SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q/A (Mark one) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------------------- -------------------- Commission file number 001-14049 IMS Health Incorporated - - ------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-1506026 - - ---------------------------------------- ----------------------------- - - ---------------------------------------- ------------------------------------ (State of Incorporation) (I.R.S. Employer Identification No.) 200 Nyala Farms, Westport, CT 06880 - - --------------------------------------- ----------------------------------- - - --------------------------------------- ----------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (203) 222-4200 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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: Title of Class Shares Outstanding Common Stock, at June 30, 1998 par value $.01 per share 166,812,695 IMS HEALTH INCORPORATED INDEX TO FORM 10-Q/A PART I. FINANCIAL INFORMATION PAGE(S) Item 1. Financial Statements Condensed Consolidated Statements of Income (Unaudited) Three Months Ended June 30, 1998 and 1997 3 Six Months Ended June 30, 1998 and 1997 4 Condensed Consolidated Statements of Comprehensive Income (Unaudited) Three Months Ended June 30, 1998 and 1997 5 Six Months Ended June 30, 1998 and 1997 5 Condensed Consolidated Statements of Financial Position (Unaudited) June 30, 1998 and December 31, 1997 6 Condensed Consolidated Statements of Cash Flows (Unaudited) Six Months Ended June 30, 1998 and 1997 7 Notes to Condensed Consolidated Financial Statements (Unaudited) 8-18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19-27 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 28 SIGNATURE 29 PART I. FINANCIAL INFORMATION Item I. FINANCIAL STATEMENTS IMS HEALTH INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollar amounts in thousands, except per share data) Three Months Ended June 30, ---------------------------- 1998 1997 ---------------------- ------------------ Operating Revenue $ 270,496 $ 251,076 Operating Costs 151,362 107,765 Selling and Administrative Expenses 89,639 81,232 In-Process Research and Development 21,900 0 Depreciation and Amortization 21,507 22,724 ---------------------- ------------------ Operating (Loss)/Income (13,912) 39,355 Interest Income 4,771 1,666 Interest Expense (212) (131) Gartner Equity Income 17,320 15,137 Gain from Stock Sale by Gartner 5,392 0 Gain on Issuance of Subsidiary Stock 12,777 0 Other Expense - Net (2,477) (1,331) ---------------------- ------------------ Non-Operating Income - Net 37,571 15,341 Income from Continuing Operations, Before Provision for Taxes 23,659 54,696 Provision for Income Taxes (22,107) (14,629) ---------------------- ------------------ Income from Continuing Operations 1,552 40,067 Income from Discontinued Operations, Net of Income Tax Provision of $7,960 and $7,367 for June 30, 1998 and 1997, respectively 21,088 19,988 ---------------------- ------------------ Net Income $ 22,640 $ 60,055 ====================== ================== Earnings Per Share of Common Stock: Basic Income from Continuing Operations $0.01 $ 0.24 Income from Discontinued Operations 0.13 0.12 ---------------------- ------------------ Basic Earnings Per Share $0.14 $ 0.36 Diluted Income from Continuing Operations $0.01 $ 0.24 Income from Discontinued Operations 0.12 0.12 ---------------------- ------------------ Diluted Earnings Per Share $0.13 $ 0.36 Average Number of Shares Outstanding - Basic 163,305,000 165,526,000 Dilutive Effect of Shares Issuable as of June 30, 1998 Under Stock Option 4,739,000 435,000 Plans Adjustment of Shares to Reflect Options Exercised and Cancelled During the Period 1,043,000 93,000 ====================== ================== Average Number of Shares Outstanding - Diluted 169,087,000 166,054,000 ====================== ================== <FN> See accompanying notes to the condensed consolidated financial statements (unaudited) </FN> IMS HEALTH INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollar amounts in thousands, except per share data) Six Months Ended June 30, ---------------------- 1998 1997 ------------------- ------------------ Operating Revenue $ 511,464 $ 480,381 Operating Costs 270,954 216,465 Selling and Administrative Expenses 170,593 153,918 In-Process Research and Development 21,900 0 Depreciation and Amortization 43,201 49,035 ------------------- ------------------ Operating Income 4,816 60,963 Interest Income 8,869 5,276 Interest Expense (412) (581) Gartner Equity Income 32,894 30,671 Gain from Stock Sale by Gartner 13,379 0 Gain on Issuance of Subsidiary Stock 12,777 0 Gains from Dispositions, Net 10,415 5,436 Other Expense - Net (5,247) (2,094) ------------------- ------------------ Non-Operating Income - Net 72,675 38,708 Income from Continuing Operations, Before Provision for Taxes 77,491 99,671 Provision for Income Taxes (36,857) (26,233) ------------------- ------------------ Income from Continuing Operations 40,634 73,438 Income from Discontinued Operations, Net of Income Tax Provision of $15,887 and $14,118 for six months ended June 30, 1998 and 1997, respectively 42,093 39,522 ------------------- ------------------ Net Income $ 82,727 $ 112,960 =================== ================== Earnings Per Share of Common Stock: Basic Income from Continuing Operations $ 0.25 $ 0.44 Income from Discontinued Operations 0.26 0.23 ------------------- ------------------ Basic Earnings Per Share $ 0.51 $ 0.67 Diluted Income from Continuing Operations $ 0.24 $ 0.44 Income from Discontinued Operations 0.25 0.23 ------------------- ------------------ Diluted Earnings Per Share $ 0.49 $ 0.67 Average Number of Shares Outstanding - Basic 162,843,000 167,610,000 Dilutive Effect of Shares Issuable as of June 30, 1998 Under Stock Option Plans 4,347,000 197,000 Adjustment of Shares to Reflect Options Exercised and Cancelled During the Period 1,734,000 108,000 =================== ================== Average Number of Shares Outstanding - Diluted 168,924,000 167,915,000 =================== ================== <FN> See accompanying notes to the condensed consolidated financial statements (unaudited) </FN> IMS HEALTH INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Dollar amounts in thousands) Three Months Ended June 30, ------------------------- 1998 1997 --------------------- ----------------- Net Income $ 22,640 $ 60,055 Other Comprehensive Income/(Loss), net of tax: Foreign Currency Translation Adjustments (10,499) (13,649) Unrealized Gains on Securities: Unrealized Holding Gains Arising During the Period (Net of tax expense of ($1,690) and ($1,604) in 1998 and 1997, respectively) 4,478 4,392 --------------------- ----------------- Net Unrealized Gains 4,478 4,392 --------------------- ----------------- Other Comprehensive Loss (6,021) (9,257) --------------------- ----------------- Comprehensive Income $ 16,619 $ 50,798 ===================== ================= Six Months Ended June 30, ------------------------- 1998 1997 --------------------- ----------------- Net Income $ 82,727 $ 112,960 Other Comprehensive Income/(Loss), net of tax: Foreign Currency Translation Adjustments (9,596) (42,484) Unrealized Gains/(Losses) on Securities: Unrealized Holding Gains/(Losses) Arising During the Period (Net of tax (expense)/benefit of ($1,717) and $785 in 1998 and 1997, respectively) 4,549 (2,197) Less: Reclassification Adjustment for Realized Gains included in Net Income (net of tax benefit of $2,910 in 1998) (7,710) 0 --------------------- ----------------- Net Unrealized Losses (3,161) (2,197) --------------------- ----------------- Other Comprehensive Loss (12,757) (44,681) --------------------- ----------------- Comprehensive Income $ 69,970 $ 68,279 ===================== ================= IMS HEALTH INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (Unaudited) (Dollar amounts in thousands) June 30, December 31, 1998 1997 ------------------- -------------------- Assets Current Assets Cash and Cash Equivalents $ 702,550 $ 312,442 Accounts Receivable-Net 261,267 251,623 Other Current Assets 72,678 65,692 ------------------- ------------------- Total Current Assets 1,036,495 629,757 ------------------- -------------------- Investment in Gartner Group 228,674 195,695 Marketable Securities and Other Investments 109,708 109,712 Property, Plant and Equipment-Net 175,304 178,533 Other Assets-Net Computer Software 132,927 99,175 Goodwill 245,836 87,430 Other Assets 80,924 79,009 ------------------- -------------------- Total Other Assets-Net 459,687 265,614 ------------------- -------------------- Net Assets from Discontinued Operations 0 122,778 ------------------- -------------------- Total Assets $ 2,009,868 $ 1,502,089 =================== ==================== Liabilities and Shareholders' Equity Current Liabilities Accounts and Notes Payable $ 46,659 $ 44,441 Accrued and Other Current Liabilities 249,927 189,384 Accrued Income Taxes 60,235 52,696 Deferred Revenues 130,068 110,768 ------------------- -------------------- Total Current Liabilities 486,889 397,289 Postretirement and Postemployment Benefits 43,539 38,082 Deferred Income Taxes 102,646 92,153 Minority Interests 112,063 101,209 Other Liabilities 81,773 71,786 ------------------- -------------------- Total Liabilities 826,910 700,519 ------------------- -------------------- Shareholders' Equity 1,182,958 801,570 ------------------- -------------------- Total Liabilities and Shareholders' Equity $ 2,009,868 $ 1,502,089 =================== ==================== <FN> See accompanying notes to the condensed consolidated financial statements (unaudited). </FN> IMS HEALTH INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollar amounts in thousands) Six Months Ended June 30, ------------------------------ 1998 1997 ------------ ----------------- Cash Flows from Operating Activities: Net Income $ 82,727 $ 112,960 Less Income from Discontinued Operations (42,093) (39,522) ------------ ----------------- Income from Continuing Operations 40,634 73,438 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Depreciation and Amortization 43,201 49,035 Gains on Issuance of Subsidiary Stock (12,777) Gains from Sale of Investments, Net (10,415) (5,436) Write-off of Purchased in Process Research & Development 21,900 0 Postemployment Benefit Payments (2,083) (4,059) Non-recurring Payments (1,910) (2,750) Net Decrease (Increase) in Accounts Receivable 3,696 (11,626) Net Increase in Deferred Revenues 16,673 34,024 Gartner Group Equity Income, Net of Taxes (19,600) (17,760) Gain from Stock Sale by Gartner (13,379) 0 Minority Interest Expense 4,183 712 Deferred Income Taxes 7,889 5,869 Net Increase (Decrease) in Accrued Income Taxes 8,916 (13,261) Net (Increase) in Other Working Capital Items (8,569) (21,246) - - ----------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 78,359 86,940 - - ----------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Payments for Acquisitions of Businesses (2,938) 0 Cash of Companies Acquired in Stock Purchases 9,480 0 Proceeds from Sale of Investments 23,165 7,004 Capital Expenditures (13,561) (21,990) Additions to Computer Software (21,060) (19,992) Additions to Other Assets (13,829) (10,936) Increase in Investments (12,604) (14,349) Other 12,031 13,946 - - ----------------------------------------------------------------------------------------------------------------------- Net Cash (Used in) Investing Activities (19,316) (46,317) - - ----------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Payments for Purchase of Treasury Shares (7,809) (204,564) Proceeds from Exercise of Stock Options 43,232 4,345 Proceeds from Issuance of Subsidiary Stock 27,128 0 Payments of Dividends (9,813) (10,092) Employee Stock Purchase Plan 2,607 0 Proceeds from Debt assumed by Nielsen Media Research 300,000 0 Minority Interest Financing 0 100,000 Other (199) (490) - - ----------------------------------------------------------------------------------------------------------------------- Net Cash Provided by / (Used in) Financing Activities 355,146 (110,801) - - ----------------------------------------------------------------------------------------------------------------------- Change of Gartner Group to Equity Basis 0 (123,697) Effect of Exchange Rate Changes on Cash and Cash Equivalents (6,908) (5,073) Cash Flow from Discontinued Operations (17,173) 23,360 - - ----------------------------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents 390,108 (175,588) Cash and Cash Equivalents, Beginning of Period 312,442 422,963 - - ----------------------------------------------------------------------------------------------------- ----------------- Cash and Cash Equivalents, End of Period $702,550 $ 247,375 ======================================================================================================================= Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 412 $ 581 Cash paid during the period for income taxes $ 49,324 $ 45,830 Non-Cash Investing Activities: Stock Issued in Connection with Walsh and Chinametrik Acquisitions $168,937 $ 0 <FN> See accompanying notes to the condensed consolidated financial statements (unaudited). </FN> IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 1. Interim Consolidated Financial Statements The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for the interim financial information and Article 10 of Regulation S-X under the Securities and Exchange Act of 1934, as amended. The condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes of IMS Health Incorporated (the "Company" or "IMS Health") on the Form 8K/A-2 filed July 22, 1998. Accordingly, the accompanying condensed consolidated financial statements do not include all the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented have been included. Certain prior-period amounts have been reclassified to conform with the 1998 presentation. Note 2. Restatement of Interim Financial Statements The Company's Form 10-Q/A as of and for the three and six months ended June 30, 1998 has been filed for the restatement of the value initially allocated to acquired in-process research and development projects relating to the acquisition of Walsh International Inc. The amount originally recorded was based on the Company's application of the then general methods of allocating the purchase price and the determination of in-process research and development. Since that date, however, the SEC has revised the approach for such valuation. The estimate for the one-time charges for acquired in process research and development projects for the initial filing was $57,000, which has subsequently been reduced to $21,900. In addition, based on a third party appraiser, the Company allocated $29,000 to existing core technology representing computer software that is currently in use, which is amortized over 5 years. Approximately $156,557 is recorde as the excess of the purchase price over the fair value of identifiable assets, (goodwill), which is being amortized on a straight-line basis over 15 years. The restatement does not affect previously reported net cash flows for the periods. The effect of this reallocation on previously reported condensed consolidated financial statements as of and for the three and six month periods ended June 30, 1998 is as follows: Three months Six months ended June 30, 1998 ended June 30, 1998 Statement of Operations: As Previously As Previously reported As restated reported As restated In-process Research and Development $ 57,000 $ 21,900 $ 57,000 $ 21,900 Net Income/ (loss) $(12,460) $ 22,640 $ 47,627 $ 82,727 (Loss)/Earnings per common share - Basic $ (0.08) $ 0.14 $ 0.29 $ 0.51 Earnings per common share - Diluted $ (0.07) $ 0.13 $ 0.28 $ 0.49 June 30, 1998 As Previously Balance Sheet reported As restated Computer Software $ 103,927 $132,927 Other Assets $ 92,540 $ 80,924 Goodwill $219,420 $245,836 IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 3. Basis of Presentation This document relates to IMS Health. The Common Stock of IMS Health was distributed by Cognizant Corporation ("Cognizant") to its shareholders on June 30, 1998. Simultaneously with the distribution ("The Distribution"), Cognizant changed its name to Nielsen Media Research, Inc. ("Nielsen Media Research"). Notwithstanding the legal form of the distribution, whereby Cognizant spun off IMS Health, for accounting purposes the transaction is accounted for as if Cognizant spun off Nielsen Media Research and IMS Health has been deemed the "accounting successor" to Cognizant. The separation created IMS Health as the premier global provider of information solutions to the pharmaceutical and healthcare industries, and established an independent Nielsen Media Research, the leader in electronic audience measurement services. IMS Health consists of IMS ("IMS"), Erisco, Inc. ("Erisco"), Enterprises Associates, Inc. ("Enterprises"), Cognizant Technology Solutions Corporation ("CTS"), SSJ K.K. ("Super Systems Japan"), and an equity investment in Gartner Group, Inc. ("Gartner"). Cognizant received a favorable ruling from the Internal Revenue Service with respect to the tax-free treatment of the transaction in May 1998. Cognizant's Board of Directors on June 15, 1998 approved the final plan, terms and conditions relating to the separation of the company including distribution, tax allocation, employee benefits and other agreements and authorized management to execute the plan of distribution. The Board of Directors declared a dividend to shareholders of record as of the close of business on June 25, 1998 consisting of one share of IMS Health Common Stock for each share of Cognizant Common Stock. The Distribution was effective June 30, 1998. Pursuant to Accounting Principles Board ("APB") No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," the consolidated financial statements of the Company have been reclassified to reflect Nielsen Media Research as discontinued operations. In connection with the Distribution, Cognizant borrowed $300 million on June 24, 1998, which was used to repay existing intercompany liabilities. This debt remained the obligation of Nielsen Media Research following the spin-off. In connection with the Distribution, Cognizant contributed to IMS Health all cash in Cognizant's accounts other than (i) cash required by Cognizant (renamed Nielsen Media Research) to satisfy certain specified obligations and (ii) such additional cash as was necessary for the net borrowings of Cognizant (renamed Nielsen Media Research) to equal $300 million as of the Distribution. Prior to the Distribution, Cognizant and IMS Health entered into certain agreements that will govern the relationship between Nielsen Media Research and IMS Health subsequent to the Distribution and provide for the allocation of tax, employee benefits and certain other liabilities and obligations arising from periods prior to the Distribution. Among other things, the agreements set forth principles to be applied in allocating certain Distribution-related costs and specify portions of contingent liabilities to be shared if certain amounts are exceeded. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 3. Basis of Presentation (continued) Following the Distribution, IMS Health does not have any ownership interest in Nielsen Media Research (other than 800,000 shares of Nielsen Media Research Common Stock which IMS Health owns as a result of Cognizant Stock held by a subsidiary of IMS Health and which IMS Health intends to sell). The Consolidated Financial Statements have been restated to present Nielsen Media Research as discontinued operations and reflect the Distribution which occurred at June 30, 1998. Summarized data for discontinued operations is as follows (dollar amounts in thousands): Results of Operations (Unaudited) (Unaudited) Three Months Ended June 30, Six Months Ended June 30, -------------------------------- ------------------------------ 1998 1997 1998 1997 -------------- ----------------- ------------- ---------------- Operating Revenue $ 97,932 $ 87,184 $ 193,996 $ 173,455 Income Before Provision for Income Taxes 29,048 27,355 57,980 53,640 ============== ================= ============= ================ Income from Discontinued Operations, Net of Income Taxes $ 21,088 $ 19,988 $ 42,093 $ 39,522 ============== ================= ============= ================ Net Assets of Discontinued Operations December 31, 1997 ---------------------- Current Assets $ 64,655 Property Plant & Equipment 55,050 Computer Software 43,093 Deferred Charges 16,299 Other Assets 21,112 Current Liabilities (43,921) Other Liabilities (33,510) ====================== Net Assets of Discontinued Operations $ 122,778 ====================== Note 4. Investments In the third quarter of 1997, the Company's voting interest in Gartner fell below 50% as a result of the exercise of Gartner employee stock options and employee stock purchases. Accordingly, effective January 1, 1997, the Company has deconsolidated Gartner and is accounting for its ownership interest under the equity basis. The Company recognizes as income any gains or losses related to the sale or issuance of stock by a consolidated subsidiary or a company accounted for under the equity basis ("SAB 51 Gain"). In the second quarter of 1998, proceeds from the issuance of shares to Gartner employees, including associated tax benefits, increased Gartner's equity by $14,147 and reduced the Company's ownership interest by less than 1% to 46.9% at June 30, 1998. Accordingly, the Company recognized a pre-tax unrealized gain on Gartner stock of $5,392 corresponding to the net increase in the value of its underlying investment in Gartner. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 5. Public Offering of a Subsidiary CTS effected an initial public offering ("the CTS IPO") of 2,917,000 shares of Class A Common Stock, par value $0.01 per share, of CTS (3,354,550 including the underwriters' over-allotment option granted by Cognizant) on June 19, 1998. Of such shares, 2,500,000 were offered by CTS and 417,000 shares were offered by Cognizant. Of the total proceeds, CTS used approximately $6.5 million to repay intercompany debt owed to Cognizant. Cognizant's interest in CTS was transferred to the Company in the Distribution. After completion of the offering, the Company holds 66.7% of the outstanding stock of CTS and accordingly, will continue to consolidate CTS results within its financial statements. Any minority interest is captured on the Statement of Financial Position in the minority interest line. The transaction (other than the over-allotment option) closed on June 24, 1998 and resulted in a gain of $12,777, which is a SAB 51 gain, representing the Company's portion due to the Distribution. The underwriters over-allotment option was exercised during the third quarter. The Company expects to recognize a gain from this sale resulting in a reduction of its ownership to 61.9%. CTS's Class A Common Stock is listed on the NASDAQ National Market under the symbol "CTSH". Note 6. Acquisitions On June 24, 1998 Cognizant acquired Walsh International, Inc. ("Walsh"). The total purchase price of the acquisition was $193,748, including $167,148 of common stock, $9,521 of stock options to be issued and $17,079 of accrued acquisition and integration costs. Under terms of the Walsh acquisition agreement, Walsh shareholders received .3041 shares of Cognizant common stock per Walsh share (or, based on a Cognizant share price of $51.792, consideration of approximately $167,148). Walsh had 10,612,628 shares outstanding. Cognizant issued 3,227,300 shares from treasury stock to consummate the Walsh acquisition. The direct acquisition and integration costs consist of severance of $4,876, lease terminations of $2,569, and other direct acquisition and integration costs of $9,634. These direct acquisition and integration costs are incremental to other costs and were incurred as a direct result of the formal plan to exit certain activities as part of the overall integration effort (such as severance costs related to Walsh employees) and certain contractual cancellation costs (such as Walsh leases). Approximately $156,557 is recorded as the excess of the purchase price ove the fair value of the identifiable net assets (goodwill), which is being amortized on a straight-line basis over 15 years. Purchase Price Allocation The Company made allocations of the aggregate purchase price to acquired in-process research and development ("IPR&D") amounting to $21,900 related to the Walsh acquisition. The Securities and Exchange Commission (the "SEC") recently issued revised guidance with respect to allocations of IPR&D projects in connection with acquisitions. In accordance with this guidance, the amount allocated to IPR&D reflects the relative value and contribution of the acquired IPR&D. Consideration was given to the project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred and the projected cost to complete the projects. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 6. Acquisitions - (continued) In addition, based on a third party independent appraiser, the Company allocated $29,000 to existing core technology representing computer software that will be used, which is being amoritzed over 5 years. The preliminary allocation of the Company's aggregate purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed in connection with the acquisition was based primarily on independent appraisals of estimates of fair value. The allocation is summarized as follows: In-process R&D write-off $ 21,900 Net liabilities assumed (5,009) Software/Core technology 29,000 Deferred taxes (8,700) Goodwill 156,557 -------------------------------------------- ---------------- Total Purchase Price $ 193,748 -------------------------------------------- ---------------- The Company does not believe that the current purchase price allocation, related to the Walsh acquisition will differ significantly from this preliminary purchase price allocation. At the date of the acquisition, the development of the IPR&D projects had not yet reached technological feasibility and had no alternative future use. Accordingly, these costs were expensed as of the acquisition date. The impact of the acquisition on results of operations, other than the one-time charges and the IPR&D write-offs, had it occurred January 1, 1998 or 1997 would be immaterial. Note 7. Investment Partnership Two of the Company's subsidiaries have contributed assets to, and participate in, a limited partnership. One subsidiary serves as general partner, and all other partners hold limited partnership interests. The partnership, which is a separate and distinct legal entity, is in the business of licensing database assets and computer software. In the second quarter of 1997, third-party investors contributed $100,000 to the partnership in exchange for limited partnership interests. For financial reporting purposes, the assets, liabilities, results of operations and cash flows of the partnership are included in the Company's consolidated financial statements because the Company and its subsidiaries maintain a controlling (84%) interest in the partnership. The third-parties' investments in this partnership are reflected in minority interests. Note 8. Litigation The Company and its subsidiaries are involved in legal proceedings and litigation arising in the ordinary course of business. In the opinion of management, the outcome of such current legal proceedings and litigation, if decided adversely, could have a material effect on quarterly or annual operating results or cash flows when resolved in a future period. However, in the opinion of management, these matters will not materially affect the Company's consolidated financial position. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 8. Litigation (continued) In addition, on July 29, 1996, Information Resources, Inc. ("IRI") filed a complaint in the United States District Court for the Southern District of New York, naming as defendants the Dun & Bradstreet Corporation ("D&B"), A.C. Nielsen Company and IMS (the "IRI Action"). The complaint alleges various violations of the United States antitrust laws, including alleged violations of Sections 1 and 2 of the Sherman Act. The complaint also alleges a claim of tortious interference with a contract and a claim of tortious interference with a prospective business relationship. These latter claims relate to the acquisition by defendants of Survey Research Group Limited ("SRG"). IRI alleges that SRG violated an alleged agreement with IRI when it agreed to be acquired by defendants and that the defendants induced SRG to breach that agreement. IRI's complaint alleges damages in excess of $350,000, which amount IRI has asked to be trebled under the antitrust laws. IRI also seeks punitive damages in an unspecified amount. On October 15, 1996, defendants moved for an order dismissing all claims in the complaint. On May 6, 1997 the United States District Court for the Southern District of New York issued a decision dismissing IRI's claim of attempted monopolization in the United States, with leave to replead within sixty days. The Court denied defendants' motion with respect to the remaining claims in the complaint. On June 3, 1997, defendants filed an answer denying the material allegations in IRI's complaint, and A.C. Nielsen Company filed a counterclaim alleging that IRI has made false and misleading statements about its services and commercial activities. On July 7, 1997, IRI filed an amended and restated complaint repleading its alleged claim of attempted monopolization in the United States and realleging its other claims. On August 18, 1997, defendants moved for an order dismissing the amended claims. On December 1, 1997, the court denied the motion and, on December 16, 1997, defendants filed a supplemental answer denying the remaining material allegations of the amended complaint. In light of the potentially significant liabilities which could arise from the IRI Action and in order to facilitate the distribution by D&B of shares of Cognizant and ACNielsen in 1996, D&B, ACNielsen Corporation ("ACNielsen"; the parent company of A.C. Nielsen Company) and Cognizant entered into an Indemnity and Joint Defense Agreement pursuant to which they agreed (i) to certain arrangements allocating liabilities that may arise out of or in connection with the IRI Action, and (ii) to conduct a joint defense of such action. In particular, the Indemnity and Joint Defense Agreement provides that ACNielsen will assume exclusive liability for liabilities up to a maximum amount to be calculated at the time such liabilities, if any, become payable (" the ACN Maximum Amount") and that Cognizant and D&B will share liability equally for any amounts in excess of the ACN Maximum Amount. The ACN Maximum Amount will be determined by an investment banking firm as the maximum amount which ACNielsen will be able to pay after giving effect to (i) any plan submitted by such investment bank which is designed to maximize the claims paying ability of ACNielsen without impairing the investment banking firm's ability to deliver a viability opinion (but which will not require any action requiring shareholder approval), and (ii) payment of IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 8. Litigation (continued) related fees and expenses. For these purposes, financial viability means the ability of ACNielsen, after giving effect to such plan, the payment of related fees and expenses and the payment of the ACN Maximum Amount, to pay its debts as they become due and to finance the current and anticipated operating and capital requirements of its business, as reconstituted by such plan, for two years from the date any such plan is expected to be implemented. Under the terms of the Distribution Agreement dated October 28, 1996 among D&B, Cognizant and ACNielsen (the "1996 Distribution Agreement"), as a condition to the Distribution, IMS Health and Nielsen Media Research are required to undertake to be a jointly and severally liable to D&B and ACNielsen for Cognizant's obligations under the 1996 Distribution Agreement. IMS Health and Nielsen Media Research have agreed that, as between themselves, IMS Health will assume 75%, and Nielsen Media Research will assume 25%, of any payments to be made in respect of the IRI Action under the Indemnity and Joint Defense Agreement or otherwise, including any legal fees and expenses related thereto incurred in 1999 or thereafter. IMS Health has agreed to be fully responsible for any legal fees and expenses incurred during 1998. Nielsen Media Research's aggregate liability to IMS Health for payments in respect of the IRI Action and certain other contingent liabilities shall not exceed $125 million. Management of the Company is unable to predict at this time the final outcome of this matter or whether the resolution of this matter could materially affect the Company's results of operations, cash flows or financial position. Note 9. Financial Instruments with Off-Balance-Sheet Risk The Company transacts business in virtually every part of the world and is subject to risks associated with changing foreign exchange rates. The Company's objective is to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on its core business activities. Accordingly the Company enters into various contracts which change in value as foreign exchange rates change to protect the value of a portion of committed and anticipated foreign currency revenues and non-functional currency assets and liabilities. By policy, the Company maintains hedge coverage between minimum and maximum percentages of its anticipated foreign exchange exposures over the next year. The gains and losses on these hedges offset changes in the value of the related exposures. It is the Company's policy to enter into foreign currency transactions only to the extent necessary to meet its objectives as stated above. The Company does not enter into foreign currency transactions for speculative purposes. The Company uses forward contracts and purchased currency options to hedge committed and anticipated foreign currency denominated revenues, respectively. The principal currencies hedged are the Japanese yen, Swiss franc, German mark and Italian lira. The Company also uses forward contracts to hedge non-functional currency assets and liabilities. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 9. Financial Instruments with Off-Balance-Sheet Risk (continued) Gains and losses on contracts hedging anticipated and committed foreign currency revenues are deferred until such revenues are recognized, and offset changes in the value of such revenues. At May 31, 1998, the notional amount hedged was $112,000. In addition, at May 31, 1998, IMS had approximately $63,000 in foreign exchange forward contracts outstanding with various expiration dates through November 1998. Gains and losses on contracts hedging non-functional currency assets and liabilities are not deferred and are included in current income in other income/expense--net. Note 10. Adoption of Statements of Financial Accounting Standards In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 is effective for all fiscal quarters for all fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in an asset's, liability's, or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current period earnings. Management has not evaluated the effects of this change on the Company's financial statements. Note 11. Operations by Business Segment In 1997, the Company adopted Statement of Financial Accounting Standard No. 131 "Disclosures About Segments of an Enterprise and Related Information". As required, the Company has restated prior period segment results in order to conform to the new statement. The Company, operating globally in approximately 80 countries, delivers information, software and related services principally through the strategic business segments referenced below. IMS is the leading global provider of market information and decision-support services to the pharmaceutical and healthcare industries. Emerging Markets includes Erisco, a leading supplier of software-based administrative and analytical solutions to the managed care industry; CTS, a provider of software applications and development services and Year 2000 and Eurocurrency compliance services; Super Systems Japan, a marketer of financial application software products to the Japanese market; Enterprises, the Company's venture capital unit focused on investments in emerging healthcare businesses; and Pilot Software Inc.("Pilot"), which was sold as of July 31, 1997. IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 11. Operations by Business Segment (continued) The accounting policies of these reportable segments are the same as those described for the consolidated entity. The Company evaluates the performance of its operating segments based on revenue and operating income. Period Ended June 30, 1998 Three Months Six Months ------------ -------------- ------------ ------------ --------------- ------------ IMS Emerging Total IMS Emerging Total Markets (1) Markets (1) ------------ -------------- ------------ ------------ --------------- ------------ Operating Revenue $249,422 $21,074 $270,496 $472,823 $38,641 $511,464 Segment Operating Income (2) $28,186 $1,685 $29,871 $59,112 $2,587 $61,699 General Corporate Expenses (3) $(43,783) $(56,883) nterest Income (4) $2,270 $48 $2,318 $4,400 $80 $4,480 Interest Expense (5) $(196) $(196) $(380) $(380) Non-Operating Income/(Expense) - Net Gartner Equity Income $17,320 $32,894 Gain on Gartner Stock (SAB 51) $5,392 $13,379 Gains from Dispositions - Net $12,777 $12,777 $23,192 $23,192 Other Expense - Net $(40) $(890) ------------ --------------- ------------ ------------ -------------- ------------ Income from Continuing Operations Before Provision for Income Taxes $23,659 $77,491 Provision for Income Taxes $(22,107) $(36,857) ------------ --------------- ------------ ------------ -------------- ------------ Income from Continuing Operations $1,552 $40,634 Income from Discontinued Operations, Net of Income Taxes $21,088 $42,093 - - -------------------------------------------- ------------ -------------- ------------ ------------ --------------- ------------ Net Income $22,640 $82,727 - - -------------------------------------------- ------------ -------------- ------------ ------------ --------------- ------------ --- ---------------------------------- -- -- ------------------------------------ Period Ended June 30, 1997 Three Months Six Months - - -------------------------- --- ---------------------------------- -- -- ------------------------------------ IMS Emerging Total IMS Emerging Total Markets (1) Markets (1) ------------- -------------- ------------ ------------ -------------- ------------ Operating Revenue $229,364 $21,712 $251,076 $439,186 $41,195 $480,381 Segment Operating Income/(Loss) $56,356 $(9,912) $46,444 $93,672 $(18,720) $74,952 General Corporate Expenses $(7,089) $(13,989) Interest Income (4) $785 $(51) $734 $1,882 $10 $1,892 Interest Expense (5) $(141) $115 $(26) $(362) $(14) $(376) Non-Operating Income/(Expense) - Net Gartner Equity Income $15,137 $30,671 Gains from Dispositions - Net $5,436 $5,436 Other (Expense)/Income - Net $(504) $1,085 ------------------------------------------- ---------- ------------- ---------------- Income from Continuing Operations Before Provision for Income Taxes $54,696 $99,671 Provision for Income Taxes $(14,629) $(26,233) ------------ -------------- -------------- --------------------------------------- Income from Continuing Operations $40,067 $73,438 Income from Discontinued Operations, Net of Income Taxes $19,988 $39,522 - - ------------------------------------------- ------------- -------------- ------------ ------------ -------------- ------------ Net Income $60,055 $112,960 - - ------------------------------------------- ------------- -------------- ------------ ------------ -------------- ------------ (See Notes to Operations by Business Segments on next page) IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 11. Operations by Business Segment (continued) Notes to Operations by Business Segments: (1) Excludes intersegment sales in 1998 of $4,173, and $7,907 for the three and six month periods presented, respectively. Excludes intersegment sales in 1997 of $3,267, and $5,754 for the three and six month periods presented, respectively. These sales, primarily from CTS to IMS, are accounted for on a time and materials basis and recognized as the service is performed. (2) Segment operating income in 1998 includes a one-time in-process research and development write-off of $21,900 for both the three and six months periods presented. (3) General Corporate Expenses in 1998 include charges related to the Distribution of $30,125 and $35,025 for the three and six month periods presented, respectively. In addition, General Corporate Expenses in 1998 include one-time Walsh acquisition costs of $5,000 for both the three and six month periods presented. (4) Interest income in 1998 excludes amounts recorded at corporate of $2,453 and $4,389 for the three and six month periods presented, respectively. Interest income in 1997 excludes amounts recorded at corporate of $932 and $3,384 for the three and six month periods presented, respectively. (5) Interest expense in 1998 excludes amounts recorded at corporate of $16 and $32 for the three and six month periods presented, respectively. Interest expense in 1997 excludes amounts recorded at corporate of $105 and $205 for the three and six month periods presented, respectively. Note 12. Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. This statement, which the Company adopted in the first quarter of 1998, establishes standards for reporting and displaying comprehensive income and its components in a full set of general purpose financial statements. Where applicable, earlier periods have been restated to conform to the standards set forth in SFAS No. 130. The Company's Comprehensive Income consists of net income, foreign currency translation adjustments and unrealized holding gains/(losses) on securities (see Condensed Consolidated Statements of Comprehensive Income). Accumulated balances of Cumulative Translation Adjustments and Unrealized Gains/(Losses) on Investments, as of June 30, 1998 are as follows: Cumulative Unrealized Total Other Translation Gains/(Losses) Comprehensive Adjustment on Investments (1) Items ----------------- -------------------- ------ --------------------- Balance December 31, 1997 $(76,771) $32,650 $(44,121) Current Period Change (9,596) (3,161) (12,757) ======================================= ================= ==================== ====== ===================== Balance June 30, 1998 $(86,367) $29,489 $(56,878) ======================================= ================= ==================== ====== ===================== <FN> (1) Current period change is principally due to the sale of Enterprises' investments in Aspect Development, Inc. and Pegasus Systems Inc. </FN> IMS HEALTH INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) Dollar amounts in thousands Note 13. Subsequent Event On July 22, 1998, the Company announced the signing of an agreement in principle to acquire the non-U.S. assets of Pharmaceutical Marketing Services Inc. ("PMSI"), which provides information services to pharmaceutical and healthcare companies in the U.S., Europe and Japan. The agreement supersedes the previous agreement dated March 23, 1998. PMSI will remain an independent company retaining PMSI Scott-Levin and all of its non-operating assets. The transaction which closed on August 5, 1998, is expected to be tax-free to PMSI. Under the terms of the agreement PMSI received approximately 1.2 million shares of IMS Health common stock, valued at approximately $75,000. It is expected that the Company will incur an in-process research and development charge as a result of this transaction. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollar amounts in thousands, except per share data) This document relates to IMS Health Incorporated ("IMS Health"). The Common stock of IMS Health was distributed by Cognizant Corporation ("Cognizant") to its shareholders on June 30, 1998. Simultaneously with the distribution ("the Distribution") Cognizant changed its name to Nielsen Media Research, Inc. ("Nielsen Media Research"). Notwithstanding the legal form of the distribution, whereby Cognizant spun off IMS Health, for accounting purposes the transaction is accounted for as if Cognizant spun off Nielsen Media Research, Inc. and IMS Health has been deemed the "accounting successor" to Cognizant. The separation created IMS Health as the premier global provider of information solutions to the pharmaceutical and healthcare industries, and established an independent Nielsen Media Research, the leader in electronic audience measurement services. IMS Health consists of IMS ("IMS"), Erisco, Inc. ("Erisco"), Enterprises Associates, Inc. ("Enterprises"), Cognizant Technology Solutions Corporation ("CTS"), SSJ K.K. ("Super Systems Japan"), and an equity investment in Gartner Group, Inc. ("Gartner"). Cognizant received a favorable ruling from the Internal Revenue Service with respect to the tax-free treatment of the transaction in May 1998. Cognizant's Board of Directors on June 15, 1998 approved the final plan, terms and conditions relating to the separation of the company including distribution, tax allocation, employee benefits and other agreements and authorized management to execute the plan of distribution. The Board of Directors declared a dividend to shareholders of record as of the close of business on June 25, 1998 consisting of one share of IMS Health Common Stock for each share of Cognizant Common Stock. The Distribution was effective June 30, 1998. Pursuant to Accounting Principles Board ("APB") No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," the consolidated financial statements of the Company have been reclassified to reflect Nielsen Media Research as discontinued operations. In connection with the Distribution, Cognizant borrowed $300 million on June 24, 1998, which was used to repay existing intercompany liabilities. This debt remained the obligation of Nielsen Media Research following the spin off. In connection with the Distribution, Cognizant contributed to IMS Health all cash in Cognizant's accounts other than (i) cash required by Cognizant (renamed Nielsen Media Research) to satisfy certain specified obligations and (ii) such additional cash as was necessary for the net borrowings of Cognizant (renamed Nielsen Media Research) to equal $300 million as of the Distribution. Prior to the Distribution, Cognizant and IMS Health entered into certain agreements that will govern the relationship between Nielsen Media Research and IMS Health subsequent to the Distribution and provide for the allocation of tax, employee benefits and certain other liabilities and obligations arising from periods prior to the Distribution. Among other things, the agreements set forth principles to be applied in allocating certain Distribution-related costs and specify portions of contingent liabilities to be shared if certain amounts are exceeded. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Following the Distribution, IMS Health does not have any ownership interest in Nielsen Media Research (other than 800,000 shares of Nielsen Media Research Common Stock which IMS Health will own as a result of Cognizant Stock held by a subsidiary of IMS Health and which IMS Health intends to sell). Acquisition On June 24, 1998 Cognizant acquired Walsh International, Inc. ("Walsh"). The total purchase price of the acquisition was $193,748, including $167,148 of common stock, $9,521 of stock options to be issued and $17,079 of accrued acquisition and integration costs. Under terms of the Walsh acquisition agreement, Walsh shareholders received .3041 shares of Cognizant Corporation common stock per Walsh share (or, based on a Cognizant share price of $51.792, consideration of approximately $167,148). Walsh had 10,612,628 shares outstanding. Cognizant issued 3,227,300 shares from treasury stock to consummate the Walsh acquisition. The direct acquisition and integration costs consist of severance of $4,876, lease terminations of $2,569 and other direct acquisition and integration costs of $9,634. These direct acquisition and integration costs are incremental to other costs and were incurred as a direct result of the formal plan to exit certain activities as part of the overall integration effort (such as severance costs related to Walsh employees) and certain contractual costs (such as Walsh leases). Approximately $156,557 is recorded as the excess of the purchase price over the fair value of identifiable net assets, (goodwill), which is being amortized on a straight-line basis over 15 years. Purchase Price Allocation The Company made allocations of the aggregate purchase price to acquired in-process research and development ("IPR&D") amounting to $21,900 related to the Walsh acquisition. The Securities and Exchange Commission (the "SEC") recently issued revised guidance with respect to allocations of IPR&D projects in connection with acquisitions. In accordance with this guidance, the amount allocated to IPR&D reflects the relative value and contribution of the acquired IPR&D. Consideration was given to the project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred and the projected cost to complete the projects. The preliminary allocation of the Company's aggregate purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed in connection with the acquisition was based primarily on independent appraisals of estimates of fair value. The allocation is summarized as follows: In-process R&D write-off $ 21,900 Net liabilities assumed (5,009) Software/Core technology 29,000 Deferred taxes (8,700) Goodwill 156,557 ------------------------------------------ ---------------- Total Purchase Price $ 193,748 ----------------------------------------- ---------------- The Company does not believe that the current purchase price allocation, related to the Walsh acquisition, will differ significantly from this preliminary purchase price allocation. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) The impact of the acquisition on results of operations, other than the one-time charges and the charge for in-process research and development, had it occurred January 1, 1998 or 1997 would be immaterial. At the date of the acquisition, the development of the IPR&D projects had not yet reached technological feasibility and had no alternative future use. Accordingly, these costs were expensed as of the acquisition date. The projects identified as IPR&D at Walsh include enhancement of Walsh's Windows based sales management information system, enhancement of its pharmaceutical marketing database and development of a next-stage integrated and enhanced sales management information system. These projects were identified as underway at Walsh and, at the date of the acquisition, would require additional effort to establish technological feasibility. In addition, based on a third party independent appraiser, the Company allocated $29,000 to existing core technology representing computer software that is currently in use, which is being amoritzed over 5 years. The amounts assigned to the IPR&D projects were determined by first estimating the degree of completion of each project and the potential net cash flows from such projects after commercial introduction. The potential net cash flows include reductions reflecting the necessary investment in fixed and working capital and other collateral assets, which include core technology, where appropriate and a fair return on those assets. A portion of the potential net cash flows for each project was then attributed to the effort already completed by Walsh, based upon the estimated degree of completion. The attributed potential net cash flows for each project were discounted to present value using a risk-adjusted discount rate. The discount rates utilized to value the IPR&D projects ranged from 17% to 30%. Such discount rates took into account the industry risk for the Walsh business acquired (as evidenced by the calculated weighted average cost of capital), technology development risk associated with completing the in-process projects, and market and commercial risk associated with introducing the new products/technology. The implied weighted average cost of capital for the different Walsh projects ranged from 12% to 15%. The degree of completion represents the extent to which the different in-process projects are complete, as of the acquisition date. The completion percentage ranged from 53% to 87% for projects at Walsh. In the opinion of management IMS Health is on target to begin realizing the benefits from these various projects through product introductions at launch dates ranging from early 1999 to January 2000. The Company believes that the assumptions used, including the revenue forecasts and margin analysis, are reasonable. No assurance can be given, however, that the underlying assumptions used to estimate expected project sales, development costs or profitability, or events associated IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) with such projects, will transpire as estimated. For these reasons, actual results may vary from the projected results. Management expects to continue supporting these IPR&D efforts and believes the Company has a reasonable chance of successfully completing the IPR&D programs. However, there is risk associated with the completion of the IPR&D projects and the Company cannot be assured that any will meet with either technological or commercial success. If none of these IPR&D projects are successfully developed the sales and profitability of the Company may be adversely affected in future periods. The failure of any particular individual project in-process would not materially impact the Company's financial condition, results of operations or cash flows. Operating results are subject to uncertain market events and risks, which are beyond the Company's control, such as trends in technology, government regulations, market size and growth, and product introduction or other actions by competitors. Public Offering of a Subsidiary CTS effected an initial public offering (`the CTS IPO") of 2,917,000 shares of Class A Common Stock, par value $0.01 per share, of CTS (3,354,550 including the underwriters' over-allotment option granted by Cognizant) on June 19, 1998. Of such shares, 2,500,000 were offered by CTS and 417,000 shares were offered by Cognizant. Of the total proceeds, CTS used approximately $6.5 million to repay intercompany debt owed to Cognizant. Cognizant's interest in CTS was transferred to the Company in the Distribution. After completion of the offering, the Company holds 66.7% of the outstanding stock of CTS and accordingly, will continue to consolidate CTS results within its financial statements. Any minority interest is captured on the Statement of Financial Position in the minority interest line. The transaction (other than the over-allotment option) closed on June 24, 1998 and resulted in a gain of $12,777, which is a SAB 51 gain, representing the Company's portion due to the Distribution. The underwriter's over-allotment option was exercised during the third quarter. The Company expects to recognize a gain from the sale, which reduces ownership to 61.9%. CTS's Class A Common Stock is listed on the NASDAQ National Market under the symbol "CTSH". In September 1997, the Company's voting interest in Gartner fell below 50% as a result of the exercise of Gartner employee stock options and employee stock purchases. Accordingly, effective January 1, 1997, the Company has deconsolidated Gartner (the "Gartner Deconsolidation") and is accounting for its ownership interest under the equity basis. Operations Revenue for the second quarter increased by 7.7% to $270,496 from $251,076 for the second quarter of the prior year. Consolidated first-half revenue increased 6.5% to $511,464 from $480,381 for the comparable period a year ago. Revenue growth for the quarter and the first-half was held down by the absence of revenues from Pilot Software Inc. ("Pilot") since its divestiture and the impact of a stronger U.S. dollar. Adjusting for these items, revenue for the second quarter and first half of 1998 increased by 14.2% and 14.4%, respectively. This increase reflected double-digit constant dollar revenue growth at IMS, Erisco and CTS. The impact of a stronger U.S. dollar decreased reported revenue by approximately 3% in the second quarter and 4% for the first-half, including the impact of gains related to the Company's hedging strategy. Operating losses for the second quarter were ($13,912), a decrease of 135.4% from operating income of $39,355 for the second quarter of the prior year. Operating losses in the second quarter include Year 2000 costs of $12,330; charges related to the Distribution of $30,125; and an in-process research and development write-off of $21,900 and one-time charge of $5,000 related to the Walsh acquisition. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Consolidated first-half operating income was $4,816, a decrease of 92.1% from operating income of $60,963 for the comparable period a year ago. First-half operating losses include Year 2000 costs of $22,301; charges related to the Distribution of $35,025; and a research and development write-off of $21,900 and one-time charge of $5,000 related to the Walsh acquisition. Adjusting for these items and the impact of a stronger U.S. dollar, operating income for the second quarter and the first-half of 1998 increased by 54.0% and 59.7%, respectively. Adjusted operating income growth outpaced revenue growth primarily due to the absence of Pilot operating losses since its divestiture. The impact of a stronger U.S. dollar decreased adjusted operating income growth by approximately 13% in the second quarter and 14% for the first-half, including the impact of gains related to the Company's hedging strategy. Non-operating income-net for the second quarter was $37,571 compared with $15,341 for the second quarter of the prior year. This increase is primarily related to realizing gains in 1998 related to the CTS IPO gain of $12,777, and recording a pre-tax unrealized gain on Gartner stock of $5,392 corresponding to the net increase in the value of the Company's investment in Gartner ("SAB 51 Gain"). Non-operating income-net for the first-half was $72,675 compared with $38,708 for the comparable period a year ago. This increase is primarily related to realizing higher gains in 1998 on the sale of Enterprises' investments of $10,415 compared with 1997 gains of $5,436, the CTS IPO gain of $12,777, and recording a pre-tax SAB 51 gain on Gartner stock of $13,379 corresponding to the net increase in the value of the Company's investment in Gartner ; partially offset by recording, within Gartner equity income, the Company's share of an in-process research and development write-off at Gartner of $2,998. The Company's effective tax rate was 93.4% for the second quarter of 1998, compared with an effective tax rate of 26.8% in the comparable period of the prior year. The second quarter 1998 effective tax rate was impacted by a one-time spin-related charge of $30,125 and a research and development write-off of $21,900 and one-time charge of $5,000 related to the Walsh acquisition. These items did not give rise to a tax benefit. Excluding these items, the Company's effective tax rate was 27.4% for the second quarter of 1998. The Company's effective tax rate was 47.6% for the first-half of 1998, compared with an effective tax rate of 26.3% in the comparable period of the prior year. Excluding the charges related to the Distribution and a research and development write-off and one-time charge related to the Walsh acquisition, the effective tax rate from operations for the first-half of 1998 was 27.4%. Income from continuing operations in the second quarter of 1998 was $1,552, compared with income from continuing operations of $40,067 in the second quarter of the prior year, a decrease of 96.1%. Excluding the after-tax impact of the SAB 51 Gain, CTS IPO gain, Year 2000 costs, the charges related to the Distribution and the in-process research and development write-off and one-time charges related to the Walsh acquisition, income from continuing operations increased 35.6% to $54,338 in 1998. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Income from continuing operations for the first-half of 1998 was $40,634, compared with $73,438 in the first-half of the prior year, a decrease of 44.7%. Excluding the after-tax impact of gains associated with Enterprises' investments, the SAB 51 Gain, the CTS IPO gain, Year 2000 costs, the charges related to the Distribution and the in-process research and development write-off and one-time charges related to the Walsh acquisition, income from continuing operations increased 34.0% to $93,034 in 1998. Income from discontinued operations net of income taxes in the second quarter of 1998 was $21,088, compared with $19,988 in the second quarter of the prior year. Income from discontinued operations net of income taxes in the first-half of 1998 was $42,093, compared with $39,522 in the first-half of the prior year. Income from discontinued operations net of income taxes represents the results of Nielsen Media Research. The Company's net income for the second quarter of 1998 was $22,640, a decrease of 62.3 % from net income of $60,055 in the second quarter of the prior year. Excluding the after-tax impact of Year 2000 costs, the charges related to the Distribution, the in-process research and development write-off, the one-time acquisition costs, the SAB 51 Gain, and the CTS IPO gain, net income for the quarter increased 25.6%. The Company's net income for the first-half of 1998 decreased 26.8% to $82,727 from $112,960 in the first-half of the prior year. Excluding the after-tax impact of Year 2000 costs, the charges related to the Distribution, the in-process research and development write-off, the one time acquisition costs, the SAB 51 Gain, gains associated with Enterprises' investments, and the CTS IPO gain, net income for the quarter increased 24.1%. Basic earnings per share from continuing operations in the second quarter of 1998 was $0.01, a decrease of 95.8% from earnings per share of $.24 in the second quarter of the prior year. Excluding the after-tax impact of the previously identified one-time items, basic earnings per share for the quarter increased 37.5%. Basic earnings per share from continuing operations in the first-half of 1998 decreased 43.2% to $0.25 from $.44 in the first-half of the prior year. Excluding the after-tax impact of the previously identified one-time items, basic earnings per share for the quarter increased 39.0%. Results by Business Segment As discussed in Note 10, in 1997 the Company adopted SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information" which changes the way public companies report information about segments. As required, the Company has restated the prior period in order to conform to the 1998 presentation. IMS is the leading global provider of market information and decision-support services to the pharmaceutical and healthcare industries. IMS revenue for the second quarter of 1998 increased 8.7% to $249,422 from $229,364 in the second quarter of the prior year. Adjusting for the impact IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Results by Business Segment -(continued) of a stronger U.S. dollar, revenue for the second quarter 1998 increased by 11.6%. IMS revenue growth benefited from strong performance of its sales management products in North America, and from increased usage of the Global Services Midas database by international pharmaceutical companies. Income from IMS for the second quarter was $28,186, a decrease of 50% from operating income of $56,356 in the second quarter of the prior year. Operating income in the second quarter of 1998 includes $12,330 of costs related to Year 2000 and a research and development write-off of $21,900. Excluding these costs and the impact of a stronger U.S. dollar, operating income for the second quarter of 1998 increased 17.4%. IMS revenue for the first-half of 1998 increased 7.7% to $472,823 from $439,186 in the first-half of the prior year. Adjusting for the impact of a stronger U.S. dollar, revenue for the first-half of 1998 increased by 12.1%. IMS operating income for the first-half of 1998 decreased 36.9% to $59,112 from $93,672 in the first-half of the prior year. Operating income in the first-half of 1998 includes $22,301 of costs related to Year 2000 and a research and development write-off of $21,900. Excluding these costs and the impact of a stronger U.S. dollar, operating income for the first-half of 1998 increased 17.3%. Emerging Markets includes Erisco, a leading supplier of software-based administrative and analytical solutions to the managed care industry; CTS, a provider of software applications and development services and Year 2000 and Eurocurrency compliance services; Super Systems Japan, a marketer of financial application software products to the Japanese market; Enterprises, the Company's venture capital unit, focused on investments in emerging healthcare businesses; and Pilot which was sold as of July 31, 1997. Emerging Markets revenue for the second quarter of 1998 decreased 2.9% to $21,074 from $21,712 in the second quarter of the prior year. This decrease was primarily due to the absence of revenues from Pilot since its divestiture. Excluding the effect of Pilot and the impact of a stronger U.S. dollar, revenue for the second quarter of 1998 increased 56.9%, primarily due to strong growth at CTS and Erisco. Emerging Markets operating income for the second quarter of 1998 increased to $1,685 from an operating loss of $9,912 in the second quarter of the prior year. This increase was primarily due to the absence of losses from Pilot since its divestiture. Emerging Markets revenue for the first-half of 1998 decreased 6.2% to $38,641 from $41,195 in the first-half of the prior year. This decrease was primarily due to the absence of revenues from Pilot since its divestiture. Excluding the effect of Pilot and the impact of a stronger U.S. dollar, revenue for the first-half of 1998 increased 54.1%. Emerging Markets operating income for the first-half of 1998 increased to $2,587 from an operating loss of $18,720 in the first half of the prior year. This increase was primarily due to the absence of losses from Pilot since its divestiture. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Condensed Consolidated Statement of Cash Flows Six Months Ended June 30, 1998 and 1997 Net cash provided by operating activities totaled $78,359 for the six months ended June 30, 1998 compared with $86,940 for the comparable period in 1997. The decrease of $8,581 principally reflects lower net income in 1998 and a lower increase in deferred revenues ($17,351). These decreases were partially offset by a decrease in accounts receivable in 1998 compared with an increase in 1997 ($15,322), an increase in accrued income taxes in 1998 compared with a decrease in 1997 ($22,177), and a lower increase in Other Working Capital items ($12,677). Net cash (used in) investing activities totaled ($19,316) for 1998 compared with ($46,317) for the comparable period in 1997. The decrease in cash used of $27,001 is principally due to higher proceeds from the sale of investments in 1998 as compared with 1997 ($16,161) and cash from companies acquired in stock purchases ($9,480). Net cash provided by / (used in) financing activities totaled $355,146 for the six months ended June 30, 1998 compared with ($110,801) for the comparable period in 1997. The increase in cash provided by financing activities of $465,947 was primarily due to proceeds from the debt assumed by Nielsen Media Research ($300,000), lower cash payments for the purchase of treasury shares ($196,755), higher proceeds from the exercise of stock options in 1998 ($43,232), as compared with 1997 ($4,345) and proceeds from the CTS IPO ($27,128). These increases were partially offset by the absence of minority interest financing in 1998 ($100,000). Changes in Financial Position at June 30, 1998 Compared to December 31, 1997 Cash & Cash Equivalents increased to $702,550 at June 30, 1998, from $312,442 at December 31, 1997, primarily reflecting the proceeds from bank borrowings assumed by Nielsen Media Research ($300,000), proceeds from the sale of investments ($23,165), proceeds from the CTS IPO ($27,128) and proceeds from exercise of stock options ($43,232). Investment in Gartner Group increased to $228,674 at June 30, 1998, from $195,695 at December 31, 1997, reflecting equity income-net of taxes ($19,600) and a gain on the sale of Gartner stock ($13,379). Goodwill increased to $245,836 at June 30, 1998, from $87,430 at December 31, 1997, primarily reflecting the Walsh acquisition ($156,557). Assets from Discontinued Operations decreased to $0 at June 30, 1998, from $122,778 at December 31, 1997, due to the distribution of Nielsen Media Research. Accrued Income Taxes increased to $60,235 at June 30, 1998, from $52,696 at December 31, 1997, primarily reflecting a higher tax provision in 1998. IMS HEALTH INCORPORATED Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) (Dollar amounts in thousands, except per share data) Changes in Financial Position at June 30, 1998 Compared to December 31, 1997 (continued) Deferred Revenue increased to $130,068 at June 30, 1998, from $110,768 at December 31, 1997, primarily reflecting higher sales at IMS and the inclusion of Walsh. Shareholders' Equity increased to $1,182,958 at June 30, 1998, from $801,570 at December 31, 1997, primarily reflecting the issuance of stock in connection with acquisitions ($168,937), the proceeds of bank borrowings net of the dividend of Nielsen Media Research's net liability ($112,000), net income ($82,727), and proceeds from stock option exercises ($43,232). These increases were partially offset by cash dividends paid ($9,813), currency translation adjustments ($9,596) and treasury share repurchases (7,809). Adoption of Statements of Financial Accounting Standards In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 is effective for all fiscal quarters for all fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in an asset's, liability's, or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current period earnings. Management has not evaluated the effects of this change on the Company's financial statements. IMS HEALTH INCORPORATED PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: 10 Material Contracts: .1 Distribution Agreement between Cognizant and IMS Health Incorporated dated as of June 30, 1998. .2 Tax Allocation Agreement between Cognizant and IMS Health Incorporated dated as of June 30, 1998. .3 Employee Benefits Agreement between Cognizant Corporation and IMS Health Incorporated dated as of June 30, 1998. .4 Amended and Restated Transition Services Agreement between The Dun & Bradstreet Corporation, The New Dun & Bradstreet Corporation, Cognizant Corporation, IMS Health Incorporated, ACNielsen Corporation and Gartner Group, Inc. dated as of June 30, 1998. .5 Undertaking of IMS Health Incorporated dated as of June 29, 1998. .6 Distribution Agreement among Cognizant Corporation, The Dun & Bradstreet Corporation and ACNielsen Corporation dated as of October 28, 1996 (incorporated by reference to Exhibit 10.1 to Cognizant's Annual Report on Form 10-K for the year ended December 31, 1996, filed March 27, 1997, file number 001-12275). .7 Tax Allocation Agreement among Cognizant Corporation, The Dun & Bradstreet Corporation and ACNielsen Corporation dated as of October 28, 1996 (incorporated by reference to Exhibit 10.2 to Cognizant's Annual Report on Form 10-K for the year ended December 31, 1996, filed March 27, 1997, file number 001-12275). .8 Employee Benefits Agreement among Cognizant Corporation, The Dun & Bradstreet Corporation and ACNielsen Corporation dated as of October 28, 1996 (incorporated by reference to Exhibit 10.3 to Cognizant's Annual Report on Form 10-K for the year ended December 31, 1996, filed March 27, 1997, file number 001-12275). .9 Indemnity and Joint Defense Agreement among Cognizant Corporation, The Dun & Bradstreet Corporation and ACNielsen Corporation dated as of October 28, 1996 (incorporated by reference to Exhibit 10.4 to Cognizant's Annual Report on Form 10-K for the year ended December 31, 1996, filed March 27, 1997, file number 001-12275). .10 TAM Master Agreement between Cognizant Corporation and ACNielsen Corporation dated as of October 28, 1996 (incorporated by reference to Exhibit 10.5 to Cognizant's Annual Report on Form 10-K for the year ended December 31, 1996, filed March 27, 1997, file number 001-12275). 27 Financial Data Schedules. (b) Reports on 8-K: A report on Form 8-K was filed on June 30, 1998 to report under Item 5, Other Events, pursuant to Accounting Principles Board ("APB") No. 30, "Reporting the Results of Operations--Reporting the effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions; and Item 7, Financial Statements to present the consolidated financial statements and associated notes of the Company to reflect Nielsen Media as a discontinued operation. A report on Form 8-K/A was filed on June 30, 1998 to report under Item 5, Other Events, and Item 7, Financial Statements A report on Form 8-K/A-1 was filed on July 23, 1998 to report under Item 5, Other Events, and Item 7, Financial Statements A report on Form 8-K/A-2 was filed on July 23, 1998 to report under Item 5, Other Events, and Item 7, Financial Statements SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. IMS Health Incorporated By: /s/ J. MICHAL CONAWAY ---------------------------------------------------------------- J. Michal Conaway Chief Financial Officer By: /s/ JAMES C. MALONE ---------------------------------------------------------------- James C. Malone Senior Vice President - Finance & Controller Date: February 24, 1999