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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): February 17, 1999 (December
31, 1998)
ENVOY CORPORATION
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(Exact name of registrant as specified in its charter)
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<S> <C> <C>
Tennessee 0-25062 62-1575729
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(State or other jurisdiction of incorporation) (Commission File Number) (I.R.S. Employer
Identification No.)
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15 Century Boulevard, Suite 600, Nashville, TN 37214
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 885-3700
Not Applicable
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(Former name or former address, if changed since last report)
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Item 5. Other Events
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This Current Report on Form 8-K is being filed to provide the
historical financial statements of ENVOY Corporation, a Tennessee corporation
("ENVOY" or the "Company"), as of the year ended December 31, 1998. In addition,
the Company has included Selected Financial Data (pursuant to Item 301 of
Regulation S-K) and Management's Discussion and Analysis of Financial Condition
and Results of Operations for (i) the year ended December 31, 1998 compared to
the year ended December 31, 1997 and (ii) the year ended December 31, 1997
compared to the year ended December 31, 1996 (pursuant to Item 303 of Regulation
S-K).
Item 7(c). Exhibits
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The following exhibits are included as part of this Current Report on
Form 8-K in connection with the filing of the Company's financial statements:
23.1 Consent of Ernst & Young LLP
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule (for SEC use only)
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SELECTED FINANCIAL DATA
(In thousands, except per share date)
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YEAR ENDED DECEMBER 31,
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1998 1997(1) 1996(2) 1995(3) 1994(3)
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(In thousands, except per share data)
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STATEMENTS OF OPERATIONS DATA:(4)
Revenues ............................... $ 184,773 $ 137,605 $ 90,572 $ 34,197 $26,114
Operating Income (Loss) ................ 23,246 (2,600) (18,739) (117) 491
Income (Loss) from Operations Before
Income Taxes and Loss in Investee .... 22,725 (2,865) (20,579) (396) 520
Income Tax (Expense) Benefit ........... (18,481) (6,333) (1,717) 50 61
Loss in Investee ....................... -- -- -- (1,776) --
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Income (Loss) from Continuing
Operations ........................... $ 4,244 $ (9,198) $ (22,296) $ (2,122) $ 581
========= ========= ========= ======== =======
Net Income (Loss) per Common Share from
Continuing Operations:(5)
Basic ............................ $ 0.20 $ (0.47) $ (2.25) $ (0.14) $ 0.04
========= ========= ========= ======== =======
Diluted .......................... $ 0.17 $ (0.47) $ (2.25) $ (0.14) $ 0.04
========= ========= ========= ======== =======
BALANCE SHEET DATA (AT PERIOD END):(4)
Working Capital of Continuing Operations $ 44,560 $ 18,027 $ 47,541 $ 10,671 $ 7,302
Assets of Continuing Operations ........ 183,519 166,625 156,368 33,949 23,171
Total Assets ........................... 183,519 166,625 156,368 33,949 59,240
Long-Term Debt and Deferred Taxes ...... 7,932 11,269 10,914 10,687 928
Preferred Stock ........................ 41,300 55,021 55,021 -- --
Shareholders' Equity of Continuing ..... 141,896 125,082 124,425 15,300 17,227
Operations
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Notes:
(1) The 1997 results include expenses of $6.6 million for the write-off of
acquired in-process technology associated with the Diverse Software
Solutions, Inc. and Healthcare Data Interchange Corporation acquisitions.
(See Note 4 of Notes to Consolidated Financial Statements.)
(2) The 1996 results include expenses of $8.7 million related to the write-off
of acquired in-process technology and $4.7 million relating to the
reorganization plan approved in conjunction with the National Electronic
Information Corporation and Teleclaims, Inc. acquisitions.
(See Notes 4 and 6 of Notes to Consolidated Financial Statements.)
(3) Amounts reflect the impact of the merger of the Company's predecessor with
First Data Corporation in June 1995. (See Note 1 of Notes to Consolidated
Financial Statements.)
(4) The Company has restated its financial statements to reflect its February
1998 business combinations with XpiData, Inc., Professional Office
Services, Inc. and Automated Revenue Management, Inc. (sometimes
hereinafter referred to collectively as the "ExpressBill Companies").
These combinations have been accounted for as poolings of interests;
therefore, the historical financial statements of the Company for all
periods have been restated to include the accounts and results of
operations of the ExpressBill Companies. (See Note 4 of Notes to
Consolidated Financial Statements.)
(5) Net loss per common share for the year ended December 31, 1996 includes the
effect of the beneficial conversion feature of the Company's Series B
Convertible Preferred Stock, which resulted in the recognition of a
preferred dividend of $14.9 million (See Note 13 of Notes to Consolidated
Financial Statements.)
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with, and is qualified in its entirety by, the Company's consolidated financial
statements, including the notes thereto, included herein.
Except for historical information contained herein, this Current Report
on Form 8-K contains forward-looking statements as defined in Section 21E of the
Securities Exchange Act of 1934. Such forward-looking statements are subject to
various risks and uncertainties that could cause actual results to differ
materially from those projected in the forward- looking statements. These risks
and uncertainties are discussed in more detail in the Company's periodic reports
and other documents filed by the Company with the Securities and Exchange
Commission (the "Commission"), as such may be amended from time to time, and
under the caption entitled "Risk Factors" herein. These forward-looking
statements generally can be identified as such because the content of the
statements will usually contain such words as the Company or management
"believes," "anticipates," "expects," "hopes," and words of similar import.
Similarly, statements that describe the Company's future plans, objectives,
goals or strategies are forward-looking statements.
OVERVIEW
ENVOY is a leading provider of electronic data interchange ("EDI") and
transaction processing services to participants in the health care market,
including pharmacies, physicians, hospitals, dentists, billing services,
commercial insurance companies, managed care organizations, state and federal
government agencies and others.
On February 27, 1998, the Company completed business combinations with
the ExpressBill Companies pursuant to separate agreements and plans of merger
for an aggregate of 3.5 million shares of the Company's Common Stock (the
"Common Stock"). These combinations have been accounted for as poolings of
interests, and the historical financial statements of the Company for all
periods have been restated to include the accounts and results of operations of
the ExpressBill Companies.
The Company also has made several acquisitions since the beginning of
1996, including the acquisitions of National Electronic Information Corporation
("NEIC") and several other businesses in 1996, Healthcare Data Interchange
Corporation ("HDIC") and Diverse Software Solutions, Inc. ("DSS") in 1997, and
Synergy Health Care, Inc. ("Synergy") and Control-O-Fax Corporation
("Control-O-Fax") in 1998 (collectively, the "Acquired Businesses"). These
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 all
periods reflect the operations of the Acquired Businesses for the periods after
their respective dates of acquisition.
On September 16, 1997, the Company completed the sale of substantially
all of the assets related to the Company's hunting and fishing licenses and
electronic benefit transfer business (collectively, "the Government Services
Business") for (i) $500,000 payable in the form of a promissory note due and
payable in full on August 31, 1999 and (ii) certain contingent payment amounts
based upon the achievement of specified future operating results of the
Government Services Business. The results of operations of the Government
Services Business are included in the Company's consolidated statements of
operations through the date of disposition, and includes revenues for 1997 of
approximately $466,000. Accordingly, the sale of the Government Services
Business is not expected to have a material impact on the Company's results of
operations.
The Company's revenues principally have been derived from EDI and
transaction processing services to the health care market which generally are
paid for by the health care providers or third party payors. Revenues generally
are earned on a per transaction basis. In addition, total revenues include
non-transaction based revenues derived from the ExpressBill Companies and some
of the Acquired Businesses. This revenue includes maintenance, licensing and
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support activities, as well as the sale of ancillary software and hardware
products and, in the case of the ExpressBill Companies, certain printing
services.
The Company's revenues generally are comprised of the following types
of EDI and transaction processing services: (i) pharmacy EDI, (ii) medical and
other EDI and (iii) patient statements. The table below shows the number of
transactions processed by the Company for the periods presented (in thousands):
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YEAR ENDED DECEMBER 31,
1998 1997 1996
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Pharmacy EDI 721,154 597,609 478,526
Medical and other EDI 291,703 215,437 132,724
Patient statements 163,731 99,823 54,251
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Total 1,176,588 912,869 665,501
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The transactions reflected above include the transactions of the Acquired
Businesses from the date of acquisition, and include the transactions of the
ExpressBill Companies for all periods.
While pharmacy EDI transactions currently represent a majority of the
Company's total transactions, the fees associated with these transactions are
significantly less on a per transaction basis than those received for medical
EDI and patient statement transactions. As a result, pharmacy EDI revenue
constituted less than 15% of the Company's total revenues in 1998. For 1998, the
pharmacy EDI business grew at a rate of approximately 21%, approximately half of
the rate experienced in the Company's other businesses based on the number of
transactions processed. The Company believes the limited growth in the Company's
pharmacy EDI revenues as compared to the Company's medical EDI and patient
statement revenues primarily is the result of two factors. First, the
acquisitions of the Acquired Businesses have contributed significantly to the
growth of the medical EDI and patient statement business, and the Company has
not made any acquisitions in the pharmacy EDI business. In addition, the Company
believes that growth in the pharmacy EDI business has not been as great as in
the medical EDI and patient statement business because of the deeper market
penetration in the more mature pharmacy EDI business. As a result, the Company
expects its pharmacy EDI business as presently conducted to represent a
decreasing portion of the Company's total revenues in the future. As the mix of
the Company's business changes, a decline in the growth rates associated with
the Company's medical EDI and patient statement business could have a material
adverse effect on the financial condition and operating results of the Company.
There can be no assurance that the mix of the Company's business or growth rates
will continue at their current level.
The Company receives a large number of medical EDI transactions from
practice management system ("PMS") vendors and other claims clearinghouses.
These third parties aggregate medical EDI transactions from health care
providers, but require a clearinghouse (such as ENVOY) with direct connections
to payors in order to complete the processing of the transactions. ENVOY
typically receives revenue from payors on these transactions, and pays rebates
based on volume to exclusive and preferred vendors as an inducement to use ENVOY
as the clearinghouse for these transactions. If the mix of transaction volume
continues to shift to large PMS vendors or claims clearinghouses, the Company's
business may increasingly become dependent on the Company's ability to maintain
or establish successful relationships with such third parties. In that regard,
Medic Computer Systems, a major PMS vendor which currently has an exclusive
processing relationship for batch transactions with the Company through June
1999 and represented approximately 3.5% of the Company's total revenues for
1998, recently announced that it has entered into a transaction processing and
development agreement with one of the Company's competitors. In the event the
Company is not able to maintain or establish relationships with major third
party PMS and claims clearinghouse vendors, including Medic, to induce them to
continue to send transactions to ENVOY, the Company's business, operating
results or financial condition may be adversely affected.
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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.
Recent Development. On December 15, 1998, the Company entered into an
Agreement and Plan of Merger (the "Merger Agreement") with Quintiles
Transnational Corp. ("Quintiles") pursuant to which the Company is anticipated
to merge with and become a wholly-owned subsidiary of Quintiles in a transaction
expected to be accounted for as a pooling of interests (the "Merger"). Under the
terms of the Merger Agreement, each issued and outstanding share of Common Stock
and each issued and outstanding share of Series B Convertible Preferred Stock
(the "Series B Preferred Stock") will be exchanged for 1.166 shares of Quintiles
common stock. In addition, Quintiles will convert any remaining unexercised
ENVOY stock options into Quintiles stock options on the same terms and
conditions, except that the number of shares and exercise price will be
adjusted for the effect of the exchange ratio. In addition, Quintiles will
convert any remaining unexercised ENVOY stock options into Quintiles stock
options on the same terms and conditions, except that the number of shares and
exercise price will be adjusted for the effect of the exchange ratio. The Merger
is subject to approval by the Company's and Quintiles' shareholders and certain
other conditions.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, the percentage
relationship certain statements of operations items bear to revenues.
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YEAR ENDED DECEMBER 31,
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1998 1997 1996
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Revenues 100.0% 100.0% 100.0%
Cost of revenues 44.6 46.7 48.0
Selling, general and administrative expenses 21.8 23.8 27.2
Research and development expenses 1.5 1.6 2.0
Depreciation and amortization expenses 19.6 25.0 28.2
Merger and facility integration costs -- -- 5.2
Write-off of acquired in-process technology -- 4.8 9.6
EMC losses -- -- 0.6
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Operating income (loss) 12.6 (1.9) (20.7)
Interest income 0.5 1.0 1.1
Interest expense (0.8) (1.2) (3.2)
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Income (loss) before income taxes 12.3 (2.1) (22.7)
Provision from income taxes 10.0 4.6 1.9
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Net income (loss) 2.3% (6.7)% (24.6)%
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FISCAL YEAR 1998 AS COMPARED WITH 1997
Revenues. Revenues for the year ended December 31, 1998 were $184.8
million compared to $137.6 million for 1997, an increase of $47.2 million or
34.3%. The increase in revenue is primarily the result of higher transaction
volumes, which increased 28.9% in 1998 compared to 1997. The increases were
primarily the result of medical EDI and patient statement internal transaction
growth and, to a lesser extent, the acquisition of HDIC and the resulting
increase in transaction volume from Aetna U.S. Healthcare Inc. ("AUSHC").
Without the transaction volume from AUSHC, volumes would have increased 27.2% in
1998 compared to 1997.
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Cost of Revenues. Cost of revenues includes the cost of communications,
computer operations, operating supplies, product development and customer
support, as well as the cost of hardware sales and rebates to third parties for
transaction processing volume. Cost of revenues for the year ended December 31,
1998 was $82.3 million compared to $64.2 million for 1997, an increase of $18.1
million or 28.1%. The dollar increase is attributable to the additional costs
associated with the increased transaction volume and, to a lesser extent,
increases in rebates paid to third parties in connection with medical EDI
transactions. The increase in rebates paid to third parties was approximately
$3.0 million and resulted primarily from an increase in the volume of claims
received from certain large third party vendors and claims clearinghouses. As a
percentage of revenues, cost of revenues improved to 44.6% for 1998 compared to
46.7% for 1997. The improvement is primarily attributable to the Company's
ability to spread certain fixed costs of revenue over a larger base of revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include marketing, finance, accounting and
administrative costs. Selling, general and administrative expenses for 1998 were
$40.2 million compared with $32.7 million in 1997, an increase of $7.5 million
or 22.9%. The dollar increase is a result of the inclusion of the Acquired
Businesses following the date of acquisition and the cost of required corporate
infrastructure to support the larger base of revenues. As a percentage of
revenues, selling, general and administrative expenses were 21.8% for 1998
compared with 23.8% in 1997. The improvement as a percentage of revenue is a
result of a larger revenue base to support these expenses, as well as the
elimination of certain duplicative costs realized in connection with the
Acquired Businesses following the date of acquisition.
Research and Development Expenses. Expenses related to research and
development of new products are expensed as incurred until technological
feasibility is established for the product. Thereafter, all development costs
are capitalized until the products are available for general use by customers.
Research and development expenses for the year ended December 31, 1998 were $2.8
million compared to $2.2 million for 1997.
Depreciation and Amortization Expenses. Depreciation and amortization
expenses relate primarily to host computers, communications equipment and
goodwill and identifiable intangible assets related to acquisitions.
Depreciation and amortization expenses for 1998 were $36.2 million compared to
$34.4 million for 1997. The increase in 1998 is primarily the result of the
amortization expense of $29.1 million for goodwill and identifiable intangible
assets related to the Acquired Businesses, compared with $28.3 million in 1997.
At December 31, 1998, the Company had net goodwill of $53.5 million associated
with the Acquired Businesses. Such goodwill is being amortized over periods of
three to 15 years from the date of acquisition. In addition, the Company had net
identifiable intangible assets of $27.4 million. These assets are being
amortized over two to ten year time periods from the date of acquisition.
Write-off of Acquired In-Process Technology. The Company recorded
write-offs of acquired in-process technology of $6.6 million in 1997 related to
the acquisitions of HDIC and DSS. These amounts represent an allocation of the
purchase price to projects that primarily included the development of: (i) new
transaction sets which would allow health care providers to submit additional
health care transactions electronically; and (ii) additional interfaces and
functionality for accounts receivable management service offerings provided by
DSS. Such amounts were charged to expense because the projects related to
research and development that had not reached technological feasibility and for
which there was no alternative future use. See "--Acquired In-Process
Technology."
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Net Interest Income (Expense). The Company recorded net interest
expense of $521,000 for the year ended December 31, 1998 compared to net
interest expense of $265,000 in 1997. Interest income decreased to $910,000 in
1998 from $1.3 million in 1997. The reduction in interest income for 1998
primarily is a result of the HDIC acquisition in August 1997. The Company
acquired HDIC for approximately $36.4 million in cash and the assumption of
certain liabilities associated with unfavorable contracts. Following the HDIC
acquisition, the Company had less cash available for investment and the Company
also was required to impute additional interest expense to account for certain
unfavorable contracts assumed in the HDIC acquisition.
Income Tax Provision. The Company's income tax provision for the year
ended December 31, 1998 was $18.5 million compared to $6.3 million in 1997. The
tax provision recorded in 1997 reflects a deferred income tax benefit of $2.5
million associated with the $6.6 million charge for the write-off of acquired
in-process technology related to the HDIC and DSS acquisitions. Income tax
expense recorded is based upon estimated taxable income. Amortization of certain
goodwill and identifiable intangibles are not deductible for income tax
purposes.
FISCAL YEAR 1997 AS COMPARED WITH 1996
Revenues. Revenues for the year ended December 31, 1997 were $137.6
million compared to $90.6 million for the same period last year, an increase of
$47.0 million or 51.9%. The increase in revenue is primarily due to a 37.2%
increase in transactions in 1997 compared to 1996. Transaction growth was
derived from both internal growth and the Acquired Businesses. Without the
increased transaction volume from the Acquired Businesses, transaction growth
would have been 32.3%. In addition, the March 1997 acquisition of DSS provided
additional revenues of $2.8 million in 1997 from software licensing, maintenance
and support activities.
Cost of Revenues. Cost of revenues for 1997 was $64.2 million compared
to $43.5 million for 1996, an increase of $20.7 million or 47.6%. The dollar
increase is attributable to the additional costs associated with the increased
transaction volume, the inclusion of the Acquired Businesses following the date
of acquisition and increases in rebates paid to third parties in connection with
medical EDI transactions. The increase in rebates to third parties was
approximately $4.7 million, and primarily results from an increase in the volume
of claims received from certain large third party vendors and claims
clearinghouses. As a percentage of revenues, cost of revenues improved to 46.7%
in 1997 compared to 48.0% in 1996. The improvement primarily is attributable to
the Company's ability to spread certain fixed costs of revenues over a larger
base of revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for 1997 were $32.7 million compared to $24.6 million in
1996, an increase of $8.1 million or 32.9%. The dollar increase is the result of
the inclusion of the Acquired Businesses following the date of acquisition and
the required infrastructure to support the larger base of revenues. As a
percentage of revenues, selling, general and administrative expenses decreased
to 23.8% for 1997 compared to 27.2% for 1996. The improvement is attributable to
a larger base of revenues and the elimination of certain duplicative costs
realized in connection with the Acquired Businesses following the date of
acquisition.
Research and Development Expenses. Research and development expenses
for the year ended December 31, 1997 were $2.2 million compared to $1.8 million
in 1996.
Depreciation and Amortization Expenses. Depreciation and amortization
expenses for 1997 were $34.4 million compared to $25.5 million for 1996. The
increase in 1997 is primarily the result of the amortization expense of $28.3
million for goodwill and identifiable intangible assets related to the Acquired
Businesses, compared with $20.6 million in 1996. Depreciation and amortization
expense for 1997 increased further as the result of the additional investment in
host computer systems and software to expand the Company's transaction
processing capabilities.
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Merger and Facility Integration Costs. The Company recognized merger
and facility integration costs in 1996 of $4.7 million related primarily to the
NEIC and Teleclaims, Inc. ("Teleclaims") acquisitions. These charges represent
costs incurred as a direct result of the plan to integrate NEIC and Teleclaims.
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 recorded
write-offs of acquired in-process technology of $6.6 million and $8.7 million in
1997 and 1996, respectively. The 1997 write-offs related to the HDIC and DSS
acquisitions, and the 1996 write-offs related to the NEIC and Teleclaims
acquisitions. These amounts represent an allocation of purchase price to
projects that primarily included: (i) projects aimed at facilitating the ease of
participation of health care providers into clearinghouse technologies and
ensuring compliance with regulatory and other industry standards; (ii) the
development of new transaction sets which would allow health care providers to
submit additional health care transactions electronically; and (iii) the
development of additional interfaces and functionality for accounts receivable
management service offerings provided by DSS. Such amounts were charged to
expense because the projects related to research and development that had not
reached technological feasibility and for which there was no alterative future
use. See "--Acquired In-Process Technology."
EMC Losses. In January 1995, ENVOY acquired a 17.5% interest in
EMC*Express, Inc. ("EMC"). In connection therewith, the Company 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, and acquired an option
to purchase the remaining 82.5% interest in EMC for approximately $2.7 million.
At December 31, 1995, the Company determined it would terminate the management
agreement and would not exercise its option to purchase the remaining 82.5%
interest in EMC, principally as a result of similar products and technology
being available to the Company through the acquisition of NEIC, EMC's poor
operating performance and the belief that operating losses at EMC likely would
continue. As such, the Company determined that it was probable an impairment of
its equity investment in EMC as of December 31, 1995 had occurred and recorded
an adjustment to recognize an impairment in the carrying value of its
investment, including writing off advances and providing for future commitments
to EMC at the time when the Company's investment was recorded at net realizable
value of zero. As a result, the Company recognized losses in 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 and option, 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 for $2.0 million in cash and settled the
related lawsuit for $300,000. In connection with the Company's acquisition of
the remaining 82.5% interest in EMC, the Company recorded identifiable
intangible assets of approximately $1.9 million related to the customer base
acquired from EMC.
Net Interest Income (Expense). The Company recorded a net interest
expense of $265,000 for 1997 compared to net interest expense of $1.8 million
for 1996. Interest income increased to $1.3 million in 1997 compared to $1.0
million in 1996, primarily because of an increase in the amount of cash
available for investment during 1997. In this regard, operating activities
provided cash of $23.2 million in 1997 compared to $3.2 million in 1996, and the
Company's August 1996 public offering of 3,320,000 shares of Common Stock
provided cash of approximately $83.0 million. The proceeds from this public
offering were used, in part, to retire indebtedness under a $25 million term
loan and $12.9 million outstanding under the Company's revolving credit
facility. Primarily as a result of these debt repayments, interest expense
decreased to $1.6 million in 1997 compared to $2.9 million in 1996.
Income Tax Provision. The Company's income tax provision for
1997 was $6.3 million compared to $1.7 million in 1996. The tax provision
recorded in 1997 reflects a deferred income tax benefit of $2.5 million
associated with the $6.6 million charge for the write-off of acquired in-process
technology related to the HDIC and DSS acquisitions.
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ACQUIRED IN-PROCESS TECHNOLOGY
In connection with the purchases of certain of the Acquired Businesses,
including NEIC, DSS and HDIC, the Company made allocations of the purchase price
to acquired in-process technology. These amounts were expensed on the respective
acquisition dates of the Acquired Businesses because the acquired in-process
technology had not yet reached technological feasibility and had no future
alternative uses.
Since the respective dates of acquisition, the Company has used the
acquired in-process technology to develop new health care EDI and transaction
processing product and service offerings, which have or will become part of the
Company's suite of products when completed. The nature of the efforts required
to develop the acquired in-process technology into commercially viable products
principally relate to the completion of all planning, designing and testing
activities that are necessary to establish that the product or service can be
produced to meet its design requirements, including functions, features and
technical performance requirements. The Company currently expects that the
acquired in-process technology will be successfully developed, but there can be
no assurance that commercial viability of these products will be achieved.
Furthermore, future developments in the health care EDI and transaction
processing industry, changes in EDI and transaction processing technology,
changes in other product and service offerings or other developments may cause
the Company to alter or abandon these plans. Failure to complete the development
of these projects in their entirety, or in a timely manner, could have a
material adverse impact on the Company's operating results, financial condition
and results of operations.
A description of the acquired in-process technology and the estimates
made by the Company for each of NEIC, DSS and HDIC is set forth below.
NEIC
The in-process technology acquired in the NEIC acquisition consisted of
five significant research and development projects. These projects were all
aimed at facilitating the ease of participation of health care providers into
clearinghouse technologies and ensuring compliance with regulatory and other
industry standards. After acquiring NEIC, the Company continued the development
of these in-process projects.
The Company has assigned a value of $8.0 million to the NEIC in-process
technology. In arriving at this value, the Company considered independent
appraisals obtained for this purpose, the views of the Commission on in-process
research and development as set forth in its September 15, 1998 letter to the
American Institute of Certified Public Accountants ("AICPA Letter"), and the
comments of the Staff of the Commission (the "Staff") in its review of a
registration statement filed by the Company in May 1998 (the "Registration
Statement"), for the Company to consider (i) the stage of completion of the
in-process technology at the date of acquisition, (ii) other contributions of
the Company's own distinct and unique proprietary advantages, and (iii) the
estimated total project costs of the in-process research and development in
arriving at the valuation amount.
A brief description of the five in-process projects is set forth below:
- UniClaim. This product is a PC based claims processing system that
extracts Health Care Financing Administration 1500 claim formats from
PMS, performs edits and transports the file to a host system where EDI
formatting is completed for delivery to payors. The Company estimates
this project, which was completed in the second quarter of 1996, was
approximately 40% complete at the date of the NEIC acquisition.
- GTEDS. This product is a computerized system for the collection,
validation and distribution of claims from various sources to claims
receivers. The Company estimates this project, which was completed in
the fourth quarter of 1996, was approximately 45% complete at the date
of the NEIC acquisition.
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- On-Line. This product is an application that performs "screen
scraping" (i.e., it captures data from a screen presentation and
creates an American National Standards Institute 270 eligibility
request.) The Company estimates this project, which was completed
during the second quarter of 1998, was approximately 35% complete at
the date of the NEIC acquisition.
- SmartPost. This product is an application to populate a physician PMS
with remittance data for automatic posting to the PMS. In the first
quarter of 1997, the Company completed the acquisition of DSS, which
already had a Receivables Management product that included
substantially the same functionality as the SmartPost product, and
determined to abandon further development of SmartPost. The Company
estimates this project was approximately 55% complete at the date of
the NEIC acquisition.
- Expect. This product is an application for screen scraping at payor
locations. In the first quarter of 1997, the Company identified an
existing software application with the same capabilities as Expect, and
made a decision to license that software and abandon the Expect
project. The Company estimates this project was approximately 35%
complete at the date of the NEIC acquisition.
At the time of the NEIC valuation, the expected total costs of all such projects
were approximately $4.0 million. Approximately $1.8 million was incurred after
the date of the NEIC acquisition for the completion of these projects, and there
are no additional expected costs to complete the research and development
projects acquired from NEIC.
DSS
The in-process technology acquired in the DSS acquisition consisted
primarily of projects related to DSS's Receivables Management product line and
four peripheral products expected to be used as add-on features to the
Receivables Management product. DSS's Receivables Management product line works
with existing hospital information system ("HIS") and PMS software and provides
claims and receivables management, including billings, collections and cash
applications, among other functions. At the time of acquisition, DSS was selling
versions of the Receivables Management product to work with certain HIS and PMS
products; however, the Company noted that there was still substantial
development work required in order to complete versions which were adapted to
other major HIS and PMS products. The Company estimates this project, which was
completed during the fourth quarter of 1997, was approximately 35% complete at
the date of the DSS acquisition.
The Company has assigned a value of $600,000 to the DSS in-process
technology. In arriving at this value, the Company considered independent
appraisals obtained for this purpose, the Commission's views on in-process
research and development as set forth in the AICPA Letter, and the Staff's
comments in its review of the Registration Statement for the Company to consider
(i) the stage of completion of the in-process technology at the date of
acquisition, (ii) other contributions of the Company's own distinct and unique
proprietary advantages, and (iii) the estimated total project costs of the
in-process research and development in arriving at the valuation amount.
A brief description of each of the four add-on features is set forth
below:
- Materials Management. This product incorporates certain customized
features into licensed software to allow for on-line transaction
processing of inventory data. The Company estimates this project, which
was completed during the third quarter of 1997, was approximately 50%
complete at the date of the DSS acquisition.
- Billing and 72-Hour Compliance. This product processes all emergency
room billings and collections, in addition to tracking patients
throughout the emergency/casualty process. The Company estimates this
project, which was completed during the first quarter of 1998, was
approximately 50% complete at the date of the DSS acquisition.
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- Registration. This product facilitates access to patient records, as
well as providing basic patient information to payors. The Company
estimates this project, which was completed during the fourth quarter
of 1998, was approximately 25% complete at the date of the DSS
acquisition.
- Collections. This product assists the health care provider's HIS or
PMS system in the management of receivables. In the fourth quarter of
1997, management placed further development of this project on hold
while it evaluated alternative technologies and development strategies.
The Company estimates this project was approximately 20% complete at
the date of the DSS acquisition. At the time that the project was
placed on hold, the Company estimates that this project was
approximately 60% complete.
At the time of the DSS valuation, the expected total costs of all such projects
totaled approximately $300,000. Approximately $170,000 was incurred after the
date of the DSS acquisition for the completion of these projects, and the
Company estimates that no additional costs will be required with respect to
these research and development projects.
HDIC
The in-process technology acquired in the HDIC acquisition consisted of
seven significant research and development projects associated with HDIC's
product line. At the time of acquisition, HDIC had developed on-line, real-time
claims transaction technology which permitted AUSHC to receive real-time EDI
transactions, and was in the process of developing new transaction sets which
would allow health care providers to submit additional health care transactions
electronically. After acquiring HDIC, the Company modified the Company's
existing front-end transaction platforms to accommodate HDIC's technology and
continued the development of seven in-process projects. The Company believes
that the resulting technology has given, and will continue to give, the Company
a competitive advantage in the marketplace by significantly enhancing the
Company's existing EDI and transaction processing capabilities with additional
transaction sets.
The Company has assigned a value of $6.0 million to the HDIC in-process
technology. In arriving at this value, the Company considered independent
appraisals obtained for this purpose, the Commission's views on in-process
research and development as set forth in the AICPA Letter, and the Staff's
comments in its review of the Registration Statement for the Company to consider
(i) the stage of completion of the in-process technology at the date of
acquisition, (ii) other contributions of the Company's own distinct and unique
proprietary advantages, and (iii) the estimated total project costs of the
in-process research and development in arriving at the valuation amount.
A brief description of each of the seven in-process projects is set
forth below:
- Real-time referrals. This product is designed to allow batch or
on-line real-time transaction processing for referral authorization and
the ability to receive or confirm acknowledgment through the Company's
network that a valid referral is on file with the primary care provider
("PCP"). The Company estimates this project, which was completed during
the second quarter of 1998, was approximately 25% complete at the date
of the HDIC acquisition.
- Vision claims. This product is designed to provide the capability for
health care providers to submit vision claims and vision-related
information electronically. The Company estimates this project, which
was completed during the third quarter of 1998, was approximately 35%
complete at the date of the HDIC acquisition.
- Lab utilization/results. This product is designed to allow electronic
transmission of lab testing requests and reporting of lab results. The
Company estimates this project, which was completed during the third
quarter of 1998, was approximately 50% complete at the date of the HDIC
acquisition.
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- Provider directories. This product is designed to allow for the
maintenance of reference information related to health care providers
and provider networks. The Company estimates this project, which was
completed in the fourth quarter of 1998, was approximately 15% complete
at the date of the HDIC acquisition.
- Real-time encounters/claims. This product is designed to allow batch
or on-line real-time transaction processing for the transmission of
encounter data from the PCP or a capitated specialist to the insurer,
and the subsequent acknowledgment of receipt. The Company estimates
this project was approximately 45% complete at the date of the HDIC
acquisition. The Company estimates that the project was approximately
70% complete as of December 31, 1998. This project has been put on hold
pending completion of Year 2000 compliance work by AUSHC. Work on this
project currently is expected to resume in the fourth quarter of 1999,
with completion expected in 2000.
- Electronic pre-certifications. This product is designed to allow
batch or real-time batch transaction processing for the request and
authorization to perform non-capitated procedures or hospital
admissions. This transaction is initiated from the PCP, specialist
hospital or other delivery system. The Company estimates this project
was approximately 35% complete at the date of the HDIC acquisition. The
Company estimates that the project was approximately 40% complete as of
December 31, 1998. This project has been put on hold pending completion
of Year 2000 compliance work by AUSHC. Work on this project currently
is expected to resume in the fourth quarter of 1999, with completion
expected in 2000.
- Rosters through the Internet. This product is designed to use the
Internet as a means to deliver to health care providers managed care
program eligibility status and capitated payment information. The
Company estimates this project was approximately 50% complete at the
date of the HDIC acquisition. The Company estimates that the project
was approximately 80% complete as of December 31, 1998. This project
has been put on hold pending completion of Year 2000 compliance work by
AUSHC. Work on this project currently is expected to resume in the
fourth quarter of 1999, with completion expected in 2000.
At the time of the HDIC valuation, the expected total costs of all such projects
was approximately $3.0 million. Approximately $400,000 has been incurred since
the date of the HDIC acquisition for these projects through January 31, 1999,
and the Company estimates that approximately $1.4 million will be required to
complete the remaining research and development projects. The remaining efforts
to complete these projects include the processes of planning, coding and testing
the primary applications and customer interfaces, and introducing such processes
into production environments at Company and customer locations.
LIQUIDITY AND CAPITAL RESOURCES
The Company was profitable in 1998, but had incurred operating losses
prior to 1998 since its inception primarily as a result of substantial non-cash
depreciation and amortization charges, together with the write-off of acquired
in-process technology related to the Acquired Businesses. Despite these losses,
the Company's operations have generated positive cash flows of $44.0 million in
1998, $23.2 million in 1997 and $3.2 million in 1996.
Investing activities consist primarily of payments for acquired
businesses and purchases of property and equipment. Investing activities used
$23.1 million in 1998, $51.2 million in 1997 and $94.0 million in 1996.
Financing activities consist primarily of proceeds from the issuance of
capital stock, and proceeds from and payments on debt. Financing activities
provided $781,000 in 1998, used $222,000 in 1997 and provided $127.2 million in
1996.
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 $6.2 million, $8.7 million and $5.4
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million for 1998, 1997 and 1996, respectively, primarily for computer hardware
and software products. The Company currently estimates that total capital
expenditures for 1999 will be approximately $9.0 to $10.0 million.
The Company is expensing as incurred all costs associated with system
changes related to its Year 2000 compliance project. The Company estimates that
the total cost of the Year 2000 expenses will be approximately $4.0 million, of
which approximately $800,000 was incurred during 1998. These costs are being
funded with available cash. See "--Year 2000 Compliance" and "Risk Factors--Year
2000 Compliance."
At February 15, 1999, the Company had no amounts outstanding under its
$50 million revolving credit facility. Any future borrowings made under the
credit facility would bear interest at a rate equal to the Base Rate (as defined
in the credit facility) or an index tied to LIBOR. Any future borrowings under
the credit facility would be due and payable in full on June 30, 2000. The
credit facility contains financial covenants applicable to the Company and its
subsidiaries, including ratios of debt to capital, annualized EBITDA to
annualized interest expense and certain other financial covenants customarily
included in a credit facility of this type. The Company and its subsidiaries
also are subject to certain restrictions relating to payment of dividends to
shareholders of the Company, acquisitions, incurrence of debt and other
restrictive provisions; however, there are no restrictions on the ability of the
Company's subsidiaries to transfer funds to the Company in the form of
dividends, loans or advances. The credit facility is secured by substantially
all of the assets of the Company and its subsidiaries.
In February 1998, the Company issued 3.5 million shares of Common Stock
in connection with the ExpressBill Companies' business combinations. Also in
February 1998, 930,233 shares of the Series B Preferred Stock were converted
into an equal number of shares of Common Stock. As a result of these
transactions, the number of shares of Common Stock outstanding increased by
approximately 4.4 million shares, or 27%.
From time to time, the Company has engaged and may continue to engage
in acquisition discussions with health care information businesses and other
companies complementary to its business. In the event the Company engages in
such acquisitions in the future, its currently available capital resources may
not be sufficient for such purposes and the Company may be required to incur
additional indebtedness or issue additional capital stock, which could result in
increased interest expense or dilution to existing investors.
Based on current operations, anticipated capital needs to fund known
expenditures and current acquisitions, the Company believes its available cash,
cash flow from operations and the $50.0 million revolving credit facility will
provide the capital resources necessary to meet its liquidity and cash flow
requirements over the next 12 months, including the Company's current short-term
obligations. The Company believes that present funding sources will provide the
ability to meet long-term obligations as they mature. As of December 31, 1998,
the Company's long-term obligations totaled $7.9 million, and consisted of
$366,000 in long-term debt net of current portion, $164,000 in non-current
deferred income tax liabilities, and $7.4 million in long-term obligations
related to unfavorable contracts assumed in connection with the HDIC
acquisition. Such amounts relate primarily to the Company's obligations under
the AUSHC services agreement entered into in connection with the HDIC
acquisition to assume a portion of the transaction processing fees related to
certain secondary Medicare transactions, and existing agreements assumed by the
Company with several businesses that served as claims clearinghouses for AUSHC
prior to the HDIC acquisition. The Company's available cash is invested in
interest bearing securities with maturities of up to 30 days.
SEASONALITY
ENVOY's business is to some extent seasonal, with more revenues being
generated from September through March as a result of a greater number of health
care transactions arising in those months, while operating expenses tend to
remain relatively constant over the course of the year.
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RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants released
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires
companies to capitalize certain costs of computer software developed or obtained
for internal use, provided that those costs are not research and development.
SOP 98-1 is effective for fiscal years beginning after December 15, 1998. The
Company has not yet completed its assessment of the impact the adoption of SOP
98-1 will have on the Company.
YEAR 2000 COMPLIANCE
Introduction
The Year 2000 ("Y2K") issue refers to the inability of a date-sensitive
computer program to recognize a two- digit date field designated as "00" as the
year 2000. Any of the Company's hardware, software and embedded systems that
have time/date sensitive software and hardware may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a major system
failure or miscalculations causing disruptions to the Company's operations. The
Company presently believes that, with modifications to existing computer
systems, as scheduled, the Y2K issue should not pose significant operational
problems for the Company's systems, as so modified and converted.
The Company began evaluating the Y2K issue in 1997. In 1998, the
Company established a Y2K Task Force, the primary function of which is to: (1)
develop and implement the Company's Y2K compliance effort, (2) monitor product
and internal systems compliance, (3) review customer preparations to implement
Y2K releases, and (4) provide centralization, accuracy and consistency of the
Company's communications regarding Y2K to customers, stockholders, employees and
the industry. To assist the Y2K Task Force, the Company has engaged a consulting
firm to provide an independent review of the status of the Company's Y2K
compliance efforts and issues, and to assist the Y2K Task Force in project
management for certain identified key Y2K projects.
Status of Progress
The Company has conducted an inventory and assessment of its technology
to identify the computer systems that could be affected by the Y2K issue. The
inventory includes information technology ("IT") systems and non-IT systems,
including telecommunications, data processing services, utilities and security
systems related to the Company's operating facilities. All of the Company's
software and hardware has been identified and assessed to determine the extent
of renovations required to be Y2K compliant.
The Company's efforts to renovate its IT and non-IT systems to make
them Y2K compliant have proceeded in tandem with its efforts to inventory and
assess its systems. As of December 31, 1998, most of the Company's major or key
systems, software and products have been remediated or replaced and significant
testing has commenced; remaining systems, software and products are scheduled to
be remediated or replaced in the first half of 1999. The Company anticipates
using the balance of 1999 for continued testing, implementing changes and making
necessary refinements. The Company expects that the internal systems, software
and products for which the Company has responsibility currently are Y2K
compliant or will be compliant on a timely basis.
Costs to Address
The Company is funding costs associated with the Y2K issue through
operating cash flows, and currently expects that costs to address Y2K issues
will total approximately $3.0 to $4.0 million. As of December 31, 1998, the
Company had incurred approximately $800,000 on Y2K projects, and expects the
remainder to be spent primarily during 1999. As a result, the Company currently
does not expect that the costs to address the Y2K issue will have a material
adverse effect on the Company's financial condition or results of operations.
There can be no assurance, however, that actual costs necessary to deal with
these issues will not exceed estimated amounts.
The Company has not yet estimated Y2K costs for periods after 1999,
which may include costs of customer service efforts resulting from the failure
of third parties to be Y2K compliant or other unforeseen problems.
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Risks
The Y2K issue creates risk for the Company from unforeseen problems in
its own computer systems and from third parties with which the Company does
business. Accordingly, the Company is requesting assurances from certain
software vendors from which it has acquired, or from which it may acquire
software, that the software will correctly process all date information at all
times. In addition, the Company is questioning certain of its customers,
including major payors and vendors, and suppliers as to their progress in
identifying and addressing problems that their computers will face in correctly
processing date information as the Year 2000 approaches and is reached. Because
of the complexity of the Y2K issue and the differing stages of readiness of
these third parties, the Company expects these discussions to continue
throughout 1999. Furthermore, because of the nature of the Company's business,
the success of the Company's efforts may depend on the success of payors,
vendors and other third parties in dealing with the Y2K issue. Failure to
appropriately address the Y2K issue by a major customer or supplier or a
material percentage of the Company's smaller customers could have a material
adverse impact on the financial condition and results of operations of the
Company.
The Company's business also is heavily reliant upon external suppliers
to provide certain operating elements of its business. Some of these providers
include telecommunications providers, data processing service providers, utility
companies, key vendors and suppliers and certain governmental agencies. The
Company exerts no control over the efforts of these companies to become Y2K
compliant. The services provided by these parties are critical to the operations
of the Company and the Company is heavily reliant upon these parties to
successfully address the Y2K issue. Therefore, if any of these parties fail to
provide the Company with services, the Company's ability to conduct business
could be materially impacted. The result of such impact may have a material
adverse effect on the financial condition and results of operations of the
Company.
Worst case scenarios could be as insignificant as a minor interruption
in the Company's ability to conduct business resulting from unanticipated
problems encountered in the IT and non-IT systems of the Company or any of the
significant third parties with whom the Company does business. The pervasiveness
of the Y2K issue makes it likely that previously unidentified issues will
require remediation during the normal course of business. On the other hand, a
worst case Y2K scenario could be as catastrophic as a complete, and long-term,
loss of telecommunications, data processing and utility services. In this
connection, an extended loss of telecommunications, data processing and utility
services could have a material adverse effect on the financial condition and
results of operations of the Company.
The Company does not anticipate that the Y2K issues and risks,
including the most reasonably likely worst case Y2K scenario, will be
significantly different than those encountered by other providers of information
services, including the Company's competitors. Although the Company believes its
remediation, replacement and testing efforts will address all of the Y2K issues
for which the Company is responsible, to the extent these efforts are not
successful, additional compliance efforts would be necessary together with
additional customer service efforts and expenditures. If third parties fail in
their compliance efforts, the Company also could be impacted and required to
provide additional customer service efforts. In such an event, the Company could
incur additional costs and experience a negative impact on its financial
condition and results of operations.
The Company's cost and timetable estimates for its Y2K efforts are
subject to potentially significant estimation uncertainties that could cause
actual results to differ materially from projected results. These estimates are
based on management's current estimates and reflect certain assumptions. Factors
which could impact these estimates include: the availability of appropriate
technology personnel; the rate and magnitude of related labor costs; the
successful identification of all aspects of the Company's systems, software and
products that require remediation or replacement; the extent of testing
required; the costs of the Company's efforts to assist certain customers in the
remediation of their customized code; the amount of cost recoveries from those
efforts; and the success of third parties in their Y2K compliance efforts. Due
to the complexity and pervasiveness of the Y2K issue, and in particular the
uncertainty
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regarding the compliance efforts of third parties, no assurance can be given
that these estimates will be achieved, and actual results could differ
materially from projected results.
Contingency Plans
The Company's Y2K compliance activities are being regularly monitored
and evaluated by management. The Y2K Task Force provides regular updates to
senior management of the Company, as well as to the Company's Board of
Directors. As risks are identified, contingency plans are being established and
additional steps are being taken to further minimize the risks associated with
the Y2K issue. Those plans will focus on matters that appear to be the Company's
most likely Y2K risks, such as possible additional customer support efforts by
the Company that would be necessary if customers or vendors are not Y2K
compliant, or if a Y2K issue should not be timely detected in the Company's own
compliance efforts.
In the event that the Company's systems do not function as a result of
a most reasonably likely worst case scenario, the Company would make reasonable
efforts to enter into temporary alternative arrangements with third parties to
service the Company's customers, including routing transactions to the Company's
competitors. In addition, in the event the Company could not process
transactions electronically, either as a result of the failure of its own
systems or a loss of telecommunications, data processing or utility services
generally, the Company or its customers could print transactions normally
processed electronically to paper for manual processing until such time as the
Company's systems are functional.
RISK FACTORS
ENVOY's business is subject to numerous risks and uncertainties which
may affect its results of operations in the future and may cause such future
results to differ materially and adversely from projections included in or
underlying any forward-looking statements made by or on behalf of the Company.
Among the factors that may adversely affect the Company's business are the
following:
Envoy Has a Limited Operating History and Recent Losses
The health care EDI and transaction processing industry is relatively new,
and ENVOY's operating history is limited. ENVOY was profitable during 1998;
however, it has experienced substantial losses in recent years, including a net
loss of $9.2 million for 1997 and $22.3 million for 1996. ENVOY had an
accumulated deficit of $49.1 million as of December 31, 1998. To be profitable,
ENVOY must have a successful business strategy, increase revenues, and control
expenses. ENVOY cannot assure that it will be profitable in the future.
Recent Acquisitions Have Affected Envoy's Results of Operations
ENVOY recently acquired several companies and these acquisitions
significantly expanded ENVOY's business. The accounting treatment of these
acquisitions negatively impacted ENVOY's reported results of operations,
particularly the NEIC acquisition in March 1996 and the HDIC acquisition in
August 1997. The NEIC and HDIC acquisitions are briefly described below:
NEIC. ENVOY's cost of acquiring NEIC was $94.3 million, which includes
fees, expenses and other costs. ENVOY wrote off acquired in-process
technology of $8.0 million. Due to the NEIC acquisition, ENVOY is
amortizing $59.6 million of goodwill over three years. This amortization
will adversely affect ENVOY's reported results of operations through March
1999.
HDIC. ENVOY's cost of acquiring HDIC was $36.4 million, plus the
assumption of certain liabilities. Prior to the acquisition of HDIC by
ENVOY, HDIC was the health care EDI subsidiary of AUSHC. In connection with
the HDIC acquisition, ENVOY and AUSHC entered into a ten-year services
agreement, in which AUSHC agreed to use ENVOY as its single source
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clearinghouse and EDI network for all AUSHC electronic health care
transactions. ENVOY recorded approximately $45.9 million of goodwill and
identifiable intangible assets. ENVOY is amortizing $38.8 million of
related goodwill over 15 years. Further, ENVOY wrote-off acquired
in-process technology of $6.0 million.
Amortization expense associated with acquisitions was approximately $29.1
million in 1998 and is expected to be $12.3 million in 1999, including $6.0
million in the three months ended March 31, 1999. If ENVOY makes additional
acquisitions, its amortization costs and write-offs of acquired-in-process
technology could increase significantly. The amounts allocated to developed
technology and in-process technology in acquisitions that are accounted for as
purchases are determined based on certain valuations. Such valuations use
estimates of future revenues, expenses, operating profit and cash flows. The
actual revenues, expenses, operating profit and cash flows related to such
acquisitions may be materially different from the estimates.
Success Of Acquisitions Depends On Many Factors
ENVOY seeks to acquire companies in the health care information business.
The success of ENVOY's acquisition of a given company depends on many factors,
including, the purchase price for the company, whether financing is available
for the acquisition and, if so, the terms of the financing, and the ability of
ENVOY's management to integrate the company into ENVOY's operations. ENVOY's
success in acquiring companies is also dependent on its ability to identify
attractive companies. Many of ENVOY's competitors are also seeking to acquire
companies, which could result in fewer companies for ENVOY to acquire, and
higher prices that ENVOY must pay for any company that it does acquire.
Acquisitions May Adversely Affect Operations
If ENVOY acquires a company, it cannot assure that it will be able to
operate the acquired company profitably. The actual revenues, expenses,
operating results and cash flows related to acquisitions may be materially
different from the estimates developed prior to the acquisition. Certain past
acquisitions of companies by ENVOY have caused temporary declines in customer
service. Such declines were caused by problems, such as computer down time and
inexperienced customer service representatives, that occurred in integrating the
acquired company into ENVOY. Although ENVOY believes that these problems have
been resolved and that it has not been materially adversely affected, ENVOY may
experience similar customer service problems in the future, which could have a
material adverse effect on ENVOY.
Envoy May Be Adversely Affected By Customer Concentration
Primarily as a result of ENVOY's acquisition of HDIC, ENVOY has one
customer, AUSHC, that accounted for 17% of its 1998 revenues and 12% of its 1997
revenues. Before 1997, none of ENVOY's customers accounted for more than 10% of
ENVOY's revenues. When ENVOY acquired HDIC, ENVOY and AUSHC entered into a
ten-year services agreement that requires AUSHC to use ENVOY as its single
source clearinghouse and EDI network for all of AUSHC's electronic health care
transactions. The fees under the AUSHC services agreement have been negotiated
for the first three years. The AUSHC services agreement also requires ENVOY to
maintain minimum transaction volumes and services levels and to perform
marketing services that are designed to encourage AUSHC providers to use
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ENVOY's services. If either ENVOY or AUSHC fail to comply with a material term
of the services agreement, the other party can terminate the services agreement
upon 180 days' notice. ENVOY believes that it is currently complying with all
material terms of the AUSHC services agreement.
ENVOY receives medical EDI transactions from PMS vendors and other claims
clearinghouses. These vendors and claims clearinghouses collect transactions
from health care providers and send ENVOY these transactions to complete the
processing of the transactions with the payors. ENVOY receives revenue from the
payors for processing these transactions and, in turn, pays rebates to exclusive
and preferred vendors based on the volume of transactions delivered to ENVOY. If
consolidation in the health care industry results in fewer vendors and
clearinghouses that gather medical EDI transactions from health care providers,
then ENVOY's medical EDI business will be more dependent on a smaller number of
vendors and clearinghouses.
To illustrate the foregoing risk, ENVOY currently processes batch
transactions for Medic Computer Systems, a practice management system vendor.
ENVOY and Medic have an exclusive relationship for processing these transactions
through June 1999. ENVOY's revenues for such processing represented 3.5% of
ENVOY's revenues for the year ended December 31, 1998. Medic recently announced
that it has entered into a processing and development agreement with one of
ENVOY's competitors. Subsequently, both ENVOY and Medic have alleged that the
other party has breached the parties' current agreement, and a lawsuit is
pending to resolve the parties' allegations. If ENVOY is not able to resolve the
parties' allegations and maintain a relationship with Medic, or other companies
like Medic, its business may be adversely affected.
As another illustration, before NEIC was acquired by ENVOY, it generated
most of its revenues from five insurance companies who were shareholders of
NEIC. These insurance companies have continued to use NEIC's services following
ENVOY's acquisition of NEIC, but they are not required to continue to use NEIC's
services in the future. If one or more of the insurance companies decreases or
ceases its use of NEIC's services, then ENVOY's business could be adversely
affected.
Year 2000 Compliance
The Year 2000 issue represents problems associated with the inability of a
computer to recognize dates beyond December 31, 1999. During 1997, ENVOY started
implementing a plan to ensure that its computer systems will not be affected by
the Year 2000 issue. In 1998, ENVOY established a Year 2000 Task Force,
primarily to develop, implement and monitor ENVOY's Year 2000 compliance efforts
and to review that of its customers. In addition, ENVOY engaged a consulting
firm to provide an independent review of ENVOY's Year 2000 compliance efforts
and to assist the Year 2000 Task Force. Some of ENVOY's computer systems are
already able to process dates beyond December 31, 1999, and ENVOY is replacing
or upgrading the remaining systems. ENVOY also has started testing customers,
vendors, suppliers and other third parties to determine whether their computers
will be affected by the Year 2000 issue, and currently expects to complete
testing in June 1999.
ENVOY's total cost for assessing and curing Year 2000 problems is estimated
at $3.0 to $4.0 million, but ENVOY cannot assure that such costs will not be
higher. For example, ENVOY has not yet estimated the Year 2000 costs for periods
after 1999, which may include costs of customer service efforts resulting from
the failure of third parties to be Year 2000 compliant or other problems.
Factors which could impact these estimates include: the availability of
19
<PAGE> 20
appropriate technology personnel, the rate and magnitude of related labor costs,
the successful identification of all aspects of ENVOY's systems, software and
products that require remediation or replacement, the extent of testing
required, the costs of ENVOY's efforts to assist certain customers in the
remediation of their customized codes, the amount of cost recoveries from such
efforts and the success of third parties in their Year 2000 compliance efforts.
ENVOY is funding these costs with operating cash flows, and will expense costs
as they are incurred. If ENVOY, its customers or other third parties with whom
it does business fail to cure their Year 2000 problems, ENVOY could be adversely
affected. See "-- Year 2000 Compliance."
Envoy Relies On Specific Data Centers
ENVOY relies on its host computer system to perform real-time EDI
transaction processing. This host computer system is contained in a single data
facility. The host computer system does not have a remote backup data center.
Although the host computer system is insured, if there is a fire or other
disaster at the data facility, ENVOY's business could be materially adversely
affected.
ENVOY also relies on a data center operated by a third party to perform
many of its other health care EDI transaction processing services. The facility
is located in Tampa, Florida and is operated by GTE Data Services Incorporated,
with whom ENVOY has contracted for such processing services. ENVOY relies
primarily on this facility to process its batch claims and other medical EDI
transaction sets. ENVOY's contract with GTE requires GTE to maintain continuous
processing capability and a "hot site" disaster recovery system. This contract
expires in December 2003. If the GTE facility's services are disrupted or
delayed, ENVOY's business could be materially adversely affected.
Envoy Cannot Predict The Need For Independent Health Care EDI Processing
ENVOY's business strategy anticipates that providers of health care
services and payors will increase their use of electronic processing of health
care transactions in the future. The development of the business of
electronically transmitting health care transactions is affected, and somewhat
hindered, by the complex nature and types of transactions that must be
processed. Furthermore, while the wide variety of processing forms used by
different payors has fostered the need for health care EDI and transaction
processing clearinghouses such as ENVOY to date, if such forms become
standardized, through consolidation of payors or otherwise, then the need for
independent third party health care EDI processing could become less prevalent.
ENVOY cannot assure that the electronic processing of health care transactions
will increase or that its business will grow.
Envoy Faces A Variety Of Competitors
ENVOY faces different types of competition in the health care EDI and
transaction processing business. Some of its competitors are similarly
specialized, such as former regional partners of ENVOY that have direct provider
relationships, and others are involved in more highly developed areas of the
business. In addition, some vendors of provider information management systems
include or may include, in their offered products, their own electronic
transaction processing systems. If electronic transaction processing becomes the
standard method of processing health care claims and information, other
companies with stronger capital resources could enter the industry. Many of
ENVOY's current and potential competitors are larger than ENVOY and have greater
resources. Competition from any or all of these sources could force ENVOY to
reduce, or even eliminate, per transaction fees, which could adversely affect
its business.
20
<PAGE> 21
Direct Links May Bypass Need For Envoy's Services
Some third party payors provide electronic data transmission systems to
health care providers, thereby directly linking the payor to the provider. Such
direct links bypass third party processors such as ENVOY. An increase in the use
of direct links between payors and providers would materially adversely affect
ENVOY's business.
Envoy Faces An Uncertain Regulatory Environment
The operations of companies in the health care industry are affected by
changes in political, economic and regulatory influences. Federal and state
legislatures periodically consider legislation that would change the federal and
state health care programs. Such legislation may include increased government
involvement in health care, lower reimbursement rates, or other changes. The
uncertainty surrounding these proposed or actual changes could cause companies
in the health care industry to curtail or defer investments in ENVOY's services
and products.
Consolidation In The Health Care Industry May Adversely Affect Envoy's Business
Many health care providers and payors are consolidating to create larger
health care organizations. This consolidation reduces the number of potential
customers for ENVOY's services, and the increased bargaining power of these
organizations could lead to reductions in the amounts paid for ENVOY's services.
Industry developments are increasing the amount of capitation-based care and
reducing the need for providers to make claims or reimbursements for products or
services. Payors and other health care information companies, such as billing
services and practice management vendors, which currently utilize ENVOY's
services, have developed or acquired transaction processing and networking
capabilities and may cease utilizing ENVOY's services in the future. The impact
of these developments in the health care EDI and transaction processing industry
is difficult to predict and could materially adversely affect ENVOY's business.
New Health Care Legislation Could Restrict Envoy's Business
The Health Insurance Portability and Accountability Act of 1996 requires
the use of standard transactions, standard identifiers, security and other
provisions and instructs the Secretary of Health and Human Services to develop
recommendations regarding the privacy of individually identifiable health
information. On September 11, 1997, the Secretary presented her recommendations,
which, among other things, advise that patient information should not be
disclosed except when authorized by the patient. This Act further establishes an
August 1999 deadline for Congress to enact privacy legislation. If Congress does
not meet this deadline, the Secretary is directed to issue regulations setting
privacy standards to protect information that is transmitted electronically.
Such changes could occur as early as the year 2000 and their impact cannot be
predicted, but such legislation or regulations could materially affect ENVOY's
business. This Act also specifically names clearinghouses as the compliance
facilitators for providers and payors, and permits clearinghouses to convert
non-standard transactions to standard transactions on behalf of their clients.
ENVOY is preparing to comply with the mandated standards within three to six
months after they are published. Whether ENVOY is successful in complying with
these standards may depend on whether providers, payors and others are also
successful in complying with the standards.
In addition, broad-based legislation restricting third party processors
from using, transmitting or disclosing certain patient data without specific
patient consent has recently been
21
<PAGE> 22
introduced in the United States Congress. Several states also have enacted or
are considering legislation that may restrict ENVOY's business. If such
legislation is adopted, it could prevent third party processors from using,
transmitting or disclosing certain treatment and clinical data. It is difficult
to predict the impact of the legislation described above, but such legislation
could materially adversely affect ENVOY's business.
Envoy Faces Evolving Industry Standards And Rapid Technological Changes
The market for ENVOY's business is characterized by rapidly changing
technology, evolving industry standards and frequent introduction of new and
enhanced products and services. To succeed, ENVOY must continue to:
- enhance its existing products and services;
- introduce new products and services on a timely and cost-effective basis
to meet evolving customer requirements;
- achieve market acceptance for new products and services; and
- respond to emerging industry standards and other technological changes.
Protecting Envoy's Technology Is Important To Its Success
ENVOY believes that its technology is important to its success and
competitive position. Accordingly, ENVOY devotes substantial resources to the
establishment and protection of the intellectual property rights associated with
its technology. These actions, however, may be inadequate to prevent a third
party from imitating or using ENVOY's technology or asserting certain rights in
ENVOY's technology and intellectual property rights. Additionally, ENVOY's
competitors may independently develop technologies that are substantially
equivalent or superior to ENVOY's technology. Although ENVOY is currently not
aware of any pending or threatened infringement claims, a third party also may
claim that ENVOY's products and services are infringing on its intellectual
property rights. Such claims could require ENVOY to enter into license
arrangements in order to use such products and services. ENVOY may not be able
to obtain such licenses.
Furthermore, litigation may be necessary to enforce or defend ENVOY's
intellectual property rights or defend against any infringement claims. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on ENVOY's business and financial results.
Envoy Increasingly Depends On Medical EDI And Patient Statement Transaction
Revenues
ENVOY's medical EDI and patient statement transaction revenues constituted
approximately 75% of ENVOY's total revenues in 1998. Although pharmacy EDI
transactions currently represent a majority of ENVOY's total transactions,
pharmacy EDI revenue constituted less than 15% of ENVOY's total revenues in 1998
as a result of lower per transaction prices on pharmacy transactions. In 1998,
the number of transactions processed in ENVOY's pharmacy EDI business grew at
approximately half the rate experienced in ENVOY's other businesses. Because of
the significant penetration and lower per transaction prices already existing in
the more mature pharmacy EDI sector, ENVOY believes that the percentage of total
revenue contributed by its pharmacy EDI business as presently conducted will
continue to decrease. Accordingly, ENVOY will have an increasing dependence on
medical EDI and patient statement transaction revenues. Any decline in growth
rates associated with these businesses could have a material adverse effect on
ENVOY's business and financial results.
22
<PAGE> 23
Envoy Depends On Key Executives
ENVOY's success depends upon the continued contributions of its senior
management and upon its ability to attract, motivate and retain highly skilled
technical, managerial and marketing personnel. The loss of the services of
certain of ENVOY's key executives or technical personnel, or the inability to
hire and retain qualified personnel could have a material adverse effect upon
ENVOY's business and financial results.
Envoy Faces Risks Concerning Unauthorized Access To Data Centers
Unauthorized access to ENVOY's data centers and misappropriation of ENVOY's
proprietary information could have a material adverse effect on ENVOY's business
and financial results. While ENVOY believes its current security measures and
the security measures used by third parties for whom ENVOY processes or
transmits health care information are adequate, such unauthorized access or
misappropriation could occur.
Certain Anti-takeover Provisions are Applicable to ENVOY
The charter, bylaws and shareholder rights plan of ENVOY, and Tennessee
law, contain certain provisions that may have the effect of inhibiting a
non-negotiated merger or other business combination involving ENVOY. Such
provisions are intended to encourage any person interested in acquiring ENVOY to
negotiate with and obtain the approval of ENVOY's Board of Directors. These
provisions include a staggered Board of Directors, blank check preferred stock,
supermajority voting provisions, the ability to issue stock purchase rights, and
the application of Tennessee law provisions on business combinations. In
addition, the Board of Directors has the power to designate the issuance of
shares of preferred stock. The rights and preferences for any series or class of
preferred stock may be set by the Board of Directors, in its sole discretion and
without approval of the holders of the Common Stock and the rights and
preferences of any such preferred stock may be superior to those of the Common
Stock, thus adversely affecting the rights of the holders of Common Stock.
Furthermore, there are currently authorized and outstanding 2,800,000 shares of
the Series B Preferred Stock. The Series B Preferred Stock has a liquidation
preference to the Common Stock and the creation of any other class or series of
preferred stock senior to or pari passu with the Series B Preferred Stock.
ENVOY's Common Stock Price Is Volatile And No Dividends Have Ever Been
Declared On The Common Stock
The market price of the Common Stock is volatile. Quarterly operating
results of ENVOY, changes in earnings estimates by analysts, changes in general
conditions in ENVOY's industry or the economy or the financial markets or other
developments affecting ENVOY could cause the market price of the Common Stock to
fluctuate substantially. In addition, in recent years the stock market has
experienced significant price and volume fluctuations. This volatility has had a
significant effect on the market prices of securities issued by many companies
for reasons unrelated to their operating performance. For the foreseeable
future, it is expected that earnings, if any, generated from ENVOY's operations
will be used to finance the growth of its business, and that no dividends will
be paid to holders of the Common Stock.
23
<PAGE> 24
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Reports of Independent Auditors and Independent Public Accountants ................................. 25
Consolidated Balance Sheets as of December 31, 1998 and 1997........................................ 28
Consolidated Statements of Operations - For the Years Ended December 31, 1998, 1997
and 1996............................................................................................ 29
Consolidated Statements of Shareholders' Equity - For the Years Ended December 31,
1998, 1997 and 1996................................................................................. 31
Consolidated Statements of Cash Flows - For the Years Ended December 31, 1998, 1997
and 1996............................................................................................ 32
Notes to Consolidated Financial Statements.......................................................... 34
</TABLE>
24
<PAGE> 25
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
ENVOY Corporation
We have audited the accompanying consolidated balance sheets of ENVOY
Corporation and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of two wholly-owned
subsidiaries, Professional Office Services, Inc. and XpiData, Inc. as of
December 31, 1997 and for each of the two years in the period ended December 31,
1997, which statements reflect total assets constituting 6% in 1997 and total
revenues constituting 18% in 1997 and 16% in 1996 of the related consolidated
totals. Those statements were audited by other auditors whose reports have been
furnished to us, and our opinion, insofar as it relates to data included for
Professional Office Services, Inc. and XpiData, Inc., is based solely on the
reports of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and reports of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of ENVOY Corporation and subsidiaries at
December 31, 1998 and 1997, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
---------------------
ERNST & YOUNG LLP
Nashville, Tennessee
January 29, 1999
25
<PAGE> 26
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Professional Office Services, Inc.:
We have audited the balance sheets of PROFESSIONAL OFFICE SERVICES, INC., not
separately presented herein, as of December 31, 1997, and the related statements
of operations, stockholders' equity and cash flows for each of the two years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Professional Office Services,
Inc. as of December 31, 1997, and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
-----------------------
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 11, 1998
26
<PAGE> 27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To XpiData, Inc.:
We have audited the balance sheet of XPIDATA, INC., not separately presented
herein, as of December 31, 1997, and the related statements of operations,
stockholders' equity and cash flows for each of the two years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of XpiData, Inc. as of December
31, 1997, and the results of its operations and its cash flows for each of the
two years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
------------------------
ARTHUR ANDERSEN LLP
Nashville, Tennessee
January 30, 1998
27
<PAGE> 28
ENVOY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
--------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 30,297 $ 8,598
Trade accounts receivable, less allowance for
doubtful accounts of $4,763 and $3,641 in 1998
and 1997, respectively 41,555 33,510
Inventories 2,588 2,585
Deferred income taxes 500 1,797
Other 3,311 1,811
--------- ---------
Total current assets 78,251 48,301
Property and equipment:
Equipment 41,984 35,890
Furniture and fixtures 3,003 2,433
Leasehold improvements 2,919 2,766
--------- ---------
47,906 41,089
Less accumulated depreciation and amortization (28,599) (21,581)
--------- ---------
19,307 19,508
Other assets:
Goodwill, net of amortization 53,509 67,001
Other intangibles, net of amortization 27,399 27,384
Other 5,053 4,431
--------- ---------
TOTAL ASSETS $ 183,519 $ 166,625
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,825 $ 3,334
Accrued expenses and other current liabilities 30,595 25,362
Short-term debt -- 1,315
Current portion of long-term debt 271 263
--------- ---------
Total current liabilities 33,691 30,274
Long-term debt, less current portion 366 527
Deferred income taxes 164 1,579
Other non-current liabilities 7,402 9,163
Shareholders' equity:
Preferred stock--No par value; authorized,
12,000,000 shares; issued, 2,800,000 and
3,730,233 in 1998 and 1997, respectively 41,300 55,021
Common stock--No par value; authorized,
48,000,000 shares; issued, 21,587,895 and
20,075,822 in 1998 and 1997, respectively 141,259 114,652
Additional paid-in capital 8,485 7,208
Retained deficit (49,148) (51,799)
--------- ---------
Total shareholders' equity 141,896 125,082
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 183,519 $ 166,625
========= =========
</TABLE>
See accompanying notes.
28
<PAGE> 29
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
Revenues $ 184,773 $ 137,605 $ 90,572
Operating costs and expenses:
Cost of revenues 82,327 64,247 43,500
Selling, general and administrative expenses 40,241 32,734 24,631
Research and development expenses 2,803 2,192 1,779
Depreciation and amortization expenses 36,156 34,432 25,497
Merger and facility integration costs -- -- 4,664
Write-off of acquired in-process technology -- 6,600 8,700
EMC losses -- -- 540
--------- --------- --------
Operating income (loss) 23,246 (2,600) (18,739)
Other income (expense):
Interest income 910 1,312 1,032
Interest expense (1,431) (1,577) (2,872)
--------- --------- --------
(521) (265) (1,840)
--------- --------- --------
Income (loss) before income taxes 22,725 (2,865) (20,579)
Provision for income taxes 18,481 6,333 1,717
--------- --------- --------
Net income (loss) 4,244 (9,198) (22,296)
Less preferred stock dividends -- -- (14,921)
--------- --------- --------
Net income (loss) applicable to common stock $ 4,244 $ (9,198) $(37,217)
========= ========= ========
Net income (loss) per common share:
Basic $ 0.20 $ (0.47) $ (2.25)
========= ========= ========
Diluted $ 0.17 $ (0.47) $ (2.25)
========= ========= ========
Weighted average shares outstanding:
Basic 21,179 19,686 16,519
========= ========= ========
Diluted 25,110 19,686 16,519
========= ========= ========
</TABLE>
(CONTINUED)
29
<PAGE> 30
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 1997 1996
------- --------- --------
<S> <C> <C> <C>
Pro forma net income (loss) data (unaudited),
reflecting pro forma tax provision on income
of ExpressBill companies (see Notes 4 and 16):
Historical income (loss) applicable to common
stock $ 4,244 $ (9,198) $(37,217)
Pro forma adjustment to provision for income
taxes 259 1,032 165
------- --------- --------
Pro forma net income (loss) applicable to
common stock $ 3,985 $ (10,230) $(37,382)
======= ========= ========
Pro forma net income (loss) per common share:
======= ========= ========
Basic $ 0.19 $ (0.52) $ (2.26)
======= ========= ========
Diluted $ 0.16 $ (0.52) $ (2.26)
======= ========= ========
</TABLE>
See accompanying notes.
30
<PAGE> 31
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK
-------------------- ---------------------
ADDITIONAL RETAINED
SHARES AMOUNT SHARES AMOUNT PAID-IN EARNINGS
CAPITAL (DEFICIT)
------ -------- ------ -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 14,789 $ 11,355 -- -- $7,183 $ (3,166)
Stock options exercised 163 510 -- -- -- --
Stock issued in connection with acquisitions 413 6,650 3,730 $ 40,100 -- --
Conversion of debt to common stock 170 1,786 -- -- -- --
Proceeds from issuance of stock 3,320 82,964 -- -- -- --
Capital distributions of ExpressBill -- -- -- -- -- (671)
Capital contributions of ExpressBill -- -- -- -- 10 --
Accretion of Series B preferred stock dividends -- -- -- 14,921 -- (14,921)
Net loss -- -- -- -- -- (22,296)
Other comprehensive income -- -- -- -- -- --
------ -------- ------ -------- ------ --------
Balance at December 31, 1996 18,855 103,265 3,730 55,021 7,193 (41,054)
Stock options exercised 437 1,844 -- -- -- --
Income tax benefit realized on exercise of
stock options -- 1,249 -- -- -- --
Conversion of debt to common stock 781 8,214 -- -- -- --
Proceeds from issuance of stock 3 80 -- -- -- --
Capital distributions of ExpressBill -- -- -- -- -- (1,547)
Capital contributions of ExpressBill -- -- -- -- 15 --
Net loss -- -- -- -- -- (9,198)
Other comprehensive income -- -- -- -- -- --
------ -------- ------ -------- ------ --------
Balance at December 31, 1997 20,076 114,652 3,730 55,021 7,208 (51,799)
Stock options exercised 567 2,393 -- -- -- --
Income tax benefit realized on exercise of
stock options -- 10,105 -- -- -- --
Proceeds from issuance of stock 15 388 -- -- -- --
Conversion of preferred stock 930 13,721 (930) (13,721) -- --
Capital distributions of ExpressBill -- -- -- -- -- (316)
Termination of ExpressBill S Corp election -- -- -- -- 1,277 (1,277)
Net income -- -- -- -- -- 4,244
Other comprehensive income -- -- -- -- -- --
------ -------- ------ -------- ------ --------
Balance at December 31, 1998 21,588 $141,259 2,800 $ 41,300 $8,485 $(49,148)
====== ======== ====== ======== ====== ========
<CAPTION>
ACCUMULATED TOTAL
COMPREHENSIVE SHAREHOLDERS'
INCOME EQUITY
------------- -------------
<S> <C> <C>
Balance at December 31, 1995 -- $ 15,372
Stock options exercised -- 510
Stock issued in connection with acquisitions -- 46,750
Conversion of debt to common stock -- 1,786
Proceeds from issuance of stock -- 82,964
Capital distributions of ExpressBill -- (671)
Capital contributions of ExpressBill -- 10
Accretion of Series B preferred stock dividends -- --
Net loss -- (22,296)
Other comprehensive income -- --
--------- ---------
Balance at December 31, 1996 -- 124,425
Stock options exercised -- 1,844
Income tax benefit realized on exercise of
stock options -- 1,249
Conversion of debt to common stock -- 8,214
Proceeds from issuance of stock -- 80
Capital distributions of ExpressBill -- (1,547)
Capital contributions of ExpressBill -- 15
Net loss -- (9,198)
Other comprehensive income -- --
--------- ---------
Balance at December 31, 1997 -- 125,082
Stock options exercised -- 2,393
Income tax benefit realized on exercise of
stock options -- 10,105
Proceeds from issuance of stock -- 388
Conversion of preferred stock -- --
Capital distributions of ExpressBill -- (316)
Capital contributions of ExpressBill -- --
Net income -- 4,244
Other comprehensive income -- --
--------- ---------
Balance at December 31, 1998 $ -- $ 141,896
========= =========
</TABLE>
See accompanying notes.
31
<PAGE> 32
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 4,244 $ (9,198) $ (22,296)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 36,156 34,432 25,507
Provision for losses on accounts receivable 2,696 1,461 1,112
Deferred income tax provision (benefit) (118) (995) 339
Write-off of certain assets and investments -- 6,600 10,281
Changes in assets and liabilities, net of
acquired businesses:
Decrease (increase) in accounts receivable (8,346) (9,782) (8,709)
Decrease (increase) in inventories 399 388 (543)
Decrease (increase) in other current assets (1,294) 981 (1,887)
Increase (decrease) in accounts payable,
accrued expenses and other current
liabilities 10,311 (650) (621)
-------- -------- ---------
Net cash provided by operating activities 44,048 23,237 3,183
INVESTING ACTIVITIES
Net decrease in short-term investments -- -- 5,103
Purchases of property and equipment (6,185) (8,744) (5,356)
Decrease (increase) in other assets 517 (1,998) --
Payments for businesses acquired, net of cash
acquired of $750, $0 and $5,543 in 1998, 1997
and 1996, respectively (17,462) (40,412) (93,744)
-------- -------- ---------
Net cash used in investing activities (23,130) (51,154) (93,997)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock -- -- 40,100
Proceeds from issuance of common stock 2,781 1,924 88,474
Capital distributions of Express Bill (316) (1,391) (671)
Capital contributions of Express Bill -- 15 10
Proceeds from long-term debt -- -- 44,267
Payments on long-term debt (369) (304) (44,387)
Proceeds from (payments on) short-term debt (1,315) (466) 639
Payment of deferred financing costs -- -- (1,200)
-------- -------- ---------
Net cash provided by (used in) financing
activities 781 (222) 127,232
-------- -------- ---------
Net increase (decrease) in cash and cash
equivalents 21,699 (28,139) 36,418
Cash and cash equivalents at beginning of year 8,598 36,737 319
-------- -------- ---------
Cash and cash equivalents at end of year $ 30,297 $ 8,598 $ 36,737
======== ======== =========
</TABLE>
32
<PAGE> 33
ENVOY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOW
INFORMATION
Interest paid $ (141) $ (238) $ (2,357)
Interest received 910 1,250 1,024
Income taxes paid (5,906) (5,952) (371)
NONCASH TRANSACTIONS
Acquisitions
Working capital $ -- $ -- $ 302
Intangible assets -- -- 1,348
Common stock issued -- -- (1,650)
-------- -------- ---------
Cash transferred $ -- $ -- $ --
======== ======== =========
Conversion of debt to common stock $ -- $ 8,214 $ 1,786
======== ======== =========
Conversion of preferred stock to common stock $ 13,721 $ -- $ --
======== ======== =========
</TABLE>
See accompanying notes.
33
<PAGE> 34
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
ENVOY Corporation, a Tennessee corporation (the "Company" or "New ENVOY"), was
incorporated in August 1994 as a wholly-owned subsidiary of ENVOY Corporation, a
Delaware corporation ("Old ENVOY"), and through a stock dividend distribution by
Old ENVOY of all of the outstanding shares of the common stock of New ENVOY (the
"Distribution") the Company ceased to be a wholly-owned subsidiary of Old ENVOY.
Immediately after the Distribution, Old ENVOY was merged with and into First
Data Corporation ("First Data"). Old ENVOY was formed in 1981 to develop and
market electronic transaction processing services to capture and transmit time
critical information for the financial services and health care markets. In
1995, the assets and liabilities of Old ENVOY associated with the electronic
transaction processing for the health care markets and governmental benefits
programs were transferred to New ENVOY. The Company currently provides
electronic data interchange ("EDI") and transaction processing services to
participants in the health care market, including pharmacies, physicians,
hospitals, dentists, billing services, commercial insurance companies, managed
care organizations, state and federal government agencies and others.
As more fully discussed in Note 4, on February 27, 1998, the Company completed
business combinations with Professional Office Services, Inc. ("POS"), XpiData,
Inc. ("XpiData") and Automated Revenue Management, Inc. ("ARM"; and together
with POS and XpiData sometimes collectively referred to as the "ExpressBill
Companies"). These transactions have been accounted for as poolings of interests
and the Company's historical consolidated financial statements have been
restated to include the accounts and results of operations of the ExpressBill
Companies.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. The carrying amount approximates
fair value because of the short maturity of those instruments.
34
<PAGE> 35
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
CONCENTRATION OF CREDIT RISK
The Company has one customer that accounted for approximately 17% of the
Company's consolidated revenues for 1998 and 12% for 1997, and accounted for
approximately 14% and 16% of consolidated accounts receivable at December 31,
1998 and 1997, respectively. No single customer accounted for more than 10% of
consolidated revenues in 1996.
INVENTORIES
Inventories consist primarily of point-of-service terminals and supplies used in
the patient statement business and are stated at the lower of cost (first-in,
first-out method) or market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is provided over the
estimated lives of the respective assets on the straight-line basis principally
over five to seven years. Depreciation expense totaled $7,067,000, $6,141,000
and $4,920,000 for 1998, 1997 and 1996, respectively.
OTHER ASSETS
Other assets consist primarily of goodwill and other intangible assets as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1998 1997 AMORTIZATION
PERIOD
--------- --------- -----------
<S> <C> <C> <C>
Goodwill $ 115,212 $ 105,059 3-15 years
Less accumulated amortization (61,703) (38,058)
--------- ---------
$ 53,509 $ 67,001
========= =========
Submitter and payor relationships $ 12,700 $ 12,700 9 years
Customer contracts 17,541 13,554 9-10 years
Developed technology 4,300 4,300 2 years
Covenants not to compete 6,237 4,081 2-5 years
Trademarks and tradenames 350 350 3-7 years
Assembled work force 3,710 3,140 3-7 years
--------- ---------
44,838 38,125
Less accumulated amortization (17,439) (10,741)
--------- ---------
$ 27,399 $ 27,384
========= =========
</TABLE>
Amortization expense related to such intangible assets for the years ended
December 31, 1998, 1997 and 1996 was $29,089,000, $28,292,000 and $20,578,000,
respectively. Amortization is provided using the straight line method
35
<PAGE> 36
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
over periods ranging from two to fifteen years. In establishing the amortization
periods for intangible assets, the Company considers several factors, including
legal, regulatory, or contractual provisions; effects of obsolescence, demand,
competition and other economic factors; service life expectancies of employees;
and expected actions of competitors and others. The Company reviews its
long-lived and intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. The
measurement of possible impairment is based upon determining whether projected
undiscounted future cash flows of the acquired business or from the use of the
asset over the remaining amortization period is less than the carrying amount of
the asset. As of December 31, 1998, in the opinion of management, there has been
no such impairment.
REVENUE RECOGNITION
Processing services revenue is recognized as the transactions are processed.
Effective January 1, 1998, the Company adopted American Institute of Certified
Public Accountants ("AICPA") Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). Revenue from software product arrangements that
include customization or modification of the software is recognized in
accordance with SOP 97-2. Revenues from software product sales is recognized
provided the collection of the sales proceeds is deemed probable and no
significant vendor obligations remain. The application of SOP 97-2 did not have
a material impact on the Company's consolidated financial statements for the
year ended December 31, 1998. Other revenue, including hardware sales,
maintenance, licensing, and support activities, is generally recognized as
hardware is shipped or as services are provided. Receivables generally are due
within 30 days and do not require collateral.
EARNINGS (LOSS) PER COMMON SHARE
Basic and diluted earnings per share are calculated in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share." Basic earnings per share excludes any dilutive effects of
options, warrants and convertible securities.
RESEARCH AND DEVELOPMENT
Research and development expenses of $2,803,000 in 1998, $2,192,000 in 1997 and
$1,779,000 in 1996 were charged to expense as incurred until technological
feasibility had been established for the applicable product. Thereafter, all
software development costs are capitalized until the products are available for
general use by customers. The Company has not capitalized any significant
software costs to date.
INCOME TAXES
The Company and XpiData have used the liability method of accounting for income
taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." The former
stockholders of POS and ARM elected under Subchapter S of the Internal Revenue
Code (the "Code") to include such companies' income in their own income for
federal and state income tax purposes. Accordingly, POS and ARM were not subject
to federal or state income taxes for periods prior to the Company's business
combinations with the ExpressBill Companies.
36
<PAGE> 37
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
STOCK BASED COMPENSATION
Under various benefit plans, the Company grants stock options for a fixed number
of shares to employees and directors with an exercise price which approximates
the fair value of the shares at the date of grant. The Company also has an
Employee Stock Purchase Plan, which is qualified under Section 423 of the Code.
The Company accounts for stock based compensation in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), and, accordingly, recognizes no compensation expense.
RECLASSIFICATIONS
Certain reclassifications have been made in the 1997 and 1996 consolidated
financial statements to conform with the 1998 presentation.
SEGMENT DISCLOSURES
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 superseded SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise." SFAS No.
131 establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The Company operates in one industry segment and, accordingly, the adoption of
SFAS No. 131 had no significant effect on the Company.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income encompasses all changes in
shareholders' equity (except those arising from transactions with owners) and
includes net income, net unrealized capital gains or losses on available for
sale securities and foreign currency translation adjustments. Adoption of this
pronouncement has not had a material impact on the Company's results of
operations, as comprehensive income for 1998 was the same as net income for the
Company.
3. PENDING MERGER WITH QUINTILES TRANSNATIONAL CORP. ("QUINTILES")
On December 15, 1998, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") with Quintiles Transnational Corp. ("Quintiles")
pursuant to which the Company is anticipated to merge with and become a
wholly-owned subsidiary of Quintiles in a transaction expected to be accounted
for as a pooling of interests (the "Merger"). Under the terms of the Merger
Agreement, each issued and outstanding share of ENVOY Common Stock (the "Common
Stock"), and each issued and outstanding share of Series B Convertible Preferred
Stock (the "Series B Preferred Stock"), will be exchanged for 1.166 shares of
Quintiles common stock. In addition, Quintiles will convert any remaining
unexercised ENVOY stock options into Quintiles stock options on the same terms
and conditions, except that the number of shares and exercise price will be
adjusted for the effect of the exchange ratio. The Merger is subject to approval
by the Company's and Quintiles' shareholders and certain other conditions.
4. BUSINESS COMBINATIONS
BUSINESS COMBINATIONS ACCOUNTED FOR AS POOLINGS OF INTERESTS
On February 27, 1998, the Company completed business combinations with the three
companies operating the ExpressBill patient statement processing and printing
services businesses, for an aggregate of 3,500,000 shares of Common Stock.
Shareholders of XpiData, based in Scottsdale, Arizona, received 1,365,000 shares
and shareholders
37
<PAGE> 38
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
of POS and its affiliated company, ARM, both of which are based in Toledo, Ohio,
received an aggregate of 2,135,000 shares. The ExpressBill patient statement
services include electronic data transmission and formatting, statement printing
and mailing services for health care providers and practice management system
vendors. These transactions have been accounted for as poolings of interests.
Accordingly, the Company's historical consolidated financial statements for 1997
and 1996 have been restated to include the accounts and results of operations of
the ExpressBill Companies.
BUSINESS COMBINATIONS ACCOUNTED FOR AS PURCHASES
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. The financial statements 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.
The Company paid $88,354,000 to the NEIC stockholders and incurred certain
transaction and acquisition costs of $5,947,000, plus the assumption of certain
liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price and transaction costs $ 94,301
Add liabilities assumed:
Current liabilities 9,033
Long-term obligations 186
Other liabilities 111
Deferred tax liability 7,682
--------
17,012
Less assets acquired:
Current assets (14,085)
Property, plant and equipment, net (3,000)
Deferred tax asset (5,797)
Deferred loan costs (1,200)
Identifiable intangibles:
Developed technology (2,100)
Covenant not to compete (4,000)
Assembled work force (1,400)
Submitter and payor relationships (12,100)
--------
(43,682)
Less write-off of acquired in-process technology (8,000)
--------
Goodwill $ 59,631
========
</TABLE>
Goodwill of $59,631,000 is being amortized over three years. Submittor and payor
relationships are being amortized over nine years; developed technology and
covenants not to compete are being amortized over two years; and assembled work
force is being amortized over seven years. In connection with the NEIC
acquisition, the Company incurred a one time write-off of acquired in-process
technology of $8,000,000. This amount represents an allocation
38
<PAGE> 39
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
of purchase price to projects aimed at facilitating the ease of participation of
health care providers into clearinghouse technologies and ensuring compliance
with regulatory and other industry standards. Such amounts were charged to
expense in 1996 because the projects related to research and development that
had not reached technological feasibility and for which there was no alternative
future use. Fair value of acquired in-process technology was determined based on
various factors, including estimates of after-tax cash flows, the stage of
completion of the in-process technology at the date of acquisition and estimates
of total project costs.
The NEIC acquisition was financed through equity and debt financing. An
aggregate of 3,730,233 shares of Series B Preferred Stock were issued to three
investors for a total purchase price of $40,100,000. Additionally, the Company
issued 333,333 shares of Common Stock to various investors for an aggregate
purchase price of $5,000,000. The Company also entered into a credit agreement,
whereby the Company obtained $50,000,000 in bank financing in the form of a
$25,000,000 revolving credit facility and a $25,000,000 term loan. An additional
840 shares of NEIC cumulative redeemable preferred stock were redeemed by the
Company on August 1, 1996 at a redemption price of approximately $2,200,000.
TELECLAIMS, INC. ("TELECLAIMS")
On March 1, 1996, the Company acquired all the issued and outstanding capital
stock of Teleclaims in exchange for 73,242 shares of Common Stock resulting in a
purchase price of approximately $1,500,000, plus the assumption of certain
liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 1,500
Add liabilities assumed 229
Less assets acquired:
Current assets (137)
Property and equipment, net (172)
Other assets (72)
Submittor and payor relationships (300)
-------
(681)
Less write-off of acquired in process technology (700)
-------
Goodwill $ 348
=======
</TABLE>
Goodwill of $348,000 is being amortized over three years and submittor and payor
relationships in the amount of $300,000 are being amortized over nine years.
Also recorded as part of the Teleclaims acquisition was a one time write-off of
acquired in-process technology of $700,000. This amount represents an allocation
of purchase price to projects for the development of new products for health
care transaction processing. Such amounts were charged to expense in 1996
because the projects related to research and development that had not reached
technological feasibility and for which there was no alternative future use.
Fair value of acquired in-process technology was determined based on various
factors, including estimates of after-tax cash flows, the stage of completion of
the in-process technology at the date of acquisition and estimates of total
project costs.
39
<PAGE> 40
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
NATIONAL VERIFICATION SYSTEMS, L.P. ("NVS")
On September 13, 1996, the Company completed the acquisition of certain assets
and liabilities of NVS for $2,150,000 in cash, plus the assumption of certain
liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 2,150
Add liabilities assumed 51
Less assets acquired:
Current assets (83)
Property and equipment, net (254)
Customer contracts (1,500)
-------
(1,837)
-------
Goodwill $ 364
=======
</TABLE>
Goodwill of $364,000 is being amortized over three years and customer contracts
in the amount of $1,500,000 are being amortized over nine years.
PROFESSIONAL OFFICE SYSTEMS, INC. ("POSI")
On October 31, 1996, the Company acquired all the issued and outstanding capital
stock of POSI, the EDI clearinghouse for Blue Cross and Blue Shield of the
National Capital Area, for approximately $6,400,000 in cash, plus the assumption
of certain liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 6,400
Add liabilities assumed 1,581
Less assets acquired:
Current assets (1,059)
Property and equipment, net (180)
Identifiable intangibles:
Customer contracts (5,100)
Assembled work force (1,200)
-------
(7,539)
-------
Goodwill $ 442
=======
</TABLE>
Goodwill of $442,000 is being amortized over three years. Customer contracts are
being amortized over nine years and assembled work force is being amortized over
seven years.
40
<PAGE> 41
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
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 and payments of $2,325,000 based upon revenue earned
during a specified period following the acquisition, plus the assumption of
certain liabilities. During 1998, the Company reduced its preliminary estimate
of goodwill by $711,000 relating to a revised estimate of the payments based on
revenues. The final allocation of purchase price is summarized as follows (in
thousands):
<TABLE>
<S> <C>
Purchase price $ 4,000
Add liabilities assumed:
Current liabilities 3,979
Less assets acquired:
Current assets (446)
Property and equipment, net (80)
Identifiable intangibles:
Developed technology (600)
Assembled work force (340)
Submittor and payor relationships (300)
Tradenames (100)
-------
(1,866)
Less write-off of acquired in-process technology (600)
-------
Goodwill $ 5,513
=======
</TABLE>
Goodwill of $5,513,000 is being amortized over a period of 15 years. Developed
technology is being amortized over two years; assembled work force is being
amortized over seven years; submittor and payor relationships are being
amortized over nine years; and tradenames are being amortized over seven years.
Also recorded as part of the DSS acquisition was a one-time write-off of
acquired in-process technology of $600,000. This amount represents an allocation
of purchase price to projects for the development of additional interfaces and
functionality for accounts receivable management service offerings provided by
DSS. This amount was charged to expense in 1997 because the projects related to
research and development that had not reached technological feasibility and for
which there was no alternative future use. Fair value of acquired in-process
technology was determined based on various factors, including estimates of
after-tax cash flows, the stage of completion of the in-process technology at
the date of acquisition and estimates of total project costs.
41
<PAGE> 42
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
HEALTHCARE DATA INTERCHANGE CORPORATION ("HDIC")
On August 7, 1997, the Company acquired all the issued and outstanding capital
stock of HDIC, the EDI health care services subsidiary of Aetna U.S. Healthcare
Inc. ("AUSHC"), for approximately $36,400,000 in cash, plus the assumption of
certain liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 36,400
Add liabilities assumed:
Unfavorable contracts 14,570
Other liabilities 993
--------
15,563
Less assets acquired:
Cash (11)
Property and equipment, net (52)
Identifiable intangibles:
Customer contract (5,000)
Developed technology (1,600)
Tradenames (250)
Assembled work force (200)
--------
(7,113)
Less write-off of acquired in process technology (6,000)
--------
Goodwill $ 38,850
========
</TABLE>
Goodwill of $38,850,000 is being amortized over a period of 15 years; developed
technology is being amortized over two years; tradenames and assembled work
force are being amortized over three years. In addition, the Company and AUSHC
simultaneously entered into a 10-year 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. The amount recorded for this
customer contract is being amortized over 10 years. Liabilities assumed include
approximately $14,570,000 relating to the assumption of unfavorable contracts.
At December 31, 1998, the remaining liability for unfavorable contracts was
$10,297,000, with $7,402,000 classified as a non-current liability, and
$2,895,000 classified as a current liability in accrued expenses and other
current liabilities. Also recorded as part of the HDIC acquisition was a
one-time write-off of acquired in-process technology of $6,000,000. This amount
represents an allocation of purchase price to projects for the development of
new transaction sets which would allow health care providers to submit
additional health care transactions electronically. This amount was charged to
expense in 1997 because the projects related to research and development that
had not reached technological feasibility and for which there was no alternative
future use. Fair value of acquired in-process technology was determined based on
various factors, including estimates of after-tax cash flows, the stage of
completion of the in-process technology at the date of acquisition and estimates
of total project costs.
42
<PAGE> 43
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
SYNERGY HEALTH CARE, INC. ("SYNERGY")
On May 6, 1998, the Company acquired all the issued and outstanding capital
stock of Synergy for $10,200,000 in cash, including amounts paid to certain
selling stockholders for noncompete agreements, plus the assumption of certain
liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 10,200
Add liabilities assumed: 441
Less assets acquired:
Cash (550)
Accounts receivable and other (917)
Property and equipment, net (281)
Identifiable intangibles:
Customer contracts (1,587)
Assembled work force (170)
Noncompete agreements (200)
------------
Goodwill (3,705)
------------
$ 6,936
============
</TABLE>
Goodwill of $6,936,000 is being amortized over a period of 15 years; customer
contracts are being amortized over nine years; assembled work force is being
amortized over seven years; and noncompete agreements are being amortized over
five years.
CONTROL-O-FAX CORPORATION
Effective as of October 1, 1998, the Company completed the acquisition of
substantially all of the assets of Control-O-Fax Corporation and its
wholly-owned subsidiary Control-O-Fax Systems, Inc. (collectively,
"Control-O-Fax") for $8,250,000 in cash, plus the assumption of certain
liabilities, summarized as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 8,250
Add liabilities assumed: 1,468
Less assets acquired:
Cash (200)
Accounts receivable and other (2,589)
Property and equipment, net (401)
Identifiable intangibles:
Customer contracts (2,400)
Assembled work force (400)
Noncompete agreements (600)
------------
Goodwill (6,590)
------------
$ 3,128
============
</TABLE>
43
<PAGE> 44
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Goodwill of $3,128,000 is being amortized over a period of 15 years; customer
contracts are being amortized over nine years; assembled work force is being
amortized over seven years; and noncompete agreements are being amortized over
three years.
The following presents unaudited pro forma results of operations (including the
one-time write-offs of acquired in- process technology and all merger and
facility integration costs) for the years ended December 31, 1997 and 1996
assuming the acquisitions accounted for as purchases, including EMC*Express,
Inc. ("EMC") (See Note 7), had been consummated at the beginning of the periods
presented (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996
--------- ---------
<S> <C> <C>
Revenues $144,099 $115,978
Net loss applicable to common stock (13,985) (45,744)
Net loss per common share (0.71) (2.72)
</TABLE>
Pro forma results of operations for 1998 acquisitions have not been presented
because the results of operations of Synergy and Control-O-Fax, the Company's
only business combinations accounted for as purchases that were completed during
1998, are not material to those of the Company.
5. 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 1997. The results of operations of the
Government Services Business are included in the Company's consolidated
statements of operations through the date of disposition.
6. 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. Certain costs of this plan to reorganize were accrued 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 were not
part of the purchase price allocation. The costs for the year ended December 31,
1996 associated with this plan that were accrued totaled $1,772,000 consisting
of $372,000 for exit costs associated with lease terminations, $200,000 for
personnel costs, and $1,200,000 for writedowns of impaired assets. These costs
were incurred as a direct result of the plan and do not benefit future
continuing 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. Amounts charged against
this liability for 1997 and 1996 were approximately $385,000 and $1,434,000,
respectively. Additionally, the Company incurred costs of $2,892,000 to
integrate the acquired businesses with the Company, consisting primarily of
travel costs incurred by employees during the transition and integration of the
acquired businesses' operations and costs paid to consultants to assist the
Company during the transition and integration process. These costs benefit the
44
<PAGE> 45
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
future continuing operations of the Company and, accordingly, were expensed as
incurred. The Company does not expect to incur any further merger and facility
integration costs related to NEIC and Teleclaims.
7. LOSS IN INVESTEE
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 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. Accordingly, the Company recorded an adjustment in the fourth quarter
of 1995 in the amount of $1,637,000 to recognize an impairment in the carrying
value of its investment including writing off advances and providing for future
commitments to EMC. During 1995, the Company recognized losses for its initial
investment and option aggregating $820,000, advances of $817,000 and equity
losses of $139,000 for a total loss in the EMC investment of $1,776,000.
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 during the fourth quarter of 1995.
Accordingly, the funding of EMC's operating costs in 1996 were charged to
operating expenses. The Company was committed through March 31, 1996 to continue
to fund certain operating costs of EMC. The amounts disbursed for the funding of
these costs during the first two quarters of 1996 were $540,000.
In March 1996, following the termination of the Management Agreement and the
Option, certain shareholders of EMC filed a lawsuit 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. The Company recorded $1,954,000
of other identifiable intangible assets related to the EMC acquisition. The
operations of EMC are included in the consolidated statements of operations from
the date of acquisition.
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consists of the following (in
thousands):
45
<PAGE> 46
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1998 1997
------- -------
<S> <C> <C>
Current portion of liability for unfavorable contracts $ 2,895 $ 3,910
Liability to former owners of DSS -- 2,200
Unearned income 2,153 1,942
Accrued communication expense 3,710 1,982
Accrued income taxes 4,265 1,679
Accrued salaries and benefits 3,614 2,348
Accrued vendor incentives 4,097 1,808
Customer deposits 3,308 1,894
Other 6,553 7,599
------- -------
$30,595 $25,362
======= =======
</TABLE>
The liability to former owners of DSS was paid in February 1998 and is related
to the DSS acquisition, and the liability for unfavorable contracts is related
to the HDIC acquisition (see Note 4).
9. SHORT-TERM DEBT
At December 31, 1997, the ExpressBill Companies had various lines of credit
collateralized by certain assets. The lines of credit charged interest at rates
ranging from prime rate to prime plus 2%, which resulted in interest rates
ranging from 8.5% to 10.5% at December 31, 1997. These lines of credit included
various financial and other covenants, and were due on demand. The Company was
in compliance with these covenants or obtained appropriate waivers at December
31, 1997. The outstanding balance under these lines of credit was $1,315,000 at
December 31, 1997. All borrowings under those lines of credit were repaid in
1998 and the lines were terminated.
10. LONG-TERM DEBT
In connection with the Distribution and First Data merger, the Company entered
into a $10,000,000 note agreement with First Data on June 6, 1995 (the
"Convertible Note"). The Convertible Note was convertible, at the option of the
holder at any time, into fully paid and nonassessable shares of Common Stock at
the rate of one share for each $10.52 face amount. The conversion price and
conversion rights were subject to adjustment for stock dividends, subdivision,
and combinations, subsequent issuances of Common Stock, issuances of certain
rights, stock purchase rights or convertible securities and certain issuer
tender offers. During 1996, First Data sold the Convertible Note to an unrelated
third party for $13,500,000.
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 pursuant to the demand of the current holders of the Convertible
Note 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 $2,245,000 in principal amount of the Convertible Notes was converted into
213,389 shares of Common Stock and sold pursuant to the registration statement.
In a series of unrelated transactions, the remaining $7,755,000 in principal
amount of the Convertible Notes was
46
<PAGE> 47
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
converted into 737,167 shares of Common Stock through June 1997. Accordingly, no
Convertible Notes remain outstanding.
In November 1996, the Company amended its revolving credit facility to increase
the amount of credit available thereunder to $50,000,000. As of December 31,
1998, the Company had no amounts outstanding under the amended credit facility.
Any outstanding borrowing made against the amended credit facility would bear
interest at a rate equal to the Base Rate (as defined in the amended credit
facility) or LIBOR. The amended credit facility expires June 30, 2000. The
amended credit facility contains financial covenants applicable to the Company
including ratios of debt to capital, annualized EBITDA to annualized interest
expense, restrictions on payment of dividends, 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 amended credit facility is secured by substantially all of the
assets of the Company and its subsidiaries.
Long-term debt at December 31, 1998 and 1997 consists primarily of capital lease
obligations payable through the year 2003, at interest rates ranging from 9.25%
to 22%. Annual long-term debt and capital lease obligations principal
requirements are $271,000 in 1999, $209,000 in 2000, $118,000 in 2001, $35,000
in 2002, and $4,000 in 2003, with none thereafter.
11. LEASES AND COMMITMENTS
The Company leases certain equipment and office space under operating leases.
Rental expense incurred under the leases during the years ended December 31,
1998, 1997 and 1996 was approximately $4,175,000, $2,207,000 and $1,955,000,
respectively.
Future minimum rental payments at December 31, 1998 under operating lease
arrangements are as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 4,433
2000 3,759
2001 3,296
2002 2,680
2003 2,437
Thereafter 6,467
--------
Total minimum lease payments $ 23,072
========
</TABLE>
12. STOCK INCENTIVE PLANS
The Company has elected to follow APB No. 25 and related interpretations in
accounting for its stock options because, as discussed below, the alternative
fair value accounting provided for under SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), requires use of option valuation
models that were not developed for use in valuing stock options. Under APB No.
25, because the exercise price of the Company's stock options equals the market
price of the underlying stock on the date of grant, no compensation expense is
recognized.
At December 31, 1998, the Company had reserved 6,649,640 shares of Common Stock
for issuance in connection with the stock option plans. Summaries of stock
options outstanding are as follows:
47
<PAGE> 48
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
<TABLE>
<CAPTION>
WEIGHTED-
OPTION AVERAGE
NUMBER OF PRICE PER EXERCISE
SHARES SHARE PRICE
---------- -------------- ----------
<S> <C> <C> <C>
Outstanding, December 31, 1995 3,035,000 $ 1.83-$18.00 $ 6.81
Granted 625,000 20.25-40.25 24.53
Exercised (163,000) 1.83-7.75 3.12
Canceled (268,000) 7.75-10.00 9.02
Outstanding, December 31, 1996 3,229,000 1.83-40.25 10.25
Granted 834,000 21.25-36.75 23.22
Exercised (437,000) 1.83-20.75 4.25
Canceled (224,000) 7.75-40.25 19.92
Outstanding, December 31, 1997 3,402,000 1.83-37.00 13.58
Granted 832,000 21.875-44.875 37.13
Exercised (567,000) 1.83-30.75 4.22
Canceled (225,000) 10.00-40.625 27.49
Outstanding, December 31, 1998 3,442,000 $ 3.50-$44.875 $ 19.90
</TABLE>
The number of stock options exercisable and the weighted average exercise price
of these options was 798,343 and $8.30 and 1,147,500 and $5.76 at December 31,
1998 and 1997, respectively. The weighted-average fair value of options granted
during 1998 and 1997 was $17.71 and $10.96, respectively. The weighted-average
remaining contractual life of those options is 5 years.
The Company's Amended and Restated 1995 Employee Stock Incentive Plan has
authorized the grant of options to key employees and consultants of the Company
for up to 3,000,000 shares of Common Stock. All options granted have 10 year
terms from the grant date and vest over periods from one to five years from the
date of grant. At December 31, 1998, options for the purchase of 2,791,935
shares were outstanding under this plan. No further grants will be made under
this plan.
The Company's Amended and Restated 1995 Stock Option Plan for Outside Directors
has authorized the grant of options to the Company's non-employee directors for
up to 60,000 shares of Common Stock. All options granted have 10 year terms and
become fully exercisable one year from the date of grant. At December 31, 1998,
options for the purchase of 30,000 shares were outstanding under this plan.
The Company's 1998 Stock Incentive Plan has authorized the grant of options to
key employees, consultants and non-employee directors of the Company for up to
2,000,000 shares of Common Stock. All options granted have 10-year terms from
the grant date and vest over periods from two to four years from the date of
grant. At December 31, 1998, options for the purchase of 113,000 shares were
outstanding under this plan.
The Company's 1998 ExpressBill Stock Option Plan has authorized the grant of
options to key employees of the ExpressBill Companies for up to 300,000 shares
of Common Stock. All options granted have 10-year terms from the grant date and
vest over periods from two to five years from the date of grant. At December 31,
1998, options for the purchase of 257,000 shares were outstanding under this
plan. No further grants will be made under this plan.
48
<PAGE> 49
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The Company's 1998 Synergy Stock Option Plan has authorized the grant of options
to key employees of Synergy for up to 75,000 shares of Common Stock. All options
granted have 10-year terms from the grant date and vest over periods from two to
five years from the date of grant. At December 31, 1998, options for the
purchase of 75,000 shares were outstanding under this plan. No further grants
will be made under this plan.
Prior to the First Data merger, Old ENVOY had outstanding non-qualified stock
options for the purchase of 1,214,640 shares of Common Stock. The grants were
made under the 1987 Stock Option Plan, the 1990 Director Stock Option Plan, the
1990 Officer and Employee Stock Option Plan, the 1992 Non-Employee Directors'
Plan and the 1992 Incentive Plan. All of these grants were made prior to the
First Data merger, no further grants may be made under these plans. All options
granted thereunder have 10 year terms from the grant date. In connection with
the Distribution and First Data merger, each holder of an outstanding option to
purchase shares of Old ENVOY common stock (an "Old ENVOY Option") received an
option to purchase an equal number of shares of Common Stock (a "New ENVOY
Option"). The exercise price of the New ENVOY Option is equal to a percentage
(the "distribution percentage") of the exercise price of the Old ENVOY Option.
The distribution percentage was established based upon the market prices of
Common Stock and Old ENVOY Common Stock as determined by the ratio of (i) the
average of the closing prices of Common Stock on the three trading days
immediately following the First Data merger to (ii) the closing price of Old
ENVOY Common Stock immediately prior to the First Data merger. The distribution
percentage was 33.33% and resulted in a retroactive correspondingly downward
adjustment of each New ENVOY Option. The distribution percentage adjustment was
designed to place the holder of an Old ENVOY Option in the same economic
position after the First Data merger as before the First Data merger. At
December 31, 1998, options for the purchase of 175,341 shares were outstanding
and fully exercisable under these plans.
Pro forma information regarding net loss and loss per share is required by SFAS
No. 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions for 1998, 1997 and 1996,
respectively: risk-free interest rates of 4.53% and 5.77% and ranging from 5.36%
to 6.69%; no dividend yield; volatility factors of the expected market price of
Common Stock ranging from .433 to .500 and .436 to .455 and .385 to .419,
respectively; and a weighted-average expected life of the option of 5 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands, except for loss per share information):
49
<PAGE> 50
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
<TABLE>
<CAPTION>
1998 1997 1996
----------- ---------- ----------
<S> <C> <C> <C>
Pro forma net loss applicable to common stock $ (794) $ (12,435) $ (38,957)
Pro forma net loss per common share:
Basic $ (0.04) $ (0.63) $ (2.36)
Diluted $ (0.04) $ (0.63) $ (2.36)
</TABLE>
Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until the
new rules are applied to all outstanding awards.
The Company implemented the ENVOY Corporation Employee Stock Purchase Plan (the
"ESPP") effective July 1, 1997, at which time participating employees became
entitled to purchase Common Stock at a discounted price through accumulated
payroll deductions. Under the terms of the ESPP, the purchase price of the
Common Stock for participating employees will be the lesser of (i) 85% of the
closing market price of the Common Stock on the last trading day of each
quarterly enrollment period or (ii) 85% of the closing market price of the
Common Stock on the first trading day of each quarterly enrollment period. The
Company has reserved 1,000,000 shares of Common Stock for issuance under the
ESPP. Shares issued under the ESPP totaled approximately 15,000 and 3,000 in
1998 and 1997, respectively.
13. SERIES B PREFERRED STOCK
In March 1996, the Company issued 3,730,233 shares of Series B Preferred Stock
in connection with the NEIC acquisition (see Note 4). The Series B Preferred
Stock is recorded in the accompanying consolidated balance sheets at the fair
market value of the underlying shares on the date of the related Stock Purchase
Agreement, $55,021,000 in the aggregate, or $14.75 per share. The difference
between the issuance price of $40,100,000, or $10.75 per share, and the fair
value of the underlying shares on the date of the related Stock Purchase
Agreement has been presented in the consolidated financial statements as a
dividend of Series B Preferred Stock for the year ended December 31, 1996. Each
share of Series B Preferred Stock is convertible into one share of Common Stock
at any time. Each share of Series B Preferred Stock shall be entitled to vote on
all matters that the holders of Common Stock are entitled to vote upon, on an
as-if-converted basis, and shall be entitled to vote as a class with respect to
actions adverse to any rights of the Series B Preferred Stock and the creation
of any other class of preferred stock senior to or pari passu with the Series B
Preferred Stock. The Series B Preferred Stock shall be entitled to dividends
only to the extent cash dividends are declared and paid on the Common Stock on
an as if converted basis. From and after January 1, 1999, the Company shall have
an optional right to redeem all of the outstanding Series B Preferred Stock at a
redemption price of $10.75 per share, provided that the average sale price of
Common Stock for 60 trading days prior to the notice of redemption is not less
than $21.50 per share. In February 1998, 930,233 shares of Series B Preferred
Stock were converted into an equal number of shares of Common Stock.
14. SHAREHOLDER RIGHTS PLAN
In June 1995, the Board of Directors adopted a shareholder rights plan for the
Company. The purpose of the shareholder rights plan is to protect the interests
of the Company's shareholders if the Company is confronted with coercive or
potentially unfair takeover tactics by encouraging third parties interested in
acquiring the Company to negotiate with the Board of Directors.
50
<PAGE> 51
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The shareholder rights plan is a plan by which the Company has distributed
rights ("Rights") to purchase (at the rate of one Right per share of Common
Stock) one-tenth of one share of the Company's Series A Preferred Stock at an
exercise price of $60 per tenth of a share. The Rights are attached to the
Common Stock and may be exercised only if a person or group (excluding certain
share acquisitions as described in the plan) acquires 20% of the outstanding
Common Stock or initiates a tender or exchange offer that would result in such
person or group acquiring 10% or more of the outstanding Common Stock. Upon such
an event, the Rights "flip-in" and each holder of a Right will thereafter have
the right to receive, upon exercise, Series A Preferred Stock having a value
equal to two times the exercise price. All Rights beneficially owned by the
acquiring person or group triggering the "flip-in" will be null and void.
Additionally, if a third party were to take certain action to acquire the
Company, such as a merger or other business combination, the Rights would
"flip-over" and entitle the holder to acquire shares of the acquiring person
with a value of two times the exercise price. The Rights are redeemable by the
Company at any time before they become exercisable for $0.01 per Right and
expire in 2005.
In connection with the Company's pending merger with Quintiles (see Note 3), the
Company amended the shareholder rights plan to exclude the Merger and related
transactions from triggering an event allowing exercise of the Rights and from
certain other restrictions under the shareholder rights plan.
15. COMMON STOCK OFFERING
In August 1996, the Company completed an underwritten public offering of
3,320,000 shares of Common Stock at $26.50 per share. Net proceeds from this
offering were approximately $83,000,000, and were used to retire indebtedness of
$25,000,000 outstanding under a term loan agreement and indebtedness of
approximately $12,900,000 outstanding under a $25,000,000 revolving credit
facility. The remaining proceeds were used for general corporate purposes,
including funding working capital requirements and acquisitions.
16. INCOME TAXES
The provision for income taxes was comprised of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
Current:
Federal $ 15,121 $ 4,957 $ 271
State 3,478 2,429 1,107
-------- ------- -------
Total current 18,599 7,386 1,378
Deferred:
Federal (105) 421 1,139
State (13) (1,474) (800)
-------- ------- -------
Total deferred (118) (1,053) 339
-------- ------- -------
Provision for income taxes $ 18,481 $ 6,333 $ 1,717
======== ======= =======
</TABLE>
51
<PAGE> 52
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The reconciliation of income tax computed by applying the U.S. federal statutory
rate to the actual income tax provision follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Income tax provision (benefit) at U.S. federal
statutory rate $ 7,954 $(1,003) $(6,997)
Nondeductible merger costs 315 -- 2,979
Nondeductible goodwill amortization 7,242 7,066 5,447
State income taxes, net of federal benefit 2,252 630 203
Change in valuation allowance -- 238 163
Other, net 718 (598) (78)
------- ------- -------
Income tax provision $18,481 $ 6,333 $ 1,717
======= ======= =======
</TABLE>
Deferred income taxes reflects the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The tax effects of
significant items comprising the Company's temporary differences are as follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1998 1997
------- -------
<S> <C> <C>
Deferred tax liability:
Difference between book and tax depreciation and amortization
related to property and equipment $(2,178) $(2,348)
Difference between book and tax amortization related to goodwill
and other intangibles (1,554) (3,517)
Difference between book and tax treatment of unfavorable contracts (1,371) 0
------- -------
Total deferred tax liabilities (5,103) (5,865)
------- -------
Deferred tax assets:
Difference between book and tax amortization related to write-off of
acquired in-process technology 2,028 2,432
Difference between book and tax treatment of leased assets 795 585
Reserves and accruals not currently deductible 2,003 1,683
Net operating loss carryforward 469 398
Difference between book and tax treatment of investments 915 900
Difference between book and tax treatment of compensation expense 144 408
Tax credits 0 583
Other 0 119
------- -------
Total deferred tax assets 6,354 7,108
Valuation allowance for deferred tax assets (915) (1,025)
------- -------
Net deferred tax assets 5,439 6,083
------- -------
Net deferred tax assets (liability) $ 336 $ 218
======= =======
</TABLE>
52
<PAGE> 53
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
At December 31, 1998, the Company had state net operating loss carryforwards of
approximately $11,600,000. These losses begin to expire in 2010.
The Company evaluates the amounts recorded for the valuation allowance for
deferred tax assets each year. The valuation allowance relates to the loss on
the investment in EMC and to certain tax credits that existed at December 31,
1997. The change in the valuation allowance at December 31, 1998 is due
primarily to tax credits which expired in 1998. In evaluating the requirement
for the valuation allowance, the Company considered its deferred tax
liabilities, which were $5,103,000 and $5,865,000 at December 31, 1998 and 1997,
respectively, as a possible source of taxable income. Management believes that
it is more likely than not that the deferred tax assets in excess of the
valuation reserves will be realized.
POS and ARM operated under Subchapter S of the Code and were not subject to
corporate federal or state income taxes. Had POS and ARM filed federal and state
income tax returns as C corporations for 1998, 1997 and 1996, pro forma income
tax expense in the consolidated financial statements under the provisions of
SFAS No. 109 would have been $18,740,000, $7,365,000 and $1,882,000,
respectively.
17. PROFIT-SHARING PLANS
The Company and its subsidiaries sponsor 401(k) profit-sharing plans and other
noncontributory plans covering all employees who meet certain length of service
and age requirements. Eligible employees may elect to reduce their current
compensation and contribute to the 401(k) plans through salary deferral
contributions. The Company matches employee contributions, generally up to 25%
of the first 6% of compensation deferred by the employee, and may make
additional discretionary contributions. The amount of expense for the Company
contribution for all plans was approximately $674,000, $613,000 and $583,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the consolidated balance sheet for cash and
cash equivalents, accounts receivable, and accounts payable approximate fair
value. The carrying amount reported in the balance sheet for short-term and
long-term debt also approximates fair value. The fair value of the Company's
short-term and long-term debt is estimated using discounted cash flows and the
Company's current incremental borrowing rate for similar types of borrowing
arrangements.
53
<PAGE> 54
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
19. NET INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation of net income (loss) per common
share (in thousands, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
------- -------- ---------
<S> <C> <C> <C>
Numerator for basic and diluted
earnings per share:
Net income (loss) $ 4,244 $ (9,198) $(22,296)
Less preferred stock dividends -- -- (14,921)
------- -------- --------
Net income (loss) applicable to
common shares $ 4,244 $ (9,198) $(37,217)
======= ======== ========
Denominator:
Denominator for basic earnings per
share - weighted average shares 21,179 19,686 16,519
Effect of dilutive securities:
Employee stock options 1,131 --(1) --(1)
Convertible preferred stock 2,800 --(1) --(1)
------- -------- --------
Denominator for diluted earnings per
share - adjusted weighted average
shares 25,110 19,686 16,519
======= ======== ========
Basic net income (loss) per common
share $ 0.20 $ (0.47) $ (2.25)
======= ======== ========
Diluted net income (loss) per
common share $ 0.17 $ (0.47) $ (2.25)
======= ======== ========
</TABLE>
(1) Stock options to purchase 3,402,000 and 3,229,000 shares of Common
Stock in 1997 and 1996, respectively; the Series B Preferred Stock
(convertible into 3,730,233 shares of Common Stock in 1997 and 1996);
and the Convertible Note (convertible into 629,281 shares of Common
Stock in 1996) were the only securities issued which would have been
included in the diluted earnings per share calculation had they not
been antidilutive due to the net loss reported by the Company.
54
<PAGE> 55
ENVOY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
1998
----------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues $42,524 $42,949 $47,290 $52,010
Gross profit $23,127 $23,141 $27,621 $28,557
Net income $ 74 $ 614 $ 2,273 $ 1,283
Net income per common share
Basic $ 0.00 $ 0.03 $ 0.11 $ 0.06
Diluted $ 0.00 $ 0.02 $ 0.09 $ 0.05
<CAPTION>
1997
---------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues $30,763 $32,169 $34,693 $39,980
Gross profit $16,257 $17,144 $18,372 $21,585
Net loss $(2,315)(a) $ (938) $(4,635)(b) $(1,310)
Net loss per common share, basic $ (0.12)(a) $ (0.05) $ (0.23)(b) $ (0.07)
and diluted
</TABLE>
(a) The Company recorded a $600,000 write-off of acquired in-process
technology related to the DSS acquisition (see Note 4).
(b) The Company recorded a $6,000,000 write-off of acquired in-process
technology related to the HDIC acquisition, less a related deferred
income tax benefit of $2,280,000 (see Note 4).
21. RELATED PARTY TRANSACTIONS
As a result of the business combinations with the ExpressBill Companies, the
Company leases office space from a partnership of a significant stockholder. The
related lease extends through February 2013, with annual rentals of $457,500
through February 2003, $503,250 through February 2008 and $553,575 through
February 2013. Rentals paid were approximately $397,000 in 1998 and $92,000 in
each of 1997 and 1996.
22. LITIGATION
Class action complaints were filed on each of August 20, 1998, August 21, 1998
and September 15, 1998, in the United States District Court, Middle District of
Tennessee, Nashville Division, against the Company and certain of its executive
officers. On December 28, 1998, the plaintiffs filed, pursuant to the Court's
instructions, a Consolidated Class Action Complaint (the "Complaint"),
consolidating the three cases into a single action. The Complaint alleges, among
other things, that from February 12, 1997 to August 18, 1998 (the "Class
Period") the defendants issued materially false and misleading statements about
the Company, its business, operations and financial position and failed to
disclose material facts necessary to make defendants' statements not false and
misleading in violation of Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, and also
55
<PAGE> 56
asserts additional claims under Tennessee common law for fraud and negligent
misrepresentation. Plaintiffs allege that the Company failed to disclose that
the Company's financial statements were not prepared in accordance with
generally accepted accounting principles due to the improper write-off of
certain acquired in-process technology, resulting in the Company's stock trading
at allegedly artificially inflated prices during the Class Period. Plaintiffs
seek unspecified compensatory damages, attorney's fees and other relief. The
Company believes that these claims are without merit and intends to defend the
allegations vigorously. Neither the likelihood of an unfavorable outcome nor the
amount of the ultimate liability, if any, with respect to these claims can be
determined at this time.
The Company also is a party in certain other pending litigation arising in the
course of its business. While the final outcome of such litigation cannot be
predicted with certainty, it is the opinion of the Company's management that the
outcome of these matters would not materially affect the consolidated financial
position or results of operations of the Company.
56
<PAGE> 57
SIGNATURES
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 hereunto duly authorized.
ENVOY CORPORATION
Date: February 17, 1999 /s/ KEVIN M. MCNAMARA
-------------------------------
Kevin M. McNamara
Senior Vice President and Chief
Financial Officer
57
<PAGE> 58
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
<S> <C>
23.1 Consent of Ernst & Young LLP
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
pertaining to the 1995 Employee Stock Incentive Plan (Form S-8 No. 33-93542),
the 1995 Stock Option Plan for Outside Directors (Form S-8 No. 333-2824), the
Employee Stock Purchase Plan (Form S-8 No. 333-33207), and the 1998 Stock
Incentive Plan, 1998 Synergy Stock Option Plan and 1998 ExpressBill Stock Option
Plan (Form S-8 No. 333-56887) of ENVOY Corporation of our report dated January
29, 1999 with respect to the consolidated financial statements of ENVOY
Corporation included in this Current Report on Form 8-K to be filed on or about
February 16, 1999 with the Securities and Exchange Commission.
/s/ ERNST & YOUNG LLP
----------------------
ERNST & YOUNG LLP
Nashville, Tennessee
February 16, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated February 11, 1998 relating to the financial statements of
Professional Office Services, Inc. as of December 31, 1997 and for each of the
two years in the period ended December 31, 1997 and the incorporation of our
report dated January 30, 1998 relating to the financial statements of XpiData,
Inc. as of December 31, 1997 and for each of the two years in the period ended
December 31, 1997 included in this Current Report on Form 8-K, of ENVOY
Corporation into ENVOY Corporation's previously filed Registration Statement
File Numbers 33-93542, 333-2824, 333-33207 and 333-56887. It should be noted
that we have not audited any financial statements of Professional Office
Services, Inc. or XpiData, Inc. subsequent to December 31, 1997 or performed any
audit procedures subsequent to the date of our reports.
/s/ARTHUR ANDERSEN LLP
----------------------
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 16, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF ENVOY CORPORATION FOR THE YEAR ENDED DECEMBER 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 30,297
<SECURITIES> 0
<RECEIVABLES> 46,318
<ALLOWANCES> 4,763
<INVENTORY> 2,588
<CURRENT-ASSETS> 78,251
<PP&E> 47,906
<DEPRECIATION> 28,599
<TOTAL-ASSETS> 183,519
<CURRENT-LIABILITIES> 33,691
<BONDS> 366
0
41,300
<COMMON> 141,259
<OTHER-SE> (40,663)
<TOTAL-LIABILITY-AND-EQUITY> 183,519
<SALES> 0
<TOTAL-REVENUES> 184,773
<CGS> 0
<TOTAL-COSTS> 82,327
<OTHER-EXPENSES> 79,200
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,431
<INCOME-PRETAX> 22,725
<INCOME-TAX> 18,481
<INCOME-CONTINUING> 4,244
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,244
<EPS-PRIMARY> 0.20
<EPS-DILUTED> 0.17
</TABLE>
