in full on June 30, 2000. The credit
facility contains financial covenants applicable to the Company and its
subsidiaries, including ratios of debt to capital, annualized EBITDA to
annualized interest expense and certain other financial covenants customarily
included in a credit facility of this type. The Company and its subsidiaries
also are subject to certain restrictions relating to payment of dividends to
shareholders of the Company, acquisitions, incurrence of debt and other
restrictive provisions; however, there are no restrictions on the ability of the
Company's subsidiaries to transfer funds to the Company in the form of
dividends, loans or advances. The credit facility is secured by substantially
all of the assets of the Company and its subsidiaries.
In February 1998, the Company issued 3.5 million shares of Common Stock in
connection with the ExpressBill Companies' business combinations. Also in
February 1998, 930,233 shares of the Company's Series B Convertible Preferred
Stock were converted into an equal number of shares of Common Stock. As a result
of these transactions, the number of shares of Common Stock outstanding
increased by approximately 4.4 million shares, or 27%.
From time to time, the Company has engaged and will continue to engage in
acquisition discussions with health care information businesses and other
companies complementary to its business. In the event the Company engages in
such 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
increased interest expense or dilution to existing investors.
Based on current operations, anticipated capital needs to fund known
expenditures and current acquisitions, the Company believes its available cash,
cash flow from operations and the $50.0 million revolving credit facility will
provide the capital resources necessary to meet its liquidity and cash flow
requirements over the next 12 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. As of September 30, 1998,
the Company's long-term obligations totaled $9.7 million and consisted of
$561,000 in long-term debt net of current portion, $573,000 in deferred income
tax liabilities and $8.6 million in long-term obligations related to unfavorable
contracts assumed in connection with the HDIC acquisition. Such amounts relate
primarily to the Company's obligations under the Company's services agreement
with AUSHC to assume a portion of the transaction processing fees related to
certain secondary Medicare transactions, and existing agreements assumed by the
Company with several businesses that served as claims clearinghouses for AUSHC
prior to the HDIC acquisition. The Company's available cash is invested in
interest bearing securities with maturities of up to 30 days.
SEASONALITY
The Company's business is to some extent seasonal, with more revenues being
generated from September through March as a result of a greater number of
pharmaceutical claims that arise in those months, while operating expenses tend
to remain relatively constant over the course of the year.
YEAR 2000 COMPLIANCE
Introduction
The Year 2000 ("Y2K") issue refers to the inability of a date-sensitive
computer program to recognize a two-digit date field designated as "00" as the
year 2000. Any of the Company's hardware, software and embedded systems that
have time/date sensitive software and hardware may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a major system
failure or miscalculations causing disruptions to the Company's operations. The
Company presently believes that, with modifications to existing computer
systems, as scheduled, the Y2K issue should not pose significant operational
problems for the Company's systems, as so modified and converted.
The Company began evaluating the Y2K issue in 1997. In 1998, the Company
established a Y2K Task Force, the primary function of which is to: (1) develop
and implement the Company's Y2K compliance effort, (2) monitor product and
internal systems compliance, (3) review customer preparations to implement Y2K
releases, and (4) provide centralization, accuracy and consistency of the
Company's communications regarding Y2K to customers, stockholders, employees and
the industry. To assist the Y2K Task Force, the Company has engaged a consulting
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firm to provide an independent review of the status of the Company's Y2K
compliance efforts and issues, and to assist the Y2K Task Force in project
management for certain identified key Y2K projects.
Status of Progress
The Company has conducted an inventory and assessment of its technology to
identify the computer systems that could be affected by the Y2K issue. The
inventory includes information technology ("IT") systems and non-IT systems,
including telecommunications, data processing services, utilities and security
systems related to the Company's operating-facilities. All of the Company's
software and hardware has been identified and assessed to determine the extent
of renovations required to be Y2K compliant.
The Company's efforts to renovate its IT and non-IT systems to make them Y2K
compliant have proceeded in tandem with its efforts to inventory and assess its
systems. By the end of 1998, most of the Company's major or key systems,
software and products will be remediated or replaced and significant testing
will have commenced; any remaining systems, software and products are scheduled
to be remediated or replaced in the first half of 1999. The Company anticipates
using the balance of 1998 and 1999 for continued testing, implementing changes
and making necessary refinements. The Company expects that the internal systems,
software and products for which the Company has responsibility currently are Y2K
compliant or will be compliant on a timely basis.
Costs to Address
The Company is funding costs associated with the Y2K issue through
operating cash flows, and currently expects that costs to address Y2K issues
will total approximately $4.0 million. As of September 30, 1998, the Company had
incurred approximately $500,000 on Y2K projects, and expects the remainder to be
spent primarily during 1999. As a result, the Company does not expect that the
costs to address the Y2K issue will have a material adverse effect on the
Company's financial condition or results of operations. There can be no
assurance, however, that actual costs necessary to deal with these issues will
not exceed estimated amounts.
The Company has not yet estimated Y2K costs for periods after 1999, which
may include costs of customer service efforts resulting from the failure of
third parties to be Y2K compliant or other unforeseen problems.
Risks
The Y2K issue creates risk for the Company from unforseen problems in its
own computer systems and from third parties with which the Company does
business. Accordingly, the Company is requesting assurances from certain
software vendors from which it has acquired, or from which it may acquire
software, that the software will correctly process all date information at all
times. In addition, the Company is questioning certain of its customers,
including major payors and vendors, and suppliers as to their progress in
identifying and addressing problems that their computers will face in correctly
processing date information as the Year 2000 approaches and is reached. Because
of the complexity of the Y2K issue and the differing stages of readiness of
these third parties, the Company expects these discussions to continue
throughout 1999. Furthermore, because of the nature of the Company's business,
the success of the Company's efforts may depend on the success of payors,
vendors and other third parties in dealing with the Y2K issue. Failure to
appropriately address the Y2K issue by a major customer or supplier or a
material percentage of the Company's smaller customers could have a material
adverse impact on the financial condition and results of operations of the
Company.
The Company's business also is heavily reliant upon external suppliers to
provide certain operating elements of its business. Some of these providers
include telecommunications providers, data processing service providers, utility
companies, key vendors and suppliers, and certain governmental agencies. The
Company exerts no control over the efforts of these companies to become Y2K
compliant. The services provided by these parties are critical to the operations
of the Company and the Company is heavily reliant upon these parties to
successfully address the Y2K issue. Therefore, if any of these parties fail to
provide the Company with services, the Company's ability to conduct business
could be materially impacted. The result of such impact may have a material
adverse effect on the financial condition and results of the operations of the
Company.
Worst case scenarios could be as insignificant as a minor interruption in
the Company's ability to conduct business resulting from unanticipated problems
encountered in the IT and non-IT systems of the Company or any of the
significant third parties with whom the Company does business. The pervasiveness
of the Y2K issue makes it likely that previously unidentified issues will
require remediation during the normal course of business. On the other hand, a
worst case Y2K scenario could be as catastrophic as a complete, and long-term,
loss of telecommunications, data processing and utility services. In this
connection, an extended loss of telecommunication, data processing and utility
services could have a material adverse effect on the financial condition and
results of the operations of the Company.
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The Company does not anticipate that the Y2K issues and risks, including the
most reasonably likely worst case Y2K scenario, will be significantly different
than those encountered by other providers of information services, including the
Company's competitors. Although the Company believes its remediation,
replacement and testing efforts will address all of the Y2K issues for which the
Company is responsible, to the extent these efforts are not successful,
additional compliance efforts would be necessary together with additional
customer service efforts and expenditures. If third parties fail in their
compliance efforts, the Company also could be impacted and required to provide
additional customer service efforts. In such an event, the Company could incur
additional costs and experience a negative impact on its financial condition
and results of operations.
The Company's cost and timetable estimates for its Y2K efforts are subject
to potentially significant estimation uncertainties that could cause actual
results to differ materially from projected results. These estimates are based
on management's current estimates and reflect certain assumptions. Factors which
could impact these estimates include: the availability of appropriate technology
personnel; the rate and magnitude of related labor costs; the successful
identification of all aspects of the Company's systems, software and products
that require remediation or replacement; the extent of testing required; the
costs of the Company's efforts to assist certain customers in the remediation of
their customized code; the amount of cost recoveries from those efforts; and the
success of third parties in their Y2K compliance efforts. Due to the complexity
and pervasiveness of the Y2K issue, and in particular the uncertainty regarding
the compliance efforts of third parties, no assurance can be given that these
estimates will be achieved, and actual results could differ materially from
projected results.
Contingency Plans
The Company's Y2K compliance activities are being regularly monitored and
evaluated by management. The Y2K Task Force provides regular updates to senior
management of the Company, as well as to the Company's Board of Directors. As
risks are identified, contingency plans are being established and additional
steps are being taken to further minimize the risks associated with the Y2K
issue. Those plans will focus on matters that appear to be the Company's most
likely Y2K risks, such as possible additional customer support efforts by the
Company that would be necessary if customers or vendors are not Y2K compliant,
or if a Y2K issue should not be timely detected in the Company's own compliance
efforts.
In the event that the Company's systems do not function as a result of
a most reasonably likely worst case scenario, the Company would make reasonable
efforts to enter into temporary alternative arrangements with third parties to
service the Company's customers, including routing transactions to the Company's
competitors. In addition, in the event the Company could not process
transactions electronically, either as a result of the failure of its own
systems or a loss of telecommunications, data processing or utility services
generally, the Company or its customers could print transactions normally
processed electronically to paper for manual processing until such time as the
Company's systems are functional.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Class action complaints were filed on each of August 20, 1998, August 21,
1998 and September 15, 1998 (the "Complaints"), in the United States District
Court, Middle District of Tennessee, Nashville Division, against the Company and
certain of its executive officers. The Court has ordered that the three
Complaints be consolidated into a single class action lawsuit in the United
States District Court, Middle District of Tennessee, Nashville Division. The
Complaints allege, among other things, that from February 12, 1997 to August 18,
1998 (the "Class Period") the defendants issued materially false and misleading
statements about the Company, its business, operations and financial position
and failed to disclose material facts necessary to make defendants' statements
not false and misleading in violation of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder. Plaintiffs allege that the Company failed to disclose that the
Company's financial statements were not prepared in accordance with generally
accepted accounting principles due to the improper write-off of certain acquired
in-process technology, resulting in the Company's stock trading at allegedly
artificially inflated prices during the Class Period. The Complaints seek
unspecified compensatory damages, attorney's fees and other relief. The Company
believes that these claims are without merit and intends to defend the
allegations vigorously.
From time to time, the Company also may be a party to legal proceedings
incidental to its business but believes that none of these proceedings is
material to its business at the present time.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K/A No. 2 on November 16, 1998
pursuant to Item 7(b) thereof with the Securities and Exchange Commission (the
"Commission") to amend an earlier Form 8-K filed on March 9, 1998, as amended on
May 5, 1998. The amendment was filed for the purpose of including certain
financial information required to be filed as a result of changes in the methods
used to value acquired in-process technology recorded and written off in
connection with certain of the Company's acquisitions in 1996 and 1997.
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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: November 16, 1998 By: /s/ Fred C. Goad, Jr.
---------------------------------------
Fred C. Goad, Jr
Chairman and Co-Chief Executive Officer
By: /s/ Kevin M. McNamara
---------------------------------------
Kevin M. McNamara
Senior Vice President and Chief
Financial Officer
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EXHIBIT INDEX
EXHIBIT NO. NAME
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27 FINANCIAL DATA SCHEDULE (FOR SEC USE ONLY)
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