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, 1997
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 OCTOBER 31, 1997:
16,566,904
CLASS:
COMMON STOCK, NO PAR VALUE PER SHARE
1
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ENVOY CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $ 3,625 $ 36,430
ACCOUNTS RECEIVABLE - NET 24,503 20,435
INVENTORIES 1,895 2,586
DEFERRED INCOME TAXES 971 1,018
OTHER 1,189 2,947
------------- ------------
TOTAL CURRENT ASSETS 32,183 63,416
PROPERTY AND EQUIPMENT, NET 17,472 15,353
OTHER ASSETS 77,354 55,045
------------- ------------
TOTAL ASSETS $ 127,009 $ 133,814
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER
CURRENT LIABILITIES $ 21,254 $ 14,899
CURRENT PORTION OF LONG-TERM DEBT 0 93
------------- ------------
TOTAL CURRENT LIABILITIES 21,254 14,992
LONG-TERM DEBT, LESS CURRENT PORTION 99 8,412
DEFERRED INCOME TAXES 736 1,965
OTHER NON-CURRENT LIABILITIES 10,056 0
SHAREHOLDERS' EQUITY:
PREFERRED STOCK - No par value; authorized,
12,000,000 shares; issued 3,730,233 40,100 40,100
COMMON STOCK - No par value; authorized, 48,000,000 shares;
issued, 16,564,137 and 11,289,421 in 1997 and 1996, respectively 113,225 103,199
ADDITIONAL PAID-IN CAPITAL 7,155 7,155
RETAINED DEFICIT (65,616) (42,009)
------------- ------------
TOTAL SHAREHOLDERS' EQUITY 94,864 108,445
------------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 127,009 $ 133,814
============= ============
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
2
<PAGE>
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES $ 28,590 $ 21,502 $ 81,098 $ 51,422
OPERATING COSTS AND EXPENSES:
COST OF REVENUES 13,811 10,773 39,609 25,824
SELLING, GENERAL AND ADMINISTRATIVE 5,440 5,124 17,254 13,027
DEPRECIATION AND AMORTIZATION 6,623 5,538 18,806 12,908
MERGER AND FACILITY INTEGRATION COSTS 0 1,398 0 3,564
WRITE OFF OF ACQUIRED IN-PROCESS
TECHNOLOGY 35,000 0 38,000 30,700
EMC LOSSES 0 0 0 540
--------- --------- --------- ---------
OPERATING LOSS (32,284) (1,331) (32,571) (35,141)
OTHER INCOME (EXPENSE)
INTEREST INCOME 282 353 1,219 520
INTEREST EXPENSE (417) (706) (905) (2,340)
--------- --------- --------- ---------
(135) (353) 314 (1,820)
--------- --------- --------- ---------
LOSS BEFORE INCOME TAXES (32,419) (1,684) (32,257) (36,961)
INCOME TAX PROVISION (BENEFIT) (11,209) 279 (8,649) 329
--------- --------- --------- ---------
NET LOSS $(21,210) $ (1,963) $(23,608) $(37,290)
========= ========= ========= =========
NET LOSS PER COMMON SHARE $ (1.28) $ (0.14) $ (1.47) $ (3.04)
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING 16,514 13,704 16,056 12,285
========= ========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
3
<PAGE>
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
1997 1996
--------------- --------------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 15,311 $ 34
INVESTING ACTIVITIES:
NET DECREASE IN SHORT-TERM INVESTMENTS 0 7,842
PURCHASES OF PROPERTY AND EQUIPMENT (6,138) (3,240)
(INCREASE) DECREASE IN OTHER ASSETS (3,280) 280
PAYMENTS FOR BUSINESSES ACQUIRED, NET
OF $4,784 CASH ACQUIRED IN 1996 AND
INCLUDING OTHER CASH PAYMENTS
ASSOCIATED WITH THE ACQUISITIONS (40,412) (85,294)
--------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (49,830) (80,412)
FINANCING ACTIVITIES:
PROCEEDS FROM ISSUANCE OF PREFERRED
STOCK 0 38,000
PROCEEDS FROM ISSUANCE OF COMMON
STOCK 1,813 88,354
PROCEEDS FROM LONG-TERM DEBT 0 43,900
PAYMENTS ON LONG-TERM DEBT (99) (43,994)
PAYMENT OF DEFERRED FINANCING COSTS 0 (1,200)
--------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,714 125,060
--------------- --------------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (32,810) 44,682
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD 36,430 222
--------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,625 $ 44,904
=============== ==============
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
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- and nine-month periods ended September 30, 1997 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1997.
These financial statements, footnote disclosures and other information
should be read in conjunction with the audited financial statements and the
accompanying notes thereto in the Company's Annual Report on Form 10-K for the
year ended December 31, 1996.
Certain reclassifications have been made in the 1996 financial statements
to conform to the classifications in 1997.
B. NET LOSS PER COMMON SHARE
Net loss per common share has been computed by dividing net loss by the
weighted average common shares outstanding.
C. RECENT ACQUISITIONS
Each of the following acquisitions was accounted for under the purchase
method of accounting, applying the provisions of APB Opinion No. 16 ("APB 16")
and, as a result, the Company recorded the assets and liabilities of the
acquired companies at their estimated fair values with the excess of the
purchase price over these amounts being recorded as goodwill. Actual allocations
of goodwill and identifiable intangibles will be based upon further studies and
may change during the allocation period, generally one year following the date
of acquisition. The financial statements for the three- and nine-month periods
ended September 30, 1997 and 1996 reflect the operations of the acquired
businesses for the periods after their respective dates of acquisition.
NATIONAL ELECTRONIC INFORMATION CORPORATION ("NEIC")
On March 6, 1996, the Company's shareholders approved the acquisition of
NEIC for an aggregate purchase price of approximately $94,301,000, consisting of
$88,354,000 paid to the NEIC stockholders and certain other transaction and
acquisition costs of $5,947,000. The Company recorded $37,631,000 in goodwill
and $19,600,000 of identifiable intangible assets related to the NEIC
acquisition. In connection with the NEIC acquisition, the Company incurred a one
time write-off of acquired in-process technology of $30,000,000. Such amount was
charged to expense in the three months ended March 31, 1996, because this amount
relates to research and development that had not reached technological
feasibility and for which there was no alternative future use.
5
<PAGE>
TELECLAIMS, INC. ("TELECLAIMS")
On March 1, 1996, the Company acquired all the issued and outstanding
capital stock of Teleclaims in exchange for 73,242 shares of the Company's
Common Stock yielding a purchase price of approximately $1,500,000. Goodwill and
identifiable intangibles in the amount of $648,000 were recorded in connection
with the acquisition of Teleclaims. Also recorded as part of the Teleclaims
acquisition was a one time write-off of acquired in-process technology of
$700,000. Such amount was charged to expense in the three months ended March 31,
1996, because this amount related to research and development that had not
reached technological feasibility and for which there was no alternative future
use.
NATIONAL VERIFICATION SYSTEMS, L. P. ("NVS")
On September 13, 1996, the Company completed the acquisition of NVS for
$2,150,000 in cash and the assumption of certain liabilities. Goodwill and other
identifiable intangible assets in the amount of $1,864,000 were recorded in
connection with the NVS acquisition.
PROFESSIONAL OFFICE SYSTEMS, INC. ("POSI")
On October 31, 1996, the Company acquired all the issued and outstanding
capital stock of POSI, the electronic data interchange clearinghouse for Blue
Cross and Blue Shield of the National Capital Area, for approximately $6,400,000
in cash and the assumption of certain liabilities. Based upon management's
preliminary estimates, goodwill and identifiable intangibles in the amount of
$6,742,000 were recorded in connection with the POSI acquisition.
DIVERSE SOFTWARE SOLUTIONS, INC. ("DSS")
On March 11, 1997, the Company completed the acquisition of certain assets
of DSS for $4,000,000 in cash, plus a contingent payout based upon the
attainment of certain revenue thresholds in future operating periods, and the
assumption of certain liabilities. The Company preliminarily recorded $3,000,000
for such contingent payment. Based on management's preliminary estimates, the
Company recorded $5,064,000 of goodwill and other identifiable intangible assets
related to the DSS acquisition. Also recorded as part of the DSS acquisition was
a one-time write-off of acquired in-process technology of $3,000,000. Such
amount was charged to expense in the three months ended March 31, 1997, because
this amount related to research and development that had not reached
technological feasibility and for which there was no alternative future use.
HEALTHCARE DATA INTERCHANGE CORPORATION ("HDIC")
On August 7, 1997, the Company acquired all the issued and outstanding
capital stock of HDIC, the electronic data interchange ("EDI") health care
services subsidiary of Aetna U.S. Healthcare, Inc. ("AUSHC"), for approximately
$36,412,000 million in cash and the assumption of certain liabilities of
approximately $14,800,000, including approximately $13,800,000 million relating
to the assumption of unfavorable contracts of which $10,056,000 is classified as
a long-term liability and the remaining $3,744,000 is classified as a current
liability. In addition, the Company and AUSHC simultaneously entered into a
long-term services agreement under which AUSHC has agreed to use the Company as
its single source clearinghouse and EDI network for all AUSHC electronic health
care transactions. Based upon management's preliminary estimates, the Company
recorded approximately $16,112,000 of goodwill and other identifiable intangible
assets related to the HDIC acquisition. Also recorded as part of the HDIC
acquisition was a one-time write-off of acquired in-process technology of
$35,000,000. Such amount was charged to expense in the three months ended
September 30, 1997, because this amount related to research and development that
had not reached technological feasibility and for which there was no alternative
future use.
6
<PAGE>
The following presents unaudited pro forma results of operations (excluding
all one-time write-offs of acquired in-process technology and merger and
facility integration costs) for the nine-month period ended September 30, 1997
and 1996 assuming all acquisitions, including EMC*Express, Inc. ("EMC") (See
Note F), had been consummated at the beginning of the periods presented:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1997 1996
------------ ------------
(in thousands,
except per share data)
<S> <C> <C>
Revenues $ 86,244 $ 73,151
Net loss $ (1,884) $ (10,856)
Net loss per common share $ ( 0.12) $ (0.94)
</TABLE>
D. SALE OF THE GOVERNMENT SERVICES BUSINESS
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 Company recorded a gain of $500,000 related to
the sale of the Government Services Business in the third quarter of 1997. The
results of operations of the Government Services Business are included in the
Company's Consolidated Statement of Operations through the date of disposition.
E. MERGER AND FACILITY INTEGRATION COSTS
As a result of the acquisitions of NEIC and Teleclaims in March 1996, the
Company approved a plan that reorganized certain of its operations, personnel
and facilities to gain the effects of potential cost savings and operating
synergies. The cost of this plan to integrate the acquired companies are
recognized as incurred in accordance with the guidance set forth in Emerging
Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" and was not part of the purchase price
allocation. The costs for the three- and nine-month periods ended September 30,
1996 associated with this plan of $1,398,000 and $3,564,000 respectively,
represented exit costs associated with lease terminations, personnel costs,
write downs of impaired assets and other related costs that were incurred as a
direct result of the plan and were classified as merger and facility integration
costs in the statement of operations. The employee groups terminated included
accounting, marketing and certain areas of the systems and operations
departments. The number of employees terminated was approximately 120.
Adjustments made to the liability as of September 30, 1997 and 1996 were
approximately $1,816,000 and $731,000, respectively.
F. EMC LOSSES
On January 28, 1995, the Company purchased 17.5% of the capital stock of
EMC for approximately $570,000. In connection therewith, the Company paid
$250,000 for an option to purchase the remainder of the capital stock of EMC
(the "Option"), and also entered into a management agreement to provide
management services to EMC (the "Management Agreement"). Under the terms of the
Management Agreement, the Company agreed to fund certain operating costs of EMC
in the form of advances. The
7
<PAGE>
Management Agreement could be terminated by the Company at any time on 60
days written notice, at which time the Option would be terminated. The Company
gave notice to terminate the Management Agreement on January 31, 1996. As a
result of the termination notice and other facts and circumstances, the Company
determined that it was probable an impairment to its investment had occurred.
Based on the Company's decision to terminate the Management Agreement, the
Company discontinued the equity method of accounting for EMC and began
accounting for the investment on a cost basis. Accordingly, the funding of EMC's
operating costs in 1996 were charged to operating expense. The Company was
committed through March 31, 1996 to continue to fund certain operating costs of
EMC. The amount disbursed for the funding of these costs during the three- and
nine-month periods ended September 30, 1996 was $0 and $540,000, respectively.
Following the termination of the Management Agreement and the Option,
certain shareholders of EMC filed a lawsuit in March 1996 against the Company
asserting claims for breach of contract and negligent conduct. On October 18,
1996, the Company settled this lawsuit for $300,000. Concurrent with the
settlement of the lawsuit, the Company completed the acquisition of the
remaining 82.5% interest in EMC for approximately $2,000,000 in cash. The EMC
acquisition was accounted for under the purchase method of accounting applying
the provisions of APB No. 16 and, as a result, the Company recorded the assets
and liabilities at their estimated fair values. Based on management's
preliminary estimates, the Company recorded $1,954,000 of other identifiable
intangible assets related to the EMC acquisition. EMC's results of operations
are included in the Company's consolidated statement of operations from the date
of acquisition.
G. TRANSACTION WITH FIRST DATA CORPORATION
On June 6, 1995, the Company completed a merger of its financial
transaction processing business with First Data Corporation (the "First Data
Merger"). Pursuant to a management services agreement entered into in connection
with the First Data Merger, the Company was entitled to receive a fee from First
Data Corporation ("First Data") of $1,500,000 per annum, payable in quarterly
installments of $375,000, during the first two years following the First Data
Merger. Management fees for the three-month periods ended September 30, 1997 and
1996 were $0 and $375,000, respectively, and $650,000 and $1,125,000 for the
nine-month periods ended September 30, 1997 and 1996, respectively. These fees
are classified in revenues in the consolidated statements of operations. First
Data's obligation to pay management fees to the Company pursuant to the
management services agreement ended during the quarter ended June 30, 1997.
H. 9% SUBORDINATED CONVERTIBLE NOTES
In June 1995, the Company issued $10 million in 9% Subordinated Convertible
Notes due in May 2000 (the "Convertible Notes"). The Convertible Notes were
convertible at the election of the holders into shares of Common Stock at a
conversion price of $10.52 per share. On November 7, 1996, the Company filed a
registration statement with the Securities and Exchange Commission covering the
offering of 321,289 shares of Common Stock. The registration statement was filed
pursuant to the demand of the then current holders of the Convertible Notes
under a Registration Rights Agreement dated June 6, 1995. The Company was
advised by the holders of the Convertible Notes that they intended to convert
$3,380,000 principal amount of the Convertible Notes into 321,289 shares of
Common Stock to permit their sale pursuant to the registration statement. Prior
to the termination of the registration statement on May 19, 1997, an aggregate
of $2,286,000 in principal amount of the Convertible Notes was converted into
217,317 shares of Common Stock and sold pursuant to the registration statement.
In a series of unrelated transactions, the remaining $7,714,000 in principal
amount of the Convertible Notes had been converted into 733,239 shares of Common
Stock as of June 9, 1997. Accordingly, no Convertible Notes remain outstanding.
8
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I. CHANGE IN ACCOUNTING PRINCIPLE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Statement
No. 128 is not expected to have any impact on the Company's computation of
primary earnings per share; however, the Company does expect to have to include
a computation of diluted earnings per share in future periods for the effect of
dilutive securities.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurances
that the forward-looking statements included herein will prove to be
accurate. There are many factors that may cause actual results to differ
materially from those indicated by the forward-looking statements,
including, among others, competitive pressures, changes in pricing
policies, delays in product development, business conditions in the
marketplace, general economic conditions and the various risk factors set
forth in the Company's periodic reports filed with the Securities and
Exchange Commission. In light of the significant uncertainties inherent in
the forward-looking statements included herein, the inclusion of such
information should not be regarded as a representation by the Company that
the objectives and plans of the Company will be achieved. The following
discussion and analysis should be read in conjunction with, and is
qualified in its entirety by, the Unaudited Consolidated Financial
Statements, including the notes thereto.
OVERVIEW
ENVOY Corporation (the "Company") is a leading provider of electronic data
interchange 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.
The Company was incorporated in Tennessee in August 1994 as a wholly-owned
subsidiary of ENVOY Corporation, a Delaware corporation which was formed in 1981
(the "Predecessor"). The Predecessor was formed to develop and market electronic
transaction processing services for the financial services and health care
markets. In June 1995, in order to facilitate the transfer of the financial
services business to First Data Corporation ("First Data"), the assets and
liabilities of the Predecessor associated with the health care business were
transferred to the Company. The capital stock of the Company then was
distributed to shareholders through a stock dividend (the "Distribution") and
the Predecessor was merged into First Data.
Since the beginning of 1996, the Company has made several acquisitions, the
most significant being the acquisitions of National Electronic Information
Corporation ("NEIC") and Healthcare Data Interchange Corporation ("HDIC")
(collectively, the "Acquired Businesses"). See Notes C and F of Notes to the
Unaudited Consolidated Financial Statements. All acquisitions were accounted for
under the purchase method of accounting and, as a result, the Company has
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. The financial statements for the three- and
nine-month periods ended September 30, 1997 and 1996 reflect the operations of
the Acquired Businesses for the periods after their respective dates of
acquisition.
Revenues principally are derived from 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
and are generally based upon the number of transactions processed rather than
the transaction volume per customer. In addition, total revenues include
non-transaction based revenues derived from some of the Acquired Businesses.
This revenue includes maintenance, licensing and support activities, as well as
the sale of ancillary software and hardware products.
10
<PAGE>
The Company's revenues are composed of two basic transaction types (i)
pharmacy and (ii) medical and other. The table below shows the number of
transactions processed by the Company for the periods presented:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- ----------------------------
1997 1996 1997 1996
---- ---- ---- ----
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Pharmacy 145,045 119,709 431,547 339,063
Medical and Other 55,425 39,324 150,952 89,046
------- ------- ------- -------
Total 200,470 159,033 582,499 428,109
======= ======= ======= =======
</TABLE>
The transactions reflected above include the transactions of the Acquired
Businesses from the date of acquisition.
While pharmacy currently represents a majority of the Company's total
transactions, the fee associated with these transactions is significantly less
than that received for a medical transaction and as such pharmacy revenue at the
end of the third quarter constituted less than 25% of the Company's total
revenues. The rate of growth of the Company's pharmacy business has slowed
during the past several quarters. For the third quarter the pharmacy business
grew at approximately half the rate experienced in the Company's medical and
other business. As a result of this trend, the Company expects its pharmacy
business as presently conducted to represent a decreasing portion of the
Company's total revenues for the next several quarters. As the mix of the
Company's business changes, a decline in the growth rates associated with the
Company's medical business could have a material impact 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 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.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1997 As Compared With Three Months Ended
September 30, 1996
Revenues. Revenues for the quarter ended September 30, 1997 were $28.6
million compared to $21.5 million for the same period last year, an increase of
$7.1 million. The majority of the increase is attributable to internal
transaction revenue growth over the same quarter last year. An increase in non-
transaction based sources of revenue, such as software licenses, maintenance and
support activities, from certain of the Acquired Businesses also contributed to
the increase.
Cost of Revenues. Cost of revenues includes the cost of communications,
computer operations, product development and customer support, as well as the
cost of hardware sales and rebates to third parties for transaction processing
volume. Cost of revenues in the third quarter of 1997 were $13.8 million
compared to $10.8 million for the third quarter of 1996, an increase of $3.0
million or 28%. The dollar increase is attributable to the additional costs
associated with the increased transaction volume and increases in rebates
11
<PAGE>
paid to third parties. The increase in rebates paid to third parties
primarily results from an increase in the mix of claims received from large
third party vendors and claim clearing houses. Therefore, if mix shifts continue
toward larger vendors and clearing houses, the Company expects rebates to
represent an increasing portion of its costs of sales. As a percentage of
revenues, cost of revenues improved to 48.3% in the third quarter of 1997
compared to 50.1% in the third quarter of 1996.
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, 1997 were $5.4 million compared to $5.1 million in
the same period in 1996, an increase of 5.9%. As a percentage of revenues,
selling, general and administrative expenses were 19.0% for the third quarter of
1997 compared to 23.8% for the third quarter of 1996. The improvement is
attributable to a larger base of revenues, the elimination of certain
duplicative costs realized in connection with the Acquired Businesses and a
one-time gain of $500,000 recognized in the third quarter of 1997 in connection
with the sale of the Government Service Business. See Note D to the Unaudited
Consolidated Financial Statements. Excluding the one-time gain, selling, general
and administrative expenses as a percentage of revenues for the third quarter of
1997 would have been 20.8%.
Depreciation and Amortization. Depreciation and amortization expense
relates primarily to host computers, communications equipment, goodwill and
other identifiable intangible assets. Depreciation and amortization expense for
the third quarter of 1997 was $6.6 million compared to $5.5 million for the
comparable period in 1996. The increase is primarily the result of the
amortization of $5.2 million in goodwill and other intangibles related to the
Acquired Businesses in the third quarter of 1997, including approximately
$315,000 relating to the HDIC acquisition, compared with $4.3 million in the
third quarter of 1996. Depreciation and amortization increased further as the
result of the additional investment in host computer systems and software to
expand the Company's transaction processing capabilities. At September 30, 1997,
the Company had goodwill of $36.2 million associated with the Acquired
Businesses, including $13.9 million relating to the HDIC acquisition, remaining
to be amortized over periods of three to fifteen years following the
acquisitions. In addition, the Company had identified intangibles of $24.3
million, including $1.9 million relating to the HDIC acquisition over two to
nine year time periods, as applicable.
Merger and Facility Integration Costs. The Company recognized merger and
facility integration costs in the third quarter of 1996 of $1.4 million related
primarily to the NEIC acquisition. These charges represent costs incurred as a
direct result of the plan to integrate NEIC and Teleclaims, Inc. ("Teleclaims").
See Note E of Notes to the Unaudited Consolidated Financial Statements. The
Company estimates that no future costs will be charged to merger and facility
integration costs related to NEIC and Teleclaims.
Write-off of Acquired in Process Technology. The Company incurred a
one-time write-off of acquired in-process technology of $35.0 million in
connection with the HDIC acquisition. Such amount was charged to expense in the
quarter ended September 30, 1997 because this amount related to research and
development that had not reached technological feasibility and for which there
was no alternative future use.
Net Interest Income (Expense). The Company recorded net interest expense of
$135,000 for the three months ended September 30, 1997 compared to net interest
expense of $353,000 for the third quarter of 1996. Net interest expense in the
third quarter of 1997 resulted from the imputed interest expense related to
certain unfavorable contracts assumed as part of the HDIC acquisition. See Note
C of Notes to the Unaudited Consolidated Financial Statements. Net interest
expense in the third quarter of 1996 resulted from interest on outstanding
borrowings under the Company's credit facilities and the Company's $10.0 million
in 9% convertible subordinated notes issued in June 1995 (the "Convertible
Notes"). The borrowings, which consisted of a $25 million term loan and
approximately $12.9 million outstanding under the Company's revolving credit
facility, were repaid in the third quarter of 1996 with a portion of the
proceeds from the Company's August 1996 public offering of 3,320,000 shares of
Common Stock. In a
12
<PAGE>
series of transactions, the Convertible Notes were converted into an
aggregate of 950,556 shares of the Company's Common Stock as of June 9, 1997.
Accordingly, no Convertible Notes remain outstanding.
Income Tax Provision (Benefit). The Company's income tax benefit for the
third quarter of 1997 was $11.2 million compared to a tax provision of $279,000
in the comparable period in 1996. The tax benefit recorded in the third quarter
of 1997 reflects a deferred income tax benefit of $13.3 million associated with
the $35.0 million charge for the write-off of acquired in process technology
related to the HDIC acquisition. The income tax expense recorded is based upon
estimated taxable income. Amortization of certain goodwill and identifiable
intangibles are not deductible for income tax purposes.
Nine Months Ended September 30, 1997 As Compared With Nine Months Ended
September 30, 1996
Revenues. Revenues for the nine-month period ended September 30, 1997 were
$81.1 million compared to $51.4 million for the same period in the prior year,
an increase of $29.7 million or 57.8%. The increase is attributable to internal
transaction revenue growth, an increase in non-transaction based sources of
revenue, such as maintenance and support activities, from the Acquired
Businesses and additional revenues generated from the Acquired Businesses.
Cost of Revenues. Cost of revenues for the nine-month period ended
September 30, 1997 was $39.6 million compared to $25.8 million for the
nine-month period ended September 30, 1996. This increase of $13.8 million, or
53.5%, is attributable to additional costs associated with increased transaction
volume in the Company's business, the inclusion of the Acquired Businesses and
increases in rebates paid to third parties. As previously stated, the increase
in rebates paid to third parties primarily results from an increase in the mix
of claims received from large third party vendors and claim clearing houses.
Therefore, if mix shifts continue toward larger vendors and clearing houses, the
Company expects rebates to represent an increasing portion of its cost of sales.
As a percentage of revenues, cost of revenues improved to 48.8% for the
nine-month period ended September 30, 1997 compared to 50.2% in the same period
last year.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the nine- month period ended September 30, 1997 were
$17.3 million compared with $13.0 million for the same period last year, an
increase of $4.3 million or 33.0%. The dollar increase is a result of the
inclusion of the Acquired Businesses and the required infrastructure to support
the larger base of revenues. As a percentage of revenues, selling, general and
administrative expenses were 21.3% for the nine-month period ended September 30,
1997 compared with 25.3% in the same period last year. The improvement as a
percentage of revenues is a result of a larger revenue base to support these
expenses, the elimination of certain duplicative costs realized in connection
with the Acquired Businesses and the one-time $500,000 gain associated with the
sale of the Government Services Business. See Note D to the Unaudited
Consolidated Financial Statements. Excluding the one-time gain, selling, general
and administrative expenses as a percentage of revenues for the nine months
ended September 30, 1997 would have been 21.9%.
Depreciation and Amortization. Depreciation and amortization expense for
the nine-month period ended September 30, 1997 was $18.8 million compared to
$12.9 million for the comparable period last year. The increase is primarily the
result of the amortization of goodwill and other intangibles related to the
Acquired Businesses of $14.6 million in 1997, including $315,000 recognized
during the third quarter of 1997 in connection with the HDIC acquisition,
compared with $9.6 million for the comparable period in 1996.
Merger and Facility Integration Costs. The Company recognized merger and
facility integration costs in the nine-month period ended September 30, 1996 of
$3.6 million related primarily to the NEIC acquisition. These charges represent
costs incurred as a direct result of the plan to integrate NEIC and Teleclaims.
See Note E of Notes to the Unaudited Consolidated Financial Statements. The
Company
13
<PAGE>
estimates that no future costs will be charged to merger and facility
integration costs related to NEIC and Teleclaims.
Write off of Acquired In Process Technology. The Company incurred a one
time write-off of acquired in process technology in connection with the
acquisition of certain of the Acquired Businesses. See Note C of Notes to the
Unaudited Consolidated Financial Statements. The Company recognized charges of
$38.0 million for the nine months ended September 30, 1997, related to the
write-off of certain acquired research and development in connection with the
March 1997 acquisition of certain assets of Diverse Software Solutions, Inc.,
and the August 1997 acquisition of HDIC. For the comparable period in 1996, the
Company recognized similar charges of $30.7 million related to the NEIC and
Teleclaims acquisitions.
EMC Losses. In January 1995, the Company acquired a 17.5% interest in
EMC*Express, Inc. ("EMC") and also entered into an agreement for the management
of EMC which required the Company to fund certain of EMC's operating costs in
the form of advances. The Company determined that it was probable an impairment
of its equity investment in EMC as of December 31, 1995 had occurred. As a
result, the Company recognized losses for the nine-month period ended September
30, 1996 of $540,000 relating to the funding of EMC operating losses through the
termination date of the management agreement in March 1996. Based upon the
Company's decision to terminate the management agreement, the Company
discontinued the equity method of accounting for EMC and began accounting for
the investment on a cost basis. Accordingly, the loss related to EMC has been
charged to operating expense. Following the termination of the management
agreement, certain shareholders of EMC filed a lawsuit against the Company
asserting claims for breach of contract and negligent conduct. In October 1996,
the Company acquired the remaining 82.5% interest in EMC and settled the related
lawsuit. See Note F of Notes to the Unaudited Consolidated Financial Statements.
EMC's results of operations are included in the Company's Consolidated Statement
of Operations from the date of acquisition.
Net Interest Income (Expense). The Company recorded net interest income of
$314,000 for the nine-month period ended September 30, 1997 compared to net
interest expense of $1.8 million in the comparable period in 1996. Net interest
income for the first nine months of 1997 resulted primarily from the elimination
of borrowings under the Convertible Notes. The Company incurred additional
interest expense in the first nine months of 1997 resulting from imputed
interest expense related to certain unfavorable contracts assumed as part of the
HDIC acquisition. See Note C of Notes to the Unaudited Consolidated Financial
Statements. However, the interest earned on the Company's cash and cash
equivalents during the nine month period ended September 30, 1997 more than
offset the interest expense for the period. The net interest expense of $1.8
million for the nine months ended September 30, 1996 was the result of
borrowings to finance the purchase of the Acquired Businesses under the
Company's credit facilities, as well as interest associated with the Convertible
Notes.
Income Tax Provision(Benefit). The Company's income tax benefit for the
nine-month period ended September 30, 1997 was $8.6 million compared to income
tax expense of $329,000 in the comparable period in 1996. The 1997 tax benefit
reflects a deferred income tax benefit of $13.3 million associated with the
$35.0 million charge for the write-off of acquired in process technology related
to the HDIC acquisition. The income tax expense recorded for the comparable 1996
period is based upon estimated taxable income. Amortization of certain goodwill
and identifiable intangibles are not deductible for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally has incurred operating losses since its health care
transaction processing business commenced operations in 1989. The operating
losses historically resulted from the Company's substantial investment in its
health care transaction processing business coupled with a disproportionate
amount of overhead and fixed costs, and, more recently, from charges to merger
and facility integration costs and
14
<PAGE>
write off of acquired in process technology related to the Acquired
Businesses. Prior to the sale of the financial processing business in 1995,
health care losses had been funded by earnings from the Company's more mature
financial business, which had a substantially higher transaction volume and
revenue base.
On August 7, 1997, the Company completed the acquisition of HDIC for
approximately $36.4 million. The HDIC acquisition was financed through the
Company's available cash. See Note C of Notes to the Unaudited Consolidated
Financial Statements. Following the HDIC acquisition and as of September 30,
1997, the Company had available cash and cash equivalents of approximately $3.6
million.
The Company currently has no amounts outstanding under the Company's $50
million revolving credit facility. Any outstanding borrowings made against 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. The total amount outstanding
under the credit facility is 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,
acquisitions, incurrence of debt and other restrictive provisions. The credit
facility is secured by substantially all of the assets of the Company and its
subsidiaries.
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 $2.4 million and $6.1 million for the quarter
and the nine-month period ended September 30, 1997, respectively, primarily for
computer hardware and software products. The Company currently estimates that
total capital expenditures for 1997 will be approximately $8 to $9 million.
From time to time, the Company has engaged and will continue to engage in
acquisition discussions with other health care information businesses and other
companies 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
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 million revolving credit facility will
provide the capital resources necessary to meet its liquidity and cash flow
requirements over the next twelve months, including the Company's current
short-term obligations. The Company believes that present funding sources will
provide the ability to meet long-term obligations as they mature. The Company's
available cash is invested in interest bearing securities with maturities of up
to 30 days.
CHANGE IN ACCOUNTING PRINCIPLE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Statement
No. 128 is not expected to have any impact on the Company's computation of
primary earnings per share; however, the Company does expect to include a
computation of diluted earnings per share in future periods for the effect of
dilutive securities.
15
<PAGE>
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 arise in those months, while operating expenses tend to
remain relatively constant over the course of the year.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, the Company 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
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on August 22, 1997 pursuant
to Item 2 thereof with the Securities and Exchange Commission to announce the
completion of the HDIC acquisition. The Company also filed a Current Report on
Form 8-K/A pursuant to Item 7(b) thereof on October 20, 1997 to amend the
original Form 8-K filed on August 22, 1997 for the purpose of including certain
pro forma financial information relating to the HDIC acquisition, which was
omitted in the Form 8-K originally filed.
16
<PAGE>
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 13, 1997 By: /s/ Fred C. Goad, Jr.
------------------------------------
Fred C. Goad, Jr.
Chairman and Co-Chief
Executive Officer
Date: November 13, 1997 By: /s/ Kevin M. McNamara
------------------------------------
Kevin M. McNamara
Senior Vice President and
Chief Financial Officer
17
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