-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ot2y5oiAV1IzCISB221mENQMYNTKKkMwf8+TlNc3UJRskuymmXsXFowvExavQNgu PAvzWAIUpyWONvzJ2iEz6g== 0000950144-98-012959.txt : 19981118 0000950144-98-012959.hdr.sgml : 19981118 ACCESSION NUMBER: 0000950144-98-012959 CONFORMED SUBMISSION TYPE: 8-K/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981116 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENVOY CORP /TN/ CENTRAL INDEX KEY: 0000932277 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 621575729 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K/A SEC ACT: SEC FILE NUMBER: 000-25062 FILM NUMBER: 98752037 BUSINESS ADDRESS: STREET 1: 15 CENTURY BLVD SUITE 600 CITY: NASHVILLE STATE: TN ZIP: 37214 BUSINESS PHONE: 6152314891 MAIL ADDRESS: STREET 1: 15 CENTURY BLVD SUITE 600 CITY: NASHVILLE STATE: TN ZIP: 37214 FORMER COMPANY: FORMER CONFORMED NAME: NEW ENVOY INC DATE OF NAME CHANGE: 19941102 8-K/A 1 ENVOY CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K/A No. 2 CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): November 16, 1998 (February 27, 1998) ENVOY CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Tennessee 0-25062 62-1575729 - --------------------------------------------- ------------------------ -------------------- (State or other jurisdiction of incorporation) (Commission File Number) (I.R.S. Employer Identification No.)
Two Lakeview Place, 15 Century Boulevard, Suite 600, Nashville, TN 37214 - ----------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (615) 885-3700 Not Applicable -------------------------------------------------------------- (Former name or former address, if changed since last report) 2 This Current Report on Form 8-K/A No. 2 amends and supersedes, to the extent set forth herein, subsection (b) and supplements subsection (c) of "Item 7. Financial Statements, Pro Forma Financial Information and Exhibits" of the Registrant's Current Report on Form 8-K/A, as filed on May 5, 1998. Furthermore, pursuant to Item 5 hereof, the Registrant has determined to update its "Management's Discussion and Analysis of Financial Condition and Results of Operations" in connection with the filing of the foregoing restated financial statements. 2 3 Item 5. Other Information 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 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 Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as such may be amended from time to time, and under the caption entitled "Risk Factors" herein. These forward-looking statements can be generally 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 Corporation ("ENVOY" or the "Company") 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 XpiData, Inc., Professional Office Services, Inc. and Automated Revenue Management, Inc. (collectively, 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 (collectively, the "1996 Acquired Businesses") and Healthcare Data Interchange Corporation ("HDIC") and Diverse Software Solutions, Inc. ("DSS") in 1997 (collectively, the "1997 Acquired Businesses"). The 1996 Acquired Businesses and 1997 Acquired Businesses are sometimes collectively referred to herein as the "Acquired Businesses." These acquisitions were accounted for under the purchase method of accounting and, as a result, the Company 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. In connection with the allocation of purchase price for these Acquired Businesses, valuations of all identified intangible assets of these Acquired Businesses were made. The intangible assets of the Acquired Businesses included in-process technology projects, among other assets, which were related to research and development that had not reached technological feasibility and for which there was no alternative future use. Pursuant to applicable accounting pronouncements, the amounts of the purchase price allocated to these projects were expensed. In previously issued financial statements, the Company recorded write-offs for acquired in-process technology of $30.7 million in 1996 and $38.0 million in 1997 in connection with certain of the Acquired Businesses, including NEIC, DSS and HDIC. After discussions with the Staff of the Securities and Exchange Commission (the "Commission"), the Company has reduced the amount of the write-offs for acquired in-process technology to $8.7 million in 1996 and $6.6 million in 1997. These reductions have been reallocated to goodwill and to other intangible assets and the Company's consolidated financial statements have been restated to reflect such adjustments as described below and in Note 2 of the Notes to Consolidated Financial Statements. See also "--Acquired In-Process Technology." The financial statements for all periods reflect the operations of the Acquired Businesses for the periods after their respective dates of acquisition. 3 4 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 future results of operations. The Company's revenues principally have been derived from EDI and transaction processing services to the health care market which generally are paid for by the health care providers or third-party payors. Revenues generally are earned on a per transaction basis. In addition, total revenues include non-transaction based revenues derived from the ExpressBill Companies and some of the Acquired Businesses. This revenue includes maintenance, licensing and support activities, as well as the sale of ancillary software and hardware products and, in the case of the ExpressBill Companies, certain printing services. The Company's revenues generally are comprised of the following types of EDI and transaction processing services: (i) pharmacy EDI, (ii) medical and other EDI and (iii) patient statements. The table below shows the number of transactions processed by the Company for the periods presented:
YEAR ENDED DECEMBER 31, 1995 1996 1997 --------------------------------------------------- (in thousands) Pharmacy EDI............. 363,084 478,526 597,609 Medical and other EDI.... 15,308 132,724 215,437 Patient statements....... 24,582 54,251 99,823 ------------- ----------- --------------- Totals........ 402,974 665,501 912,869 ============= =========== ===============
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 19% of the Company's total revenues in 1997. For 1997, the pharmacy EDI business grew at a rate of approximately 25%, less than 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 larger market penetration in the more mature pharmacy EDI business. As a result, the Company expects its pharmacy EDI business as presently conducted to represent a decreasing portion of the Company's total revenues in the future. As the mix of the Company's business changes, a decline in the growth rates associated with the Company's medical 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 4 5 Company's business may increasingly become dependent on the Company's ability to maintain or establish successful relationships with such third parties. In the event the Company is not able to maintain or establish relationships with major third party PMS and claims clearinghouse vendors to induce them to continue to send transactions to ENVOY, the Company's business, operating results or financial condition may be adversely affected. The Company continues to actively pursue the acquisition of health care information businesses and other companies complementary to its business. The Company's ability to successfully negotiate and close acquisitions will materially impact the financial condition and operating results of the Company. There can be no assurance that the Company will find attractive acquisition candidates, be able to successfully finance and complete the acquisitions, consolidate and integrate such businesses following the acquisition or successfully operate them on a going forward basis. RESULTS OF OPERATIONS The following table presents, for the periods indicated, the percentage relationship certain statements of operations items bear to revenues.
YEAR ENDED DECEMBER 31, 1995 1996 1997 ------------------------------------------------------------------- Revenues........................................ 100.0% 100.0% 100.0% Cost of revenues................................ 55.5 48.0 46.7 Selling, general and administrative expenses.... 32.6 27.2 23.8 Research and development expenses............... 4.3 2.0 1.6 Depreciation and amortization expenses.......... 8.0 28.2 25.0 Merger and facility integration costs........... --- 5.2 --- Write-off of acquired in-process technology..... --- 9.6 4.8 EMC losses...................................... --- 0.6 --- --------------- ---------------- ---------------- Operating income (loss)......................... (0.3) (20.7) (1.9) Interest income................................. 1.1 1.1 1.0 Interest expense................................ (1.9) (3.2) (1.2) --------------- ---------------- ---------------- Income (loss) from continuing operations before income taxes and loss in investee.... (1.2) (22.7) (2.1) Provision (benefit) from income taxes........... (0.2) 1.9 4.6 Loss in investee................................ (5.2) --- --- --------------- ---------------- ---------------- Income (loss) from continuing operations........ (6.2)% (24.6)% (6.7)% =============== ================ ================
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 acquisition of DSS provided additional revenues of $2.8 million from software licensing, maintenance and support activities. 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 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. 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 certain of these third parties as an inducement to use ENVOY as their clearinghouse for these 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 claim 5 6 clearinghouses. If the mix of revenues continues to shift toward larger vendors and claim clearinghouses, the Company expects rebates to represent an increasing portion of its costs of revenues. 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 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 1997 were $32.7 million compared to $24.6 million in 1996, an increase of 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. 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, 1997 were $2.2 million compared to $1.8 million in 1996. Depreciation and Amortization Expenses. Depreciation and amortization expense relates primarily to host computers, communications equipment and goodwill and identifiable intangible assets related to acquisitions. 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 of $28.3 million in goodwill and identifiable intangible assets related to the Acquired Businesses, compared with $20.6 million in 1996. Depreciation and amortization increased further as the result of the additional investment in host computer systems and software to expand the Company's transaction processing capabilities. At December 31, 1997, the Company had net goodwill of $67.0 million associated with the Acquired Businesses remaining to be amortized over periods of three to 15 years following the acquisitions. In addition, the Company had net identifiable intangible assets of $27.4 million remaining to be amortized over two to ten year time periods, as applicable. See "--Acquired In-Process Technology." 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." Net Interest 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 $22.0 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. 6 7 Income Tax Provision (Benefit). The Company's income tax provision for 1997 was $6.3 million compared to $1.7 million in 1996. The tax benefit recorded in 1997 reflects a deferred income tax benefit of $2.3 million associated with the $6.0 million charge for the write-off of acquired in-process technology related to the HDIC acquisition. Amortization of certain goodwill and identifiable intangible assets is not deductible for income tax purposes. FISCAL YEAR 1996 AS COMPARED WITH 1995 Revenues. Revenues for the year ended December 31, 1996 were $90.6 million compared to $34.2 million for the same period in 1995, an increase of $56.4 million or 165%. This increase is primarily attributable to additional revenues generated from the 1996 Acquired Businesses following the date of acquisition and a 31.8% increase in pharmacy EDI transactions over 1995. Cost of Revenues. Cost of revenues in 1996 was $43.5 million compared to $19.0 million in 1995, an increase of 129%. The dollar increase is attributable to the inclusion of results of the 1996 Acquired Businesses following the date of acquisition and increased transaction volume in the Company's pre-acquisition business. As a percentage of revenues, cost of revenues was 48.0% in 1996 compared to 55.5% in 1995. The improvement is attributable to the inclusion of results of the 1996 Acquired Businesses following the date of acquisition, which historically experienced higher gross profit margins than those of the Company's pre-acquisition business. Selling, General and Administrative Expenses. Selling, general and administrative expenses for 1996 were $24.6 million compared to $11.2 million in 1995, an increase of 120%. These expenses increased due to the inclusion of results of the 1996 Acquired Businesses following the date of acquisition and the additional costs associated with such acquisitions. As a percentage of revenues, selling, general and administrative expenses decreased to 27.2% for 1996 compared to 32.6% for 1995. The improvement is attributable to a larger base of revenues, as well as the elimination of certain duplicative costs realized in connection with the 1996 Acquired Businesses following the date of acquisition. Research and Development Expenses. Research and development expenses for the year ended December 31, 1996 were $1.8 million, compared to $1.5 million in 1995. Depreciation and Amortization Expenses. Depreciation and amortization expenses for 1996 were $25.5 million compared to $2.7 million for 1995. The increase is the result of the amortization of goodwill and identifiable intangible assets during 1996 of $20.6 million primarily related to the 1996 Acquired Businesses. See "--Acquired In-Process Technology." Depreciation and amortization increased further as the result of the additional investment in host computer systems during 1996 to expand the Company's transaction processing capabilities. Merger and Facility Integration Costs. The Company recognized merger and facility integration costs in 1996 of $4.7 million related to the NEIC and Teleclaims acquisitions. Write-off of Acquired In-Process Technology. The Company recorded a write-off of acquired in-process technology of $8.7 million in 1996 related to the NEIC and Teleclaims acquisitions. These amounts represent an allocation of purchase price to projects that primarily were 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 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." 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 7 8 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 Expense. The Company recorded net interest expense in 1996 of $1.8 million compared to $279,000 of net interest expense for 1995. Interest income increased to $1.0 million in 1996 compared to $380,000 in 1995, primarily because of an increase in the amount of cash available for investment following the Company's August 1996 public offering of 3,320,000 shares of Common Stock. Interest expense increased to $2.9 million in 1996 compared with $659,000 in 1995, primarily as a result of borrowings under the Convertible Notes and borrowings under the Company's bank credit facilities. Income Tax Provision (Benefit). The Company's income tax provision in 1996 was $1.7 million compared to an income tax benefit of $50,000 in 1995. ACQUIRED IN-PROCESS TECHNOLOGY In connection with the purchases of certain of the Acquired Businesses, including NEIC, DSS and HDIC, the Company made allocations of the purchase price to acquired in-process technology. These amounts were expensed as non-recurring charges on the respective acquisition dates of the Acquired Businesses because the acquired in-process technology had not yet reached technological feasibility and had no future alternative uses. In previously issued financial statements, the Company recorded write-offs for acquired in-process technology of $30.7 million in 1996 and $38.0 million in 1997 in connection with such acquisitions. The Staff of the Commission, in its review of a registration statement filed by the Company in May 1998 relating to a proposed underwritten public offering by certain shareholders of the Company, commented on the valuation of the in-process research and development costs for the NEIC, DSS and HDIC acquisitions. After further discussions with the Staff of the Commission, the Company has reduced the amount of the write-offs for acquired in-process technology to $8.7 million in 1996 and $6.6 million in 1997. These reductions have been reallocated to goodwill or other intangible assets to reflect such adjustments as more particularly set forth below. Since the respective dates of acquisition, the Company has used the acquired in-process technology to develop new health care EDI and transaction processing product and service offerings, which have or will become part of the Company's suite of products when completed. The nature of the efforts required to develop the acquired in-process technology into commercially viable products principally relate to the completion of all planning, designing and testing activities that are necessary to establish that the product or service can be produced to meet its design requirements, including functions, features and technical performance requirements. The Company currently expects that the acquired in-process technology will be successfully developed, but there can be no assurance that commercial viability of these products will be achieved. Furthermore, future developments in the health care EDI and transaction processing industry, changes in EDI and transaction processing technology, changes in other product and service offerings or other developments may cause the Company to alter or abandon these plans. Failure to complete the development of these projects in their entirety, or in a timely manner, could have a material adverse impact on the Company's operating results, financial condition and results of operations. 8 9 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 healthcare providers into clearinghouse technologies and ensuring compliance with regulatory and other industry standards. After acquiring NEIC, the Company continued the development of these in-process projects. At the time of the NEIC acquisition, the Company assigned a value of $30.0 million to the NEIC in-process technology with the assistance of an independent valuation prepared at such time. In an effort to facilitate the completion of the Commission's review of its registration statement, the Company engaged a second appraisal firm to conduct additional valuation analyses, which indicated a value of $28.9 million. Based on further discussions with the Staff of the Commission, the Company has determined to value the related in-process research and development projects at $8.0 million. In arriving at this value, the Company considered the previously-obtained independent appraisals, the Staff's views on in-process research and development as set forth in its September 15, 1998 letter to the American Institute of Certified Public Accountants ("AICPA Letter"), and the Staff's comments for the Company to consider (i) the stage of completion of the in-process technology at the date of acquisition, (ii) other contributions of the Company's own distinct and unique proprietary advantages, and (iii) the estimated total project costs of the in-process research and development in arriving at the valuation amount. A brief description of the five in-process projects is set forth below: - UniClaim. This product is a PC based claims processing system that extracts Health Care Financing Administration 1500 claim formats from practice management systems ("PMS"), performs edits and transports the file to a host system where EDI formatting is completed for delivery to payors. The Company estimates this project, which was completed in the second quarter of 1996, was approximately 40% complete at the date of the NEIC acquisition. - GTEDS. This product is a computerized system for the collection, validation and distribution of claims from various sources to claims receivers. The Company estimates this project, which was completed in the fourth quarter of 1996, was approximately 45% complete at the date of the NEIC acquisition. - On-Line. This product is an application that performs "screen scraping" (i.e., it captures data from a screen presentation and creates an American National Standards Institute 270 eligibility request.) The Company estimates this project, which was approximately 75% complete at December 31, 1997 and is expected to be 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. 9 10 At the time of the NEIC valuation, the expected total costs of all such projects were approximately $4.0 million. As of March 1998, approximately $1.8 million had been incurred since the date of the NEIC acquisition for these projects, and there were no additional expected costs to complete the research and development projects acquired from NEIC. DSS The in-process technology acquired in the DSS acquisition consisted primarily of projects related to DSS's Receivables Management product line and four peripheral products expected to be used as add-on features to the Receivables Management product. DSS's Receivables Management product line works with existing hospital information system ("HIS") and PMS software and provides claims and receivables management, including billings, collections and cash applications, among other functions. At the time of acquisition, DSS was selling versions of the Receivables Management product to work with certain HIS and PMS products; however, the Company noted that there was still substantial development work required in order to complete versions which were adapted to other major HIS and PMS products. The Company estimates this project, which was completed during the fourth quarter of 1997, was approximately 35% complete at the date of the DSS acquisition. At the time of the DSS acquisition, the Company assigned a value of $3.0 million to the DSS in-process technology with the assistance of an independent valuation prepared at such time. In an effort to facilitate the completion of the Commission's review of its registration statement, the Company engaged a second appraisal firm to conduct additional valuation analyses, which indicated a value of $2.8 million. Based on further discussions with the Staff of the Commission, the Company has determined to value the related in-process research and development projects at $600,000. In arriving at this value, the Company considered the previously-obtained independent appraisals, the Commission's views on in-process research and development as set forth in the AICPA Letter, and the Staff's comments for the Company to consider (i) the stage of completion of the in-process technology at the date of acquisition, (ii) other contributions of the Company's own distinct and unique proprietary advantages, and (iii) the estimated total project costs of the in-process research and development in arriving at the valuation amount. A brief description of each of the four add-on features is set forth below: - Materials Management. This product incorporates certain customized features into licensed software to allow for online transaction processing of inventory data. The Company estimates this project, which was completed during the third quarter of 1997, was approximately 50% complete at the date of the DSS acquisition. - Billing and 72-Hour Compliance. This product processes all emergency room billings and collections, in addition to tracking patients throughout the emergency/casualty process. The Company estimates this project was approximately 50% complete at the date of the DSS acquisition. This project was 90% complete at December 31, 1997 and is expected to be completed during the first quarter of 1998. - Registration. This product facilitates access to patient records, as well as providing basic patient information to payors. The Company estimates this project was approximately 25% complete at the date of the DSS acquisition. The Company estimates that this project was approximately 35% complete as of December 31, 1997, and is expected to be completed during the fourth quarter of 1998. - Collections. This product assists the health care provider's HIS or PMS system in the management of receivables. In the fourth quarter of 1997, management placed further development of this project on hold while it evaluates alternative technologies and development strategies. The Company estimates this project was approximately 20% complete at the date of the DSS acquisition. At the time that the project was placed on hold, the Company estimates that this project was approximately 60% complete. At the time of the DSS valuation, the expected total costs of all such projects totaled approximately $300,000. Approximately $150,000 had been incurred since the date of the DSS acquisition for these projects through March 31, 1998, and the Company estimates that approximately $50,000 will be required to complete the remaining research and 10 11 development projects. The remaining efforts to complete the Registration and Collections products include the selection of appropriate sites for testing and completion of the work necessary to develop and test the working prototypes. HDIC The in-process technology acquired in the HDIC acquisition consisted of seven significant research and development projects associated with HDIC's product line. At the time of acquisition, HDIC had developed on-line, real-time claims transaction technology which permitted Aetna U.S. Healthcare Inc. ("AUSHC") to receive real-time EDI transactions, and was in the process of developing new transaction sets which would allow health care providers to submit additional health care transactions electronically. After acquiring HDIC, the Company modified the Company's existing front-end transaction platforms to accommodate HDIC's technology and continued the development of seven in-process projects. The Company believes that the resulting technology has given, and will continue to give, the Company a competitive advantage in the marketplace by significantly enhancing the Company's existing EDI and transaction processing capabilities with additional transaction sets. At the time of the HDIC acquisition, the Company assigned a value of $35.0 million to the HDIC in-process technology with the assistance of an independent valuation prepared at such time. In an effort to facilitate the completion of the Commission's review of its registration statement, the Company engaged a second appraisal firm to conduct additional valuation analyses, which indicated a value of $32.9 million. Based on further discussions with the Staff of the Commission, the Company has determined to value the related in-process research and development projects at $6.0 million. In arriving at this value, the Company considered the previously-obtained independent appraisals, the Commission's views on in-process research and development as set forth in the AICPA Letter, and the Staff's comments for the Company to consider (i) the stage of completion of the in-process technology at the date of acquisition, (ii) other contributions of the Company's own distinct and unique proprietary advantages, and (iii) the estimated total project costs of the in-process research and development in arriving at the valuation amount. A brief description of each of the seven in-process projects is set forth below: - Real-time referrals. This product is designed to allow batch or on-line real-time transaction processing for referral authorization and the ability to receive or confirm acknowledgment through the Company's network that a valid referral is on file with the primary care provider ("PCP"). The Company estimates this project was approximately 25% complete at the date of the HDIC acquisition. This project was approximately 65% complete at December 31, 1997, and is expected to be completed during the second quarter of 1998. - 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 was approximately 35% complete at the date of the HDIC acquisition. The Company estimates that the project was approximately 85% complete as of December 31, 1997, and is expected to be completed during the third quarter of 1998. - 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 was approximately 50% complete at the date of the HDIC acquisition. The Company estimates that the project was approximately 70% complete as of December 31, 1997, and is expected to be completed during the third quarter of 1998. - Provider directories. This product is designed to allow for the maintenance of reference information related to health care providers and provider networks. The Company estimates this project was approximately 15% complete at the date of the HDIC acquisition. The Company estimates that the project was approximately 55% complete as of December 31, 1997, and is expected to be completed in the fourth quarter of 1998. - Real-time encounters/claims. This product is designed to allow batch or on-line real-time transaction processing for the transmission of encounter data from the PCP or a capitated specialist to the insurer, and the 11 12 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, 1997, and is expected to be completed during the first quarter of 1999. - Electronic pre-certifications. This product is designed to allow batch or real-time batch transaction processing for the request and authorization to perform non-capitated procedures or hospital admissions. This transaction is initiated from the PCP, specialist hospital or other delivery system. The Company estimates this project was approximately 35% complete at the date of the HDIC acquisition. The Company estimates that the project was approximately 40% complete as of December 31, 1997, and is expected to be completed during the second quarter of 1999. - Rosters through the Internet. This product is designed to use the Internet as a means to deliver to health care providers managed care program eligibility status and capitated payment information. The Company estimates this project was approximately 50% complete at the date of the HDIC acquisition. The Company estimates that the project was approximately 75% complete as of December 31, 1997, and is expected to be completed during the third quarter of 1999. At the time of the HDIC valuation, the expected total costs of all such projects was approximately $3.0 million. Approximately $400,000 has been incurred since the date of the HDIC acquisition for these projects through March 31, 1998, and the Company estimates that approximately $1.4 million will be required to complete the remaining research and development projects. The remaining efforts to complete these projects include the processes of planning and coding the primary applications and customer interfaces, testing such coding and interfaces, and introducing such processes into production environments at Company and customer locations. LIQUIDITY AND CAPITAL RESOURCES The Company has incurred operating losses in recent years primarily as a result of substantial non-cash depreciation and amortization charges, together with the write-off of acquired in-process technology related to the Acquired Businesses. During these periods, however, operations have generated positive cash flows of $1.8 million in 1995, $3.2 million in 1996 and $22.0 million in 1997. Investing activities consist primarily of payments for acquired businesses and purchases of property and equipment. Investing activities used $13.3 million in 1995, $94.0 million in 1996 and $51.2 million in 1997. Financing activities consist primarily of proceeds from the issuance of capital stock, and proceeds from and payments on debt. Financing activities provided $7.4 million in 1995, $127.2 million in 1996 and $1.0 million in 1997. 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 $8.7 million and $5.4 million for 1997 and 1996, respectively, primarily for computer hardware and software products. The Company currently estimates that total capital expenditures for 1998 will be approximately $8 to $9 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 $2.5 million will be incurred during 1998. These costs are being funded with available cash. See "Risk Factors--Year 2000 Compliance." At February 28, 1998, the Company had no amounts outstanding under its $50 million revolving credit facility. Any future borrowings made under the credit facility would bear interest at a rate equal to the Base Rate (as defined in the credit facility) or an index tied to LIBOR. Any future borrowings under the credit facility would be due and payable in full on June 30, 2000. The credit facility contains financial covenants applicable to the Company and its subsidiaries, including ratios of debt to capital, annualized EBITDA to annualized interest expense and certain other financial 12 13 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%, to 21.1 million shares. From time to time, the Company has engaged and will continue to engage in acquisition discussions with health care information businesses and other companies complementary to its business. In the event the Company engages in such acquisitions in the future, its currently available capital resources may not be sufficient for such purposes and the Company may be required to incur additional indebtedness or issue additional capital stock, which could result in increased interest expense or dilution to existing investors. Based on current operations, anticipated capital needs to fund known expenditures and current acquisitions, the Company believes its available cash, cash flow from operations and the $50.0 million revolving credit facility will provide the capital resources necessary to meet its liquidity and cash flow requirements over the next 12 months, including the Company's current short-term obligations. The Company believes that present funding sources will provide the ability to meet long-term obligations as they mature. As of December 31, 1997, the Company's long-term obligations totaled $11.3 million, and consisted of $527,000 in long-term debt net of current portion, $1.6 million in non-current deferred income tax liabilities, and $9.2 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 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. IMPACT OF INFLATION Inflation has not had a significant impact on ENVOY's results of operations to date. 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: Limited Operating History; Recent Losses. The health care EDI and transaction processing industry is relatively new, and the Company's operating history is relatively limited. ENVOY has experienced substantial net losses in recent years, including a net loss of approximately $9.2 million for the year ended December 31, 1997, and had an accumulated deficit of approximately $51.8 million as of December 31, 1997. In order to achieve long-term profitability, the 13 14 Company must successfully implement its business strategy and increase its revenues, while controlling expenses. There can be no assurance that the Company will achieve long-term profitability. Financial Impact of Recent Acquisitions. The Company has recently completed several acquisitions, which have created a significant expansion of ENVOY's overall business. As a result of the accounting treatment for these acquisitions, including the acquisitions of NEIC in March 1996 and HDIC in August 1997, the Company's results of operations have been negatively impacted. A brief description of significant terms of the NEIC and HDIC acquisitions follows: NEIC. The Company acquired NEIC for approximately $94.3 million, including fees, expenses and other costs associated with the acquisition. In connection with the acquisition, the Company recognized a write-off of acquired in-process technology of approximately $8.0 million. As a result of the NEIC acquisition, the Company is amortizing $59.6 million of goodwill over a three year period, and such amortization will adversely affect the Company's results of operations through March 1999. HDIC. The Company completed the acquisition of HDIC for approximately $36.4 million in cash and the assumption of approximately $14.8 million of liabilities. In addition, the Company and AUSHC simultaneously entered into a long-term services agreement under which AUSHC agreed to use the Company as its single source clearinghouse and EDI network for all AUSHC electronic health care transactions. The Company recorded approximately $45.1 million of goodwill and identifiable intangible assets related to the HDIC acquisition and is amortizing the related goodwill of $38.1 million over a period of 15 years. Also recorded as part of the HDIC acquisition was a write-off of acquired in-process technology of $6.0 million. Amortization expense related to acquisitions is expected to be approximately $28.3 million in 1998 and $10.8 million in 1999, including $5.6 million in the three months ended March 31, 1999. The consummation of additional acquisitions may significantly increase amortization costs and result in significant write-offs of acquired in-process technology. The amounts allocated under purchase accounting to developed technology and in-process technology in those acquisitions involve valuations utilizing estimations of future revenues, expenses, operating profit and cash flows. The actual revenues, expenses, operating profit and cash flows from the acquired technology recognized in the future may vary materially from such estimates. Acquisition Strategy; Impact on Operating Results; Need for Capital. The Company's strategy includes acquisitions of related health care information businesses and other companies complementary to its business. The success of any such acquisition will depend on many factors, including the Company's ability to identify suitable acquisition candidates, the purchase price, the availability and terms of financing, and management's ability to integrate effectively the acquired services, technologies (including different transaction processing systems) or businesses into the Company's operations. Significant competition for acquisition opportunities exists in the health care EDI and transaction processing industry, which may significantly increase the costs of and decrease the opportunities for acquisitions. Although ENVOY is actively pursuing potential acquisitions, there can be no assurance that any acquisition will be consummated. Further, to the extent that the Company is able to consummate an acquisition, no assurance can be given that the Company will be able to operate any acquired business profitably or otherwise successfully implement its expansion strategy. In that regard, the Company has, in the past, experienced temporary declines in customer service due to computer down time and inexperienced customer service representatives in connection with the integration of certain acquired businesses. Although the Company believes that it has resolved such problems and that there has been no material adverse effect in the Company's operating results to date, there can be no assurance that the Company will not experience temporary declines in customer service in the future, which could materially adversely affect the Company's business, operating results or financial condition. ENVOY may finance future acquisitions through borrowings or the issuance of debt or equity securities. Although the Company historically has obtained financing on reasonable terms, there can be no assurances that future lenders will extend credit, or extend credit on favorable terms. Further, any issuance of equity securities could have a dilutive effect on the holders of Common Stock. Such acquisitions may result in the recognition by the Company of significant goodwill and other intangible assets, increases in the amount of depreciation and amortization expense and write-offs of acquired in-process technology, all of which could adversely 14 15 affect the Company's operating results in future periods. The amounts allocated under purchase accounting to developed technology (which must be amortized) and in-process technology (which must be expensed) involve valuations utilizing estimations of future revenues, expenses, operating profit and cash flows. The actual revenues, expenses, operating profit and cash flows from such technology may vary materially from such estimates. Customer Concentration. Primarily as a result of the HDIC acquisition, the Company has one customer, AUSHC, that accounted for approximately 12% of the Company's consolidated revenues for 1997. Prior to 1997, no customer accounted for more than 10% of the Company's revenues. Concurrently with the HDIC acquisition, the Company and AUSHC entered into a ten year services agreement which requires AUSHC to use the Company as its single source clearinghouse and EDI network for all AUSHC electronic health care transactions, and contains fixed fee pricing for the first five years of the agreement. The AUSHC services agreement specifies performance criteria for the Company requiring the Company to maintain certain minimum transaction volumes and service levels, and to perform marketing services designed to increase the use of the Company's services by AUSHC providers. In the event of an uncured material default by either party, the AUSHC services agreement can be terminated by the non-defaulting party prior to the expiration of its term on 180 days' notice. The Company believes that it is currently in compliance in all material respects with the terms of the AUSHC services agreement. Further consolidation in the health care industry is likely to increase customer concentration and may increase the Company's dependency on a limited number of customers. In that regard, the Company receives a large number of medical EDI transactions from PMS vendors and other claims clearinghouses. These third parties aggregate medical EDI transactions from health care providers, but require a clearinghouse (such as ENVOY) with direct connections to payors in order to complete the processing of the transactions. ENVOY typically receives revenue from payors on these transactions, and pays rebates based on volume to exclusive and preferred vendors as an inducement to use ENVOY as the clearinghouse for these transactions. If the mix of transaction volume continues to shift to large PMS vendors or claims clearinghouses, the Company's business may increasingly become dependent on the Company's ability to maintain or establish successful relationships with such third parties. In the event the Company is not able to maintain or establish relationships with major third party PMS and claims clearinghouse vendors to induce them to continue to send transactions to ENVOY, the Company's business, operating results or financial condition may be adversely affected. In addition, a significant portion of NEIC's revenues has been generated by five major insurance company payors who were shareholders of NEIC before its acquisition by ENVOY. Although each of these carriers has continued to use the Company's services after the acquisition of NEIC, they have no minimum transaction commitment to the Company in the future, and there can be no assurance that the volume of business generated by these payors will not decline or terminate. The termination of the AUSHC services agreement or the loss of one or more other significant customers could have a material adverse effect on the Company's business, operating results or financial condition. Year 2000 Compliance. The Year 2000 issue is primarily the result of many computer programs and data structures' failure to include the century when storing the representation for a year. During 1997, the Company developed and began implementing a plan to ensure its computer systems will be Year 2000 compliant. An inventory of all relevant software and hardware was taken to determine the state of compliance. Some systems require no changes because they already conform to the 4-digit-year configuration which is the basis for the Year 2000 issue. The Company intends to replace or modify the remaining systems as needed to properly display dates and perform date arithmetic. The Company anticipates commencing testing with customers and other third parties in the second quarter of 1998 with completion expected in June 1999. In addition to validating the Company's internal program changes, this testing will determine the readiness of the Company's customers to deal with the Year 2000 issue in their own systems. Where warranted, the Company may assist customers in dealing with the changes required to be compliant to ensure successful information processing for all parties. Because of the nature of the Company's business, the success of the Company's efforts may depend on the success of providers, payors and others in dealing with the Year 2000 issue. Total costs of the Company's Year 2000 project is estimated to be $4.0 million and is being funded through operating cash flows. The Company is expensing all costs associated with these system changes as the costs are being incurred. The Company estimates that Year 2000 expense for 1998 will be approximately $2.5 million. There can be no assurance, however, that actual costs necessary to deal with these issues will not exceed estimated amounts. If the Company or third parties 15 16 with which it interacts are unable to deal successfully with the Year 2000 issue, such inability could have a material adverse effect on the Company's business, results of operation or financial condition. Reliance on Data Centers. ENVOY's real-time EDI transaction processing services depend on its host computer system which is contained in a single data center facility. In addition, the Company's primary batch claims processing capacity is outsourced to GTE Data Services Incorporated, located in Tampa, Florida ("GTEDS"), which processes claims through a single computer center. The contractual arrangement between the Company and GTEDS requires GTEDS to maintain 24 hours a day, seven days a week processing capability and a "hot site" disaster recovery system. The Company's current contract with GTEDS expires in December 1998. Any failure to renew this contract, or the failure to renew the contract on favorable terms, could have a material adverse effect on the Company's business, operating results or financial condition. The Company also operates a batch claims processing center which is contained in a single data center facility in Oklahoma City, Oklahoma for the processing of Blue Cross, Blue Shield, Medicare and Medicaid claims. Although ENVOY is currently evaluating certain disaster recovery alternatives, neither the real-time host computer system nor the Oklahoma City batch claims center have a remote backup data center. Furthermore, while the Company has insurance coverage for the Company's host computer system and data centers, there can be no assurance that fire or other disaster affecting such data centers would not disable the Company's respective systems or otherwise have a material adverse effect on the Company's business, financial condition or results of operations. In addition, a disruption in service due to service problems, delays or outages from GTEDS providing batch claims processing services to the Company could have a material adverse effect on the Company's business, operating results or financial condition. Development of Electronic Processing in the Health Care Industry. ENVOY's strategy anticipates that electronic processing of health care transactions, including transactions involving clinical as well as financial information, will win market acceptance and that providers and third-party payers increasingly will use EDI and transaction processing networks for the processing and transmission of data. Electronic transmission of health care transactions is still developing, and complexities in the nature and types of transactions which must be processed has hindered to some degree the development and acceptance of electronic processing in this market. In addition, while the multiplicity of claims forms and formats used by the many different third-party payers fostered the development of EDI and transaction processing clearinghouses, the standardization of these claims formats, whether due to consolidation in the industry or otherwise, could reduce the use of EDI and transaction processing clearinghouses. There can be no assurance that continued conversion from paper-based transaction processing to electronic transaction processing in the health care market will occur or that, to the extent it does occur, health care providers and payers will use independent networks such as those being developed by the Company. Competition. ENVOY faces significant competition in the health care sector of the EDI and transaction processing market from companies that are similarly specialized, including former regional partners of the Company that have direct provider relationships, and also from companies that are involved in other, more highly developed sectors of the EDI and transaction processing market. The Company also faces competition from other companies, such as vendors of provider information management systems, which have added or may add their own proprietary transaction processing systems to existing or future products. As a result of such competition, the Company may be pressured to reduce per transaction prices or eliminate per transaction prices altogether. If electronic transaction processing becomes the standard for claims and information processing, a number of larger and better capitalized entities may elect to enter the industry and further increase competitive pricing pressures. Many of the Company's existing and potential competitors are larger and have significantly greater financial, marketing, technological and other resources than the Company. Availability of Direct Links. Certain third-party payors provide electronic data transmission systems to health care providers that establish a direct link between the provider and the payer, bypassing third-party processors such as the Company. Any significant increase in the utilization of direct links between health care providers and payers would have a material adverse effect on the Company's business, operating results and financial condition. Uncertain Regulatory Environment and Consolidation in the Health Care Industry. The health care industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and 16 17 operations of health care industry participants. Federal and state legislatures periodically consider programs to modify or amend the United States health care system at both the federal and state level. These programs may contain proposals to increase governmental involvement in health care, lower reimbursement rates or otherwise change the environment in which health care industry participants operate. Health care industry participants may react to these proposals and the uncertainty surrounding such proposals by curtailing or deferring investments, including investments in the Company's services and products. In addition, many health care providers are consolidating to create larger health care delivery organizations. This consolidation reduces the number of potential customers for the Company's services, and the increased bargaining power of these organizations could lead to reductions in the amounts paid for the Company's services. Industry developments are increasing the amount of capitation-based health care and reducing the need for providers to make claims of reimbursement for products or services. Other health care information companies, such as billing services and practice management vendors, which currently utilize the Company's services, have developed or acquired transaction processing and networking capabilities and may cease utilizing the Company'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 have a material adverse effect on the Company's business, operating results or financial condition. Health Care Data Legislation. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") mandates the use of standard transactions, standard identifiers, security and other provisions, the use of which is currently scheduled to occur as early as the year 2000. HIPAA specifically names clearinghouses as the compliance facilitators for providers and payors. Clearinghouses are given the freedom to utilize non-standard transactions and convert them to the mandated standards on behalf of their clients. The Company is preparing to comply with the mandated standards within three to six months after their publication; however, the success of the Company's compliance efforts may be dependent on the success of providers, payors and others in dealing with the standards. Legislation which would impose restrictions on the ability of third-party processors to transmit certain patient data without specific patient consent also recently has been introduced in the U.S. Congress. Such legislation, if adopted, could adversely affect the ability of third-party processors to transmit certain data, including treatment and clinical data. The impact of the foregoing or other legislation is difficult to predict and could materially adversely affect the Company's business, operating results or financial condition. Evolving Industry Standards and Rapid Technological Changes. The market for the Company's business is characterized by rapidly changing technology, evolving industry standards and frequent introduction of new and enhanced products and services. ENVOY's success will depend upon its continued ability to enhance its existing products and services, to introduce new products and services on a timely and cost effective basis to meet evolving customer requirements, to achieve market acceptance for new products and services and to respond to emerging industry standards and other technological changes. There can be no assurance that the Company will be able to respond effectively to technological changes or new industry standards. Moreover, there can be no assurance that competitive products and services will not be developed, or that any such competitive services will not have an adverse effect upon the Company's business, operating results or financial condition. Dependence on Technology; Risk of Infringement. ENVOY's ability to compete effectively depends to a significant extent on its ability to protect its proprietary information. The Company relies primarily on copyright, trade secret and patent laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. The Company generally enters into confidentiality agreements with its consultants and employees and generally limits access to and distribution of its technology, software and other proprietary information. Although the Company intends to defend its intellectual property, there can be no assurance that the steps taken by ENVOY to protect its proprietary information will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. ENVOY is also subject to the risk of alleged infringement by ENVOY of the intellectual property rights of others. Although the Company is not currently aware of any pending or threatened infringement claims with respect to the Company's current or future products, there can be no assurance that third parties will not assert such claims. Any such claims could require 17 18 the Company to enter into license arrangements or could result in protracted and costly litigation, regardless of the merits of such claims. No assurance can be given that any necessary licenses will be available or that, if available, such licenses can be obtained on commercially reasonable terms. Furthermore, litigation may be necessary to enforce ENVOY's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, operating results or financial condition. Increasing Dependence on Medical EDI and Patient Statement Transaction Revenues. The Company's medical EDI and patient statement transaction revenues constituted approximately 70% of the Company's total revenues in 1997, and approximately 75% of the Company's total revenues in the first quarter of 1998. Although 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 19% of the Company's total revenues in 1997. For 1997, the Company's pharmacy EDI business grew at less than half the rate experienced in the Company's other businesses based on the number of transactions processed. Because of the significant penetration and lower per transaction prices already existing in the more mature pharmacy EDI sector, the Company believes that its pharmacy EDI business as presently conducted will continue 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 growth rates associated the Company's medical EDI and patient statement services business could have a material adverse effect on the Company's business, operating results or financial condition. There can be no assurance that the mix of the Company's business or growth rates will continue at their current level. Dependence on Key Executives. The Company's success depends upon the continued contributions of its senior management. The Company believes that its continued future success also will depend upon its ability to attract, motivate and retain highly-skilled technical, managerial and marketing personnel. The loss of the services of certain of the Company's key executives or technical personnel, particularly Fred C. Goad, Jr. and Jim D. Kever, or the inability to hire and retain qualified personnel could have a material adverse effect upon the Company's business, operating results or financial condition. Unauthorized Access to Data Centers. Unauthorized access to the Company's data centers and misappropriation of ENVOY's proprietary information could have a material adverse effect on ENVOY's business, operating results or financial condition. While ENVOY employs what it believes to be appropriate security measures to protect against unauthorized access to its data centers and misappropriation of its proprietary information, there can be no assurance that such unauthorized access or misappropriation could not occur. Likewise, no assurances can be made as to the security measures, if any, established by third parties for whom ENVOY processes or transmits health care information. Certain Anti-takeover Provisions. The charter, bylaws and shareholders' rights plan of the Company, and Tennessee law, contain certain provisions that may have the effect of inhibiting a non-negotiated merger or other business combination involving the Company. Such provisions are intended to encourage any person interested in acquiring the Company to negotiate with and obtain the approval of the Company's Board of Directors (the "Board of Directors") in connection with any such transaction. 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. Certain of these provisions may discourage a future acquisition of the Company not approved by the Board of Directors in which shareholders might receive a premium value for their shares. As a result, shareholders who might desire to participate in such a transaction may not have the opportunity to do so. 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 Company's Series B Convertible Preferred Stock, no par value per share (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. 18 19 Volatility of Stock Price; Absence of Dividends. From time to time, there may be significant volatility in the market price for the Common Stock. Quarterly operating results of the Company, changes in earnings estimates by analysts, changes in general conditions in the Company's industry or the economy or the financial markets or other developments affecting the Company 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. 19 20 Item 7. Financial Statements, Pro Forma Financial Information and Exhibits (b) The Registrant has restated certain of its historical fiscal year end audited financial statements and the related financial statement schedule to: (a) reflect the business combinations with the ExpressBill Companies consistent with the accounting treatment for a pooling of interests; (b) reflect a change in the methods used to value acquired in-process technology recorded and written off in connection with the Company's 1996 acquisition of NEIC and 1997 acquisitions of HDIC and DSS; and (c) give retroactive effect to a change in accounting for convertible securities having a beneficial conversion feature. Listed below are the financial statements, the financial statement schedule and related information which are responsive to Item 7(b) hereof. Reports of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Schedule II - Valuation and Qualifying Accounts (c) The following exhibits are being filed herewith as a result of the restatement of the Company's audited financial statements: Exhibits: 23.1 Consent of Ernst & Young LLP 23.2 Consent of Arthur Andersen LLP 27 Financial Data Schedule (for SEC use only) 20 21 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, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the accompanying financial statement schedule filed herewith. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the financial statements of Professional Office Services, Inc. and XpiData, Inc., which statements reflect total assets constituting 6% in 1997 and 4% in 1996, and total revenues constituting 18% in 1997, 16% in 1996, and 24% in 1995 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 the 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 the 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, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed more fully in Note 2, the Company and the staff of the Securities and Exchange Commission have had discussions with respect to the methods used by the Company to value acquired in-process technology. As a result of these discussions, the Company has modified the methods used to value acquired in-process technology recorded and written off in connection with the Company's 1996 acquisition of National Electronic Information Corporation and 1997 acquisitions of Healthcare Data Interchange Corporation and Diverse Software Solutions and accordingly, has restated the consolidated financial statements for the years ended December 31, 1997 and 1996 to reflect this change. Additionally, as discussed more fully in Note 2, the Company has given retroactive effect to the change in accounting for its convertible securities having a beneficial conversion feature. Ernst & Young LLP Nashville, Tennessee March 5, 1998, except for the business combinations accounted for as poolings of interests referred to in Notes 1 and 4, as to which the date is April 29, 1998; the restatement for the beneficial conversion feature referred to in Note 2, as to which the date is June 26, 1998; the restatement related to acquired in-process technology referred to in Note 2 and the subsequent event referred to in Note 22, as to which the date is November 9, 1998. 21 22 ENVOY Corporation Consolidated Balance Sheets (In thousands, except share data)
DECEMBER 31, 1997 1996 ----------------------- ------------------------ (Restated - see Note 2) (Restated - see Note 2) Assets Current assets: Cash and cash equivalents $8,598 $36,737 Trade accounts receivable, less allowance for doubtful accounts of $3,641 and $2,228 in 1997 and 1996, respectively 33,510 24,549 Inventories 2,585 2,975 Deferred income taxes 1,797 1,309 Other 1,811 3,000 ------------ ----------- Total current assets 48,301 68,570 Property and equipment: Equipment 35,890 26,791 Furniture and fixtures 2,433 3,197 Leasehold improvements 2,766 2,156 ------------ ----------- 41,089 32,144 Less accumulated depreciation and amortization (21,581) (15,507) ------------ ----------- 19,508 16,637 Other assets: Goodwill, net of amortization 67,001 42,992 Other intangibles, net of amortization 27,384 25,682 Other 4,431 2,487 ------------ ----------- Total assets $166,625 $156,368 ============ ===========
See accompanying notes. 22 23 ENVOY Corporation Consolidated Balance Sheets (continued) (In thousands, except share data)
DECEMBER 31, 1997 1996 ------------------------ ---------------------- Liabilities and shareholders' equity (Restated - see Note 2) (Restated - see Note 2) Current liabilities: Accounts payable $ 3,334 $5,707 Accrued expenses and other current liabilities 25,362 13,154 Short-term debt 1,315 1,781 Current portion of long-term debt 263 387 ---------- ----------- Total current liabilities 30,274 21,029 Long-term debt, less current portion 527 8,926 Deferred income taxes 1,579 1,988 Other non-current liabilities 9,163 0 Shareholders' equity: Preferred stock--No par value; authorized, 12,000,000 shares; issued, 3,730,233 55,021 55,021 Common stock--No par value; authorized, 48,000,000 shares; issued, 20,075,822 and 18,854,531 in 1997 and 1996, respectively 114,652 103,265 Additional paid-in capital 7,208 7,193 Retained deficit (51,799) (41,054) ---------- ----------- Total shareholders' equity 125,082 124,425 ---------- ----------- Total liabilities and shareholders' equity $166,625 $156,368 ========== ===========
See accompanying notes. 23 24 ENVOY Corporation Consolidated Statements of Operations (In thousands, except per share data)
YEAR ENDED DECEMBER 31, 1997 1996 1995 ------------------------------------------ (Restated - (Restated - see Note 2) see Note 2) Revenues $137,605 90,572 $ 34,197 Operating costs and expenses: Cost of revenues 64,247 43,500 18,967 Selling, general and administrative expenses 32,734 24,631 11,156 Research and development expenses 2,192 1,779 1,466 Depreciation and amortization expenses 34,432 25,497 2,725 Merger and facility integration costs 0 4,664 0 Write-off of acquired in-process technology 6,600 8,700 0 EMC losses 0 540 0 ------------------------------------------ Operating loss (2,600) (18,739) (117) Other income (expense): Interest income 1,312 1,032 380 Interest expense (1,577) (2,872) (659) ------------------------------------------ (265) (1,840) (279) ------------------------------------------ Loss from continuing operations before income taxes and loss in investee (2,865) (20,579) (396) Provision (benefit) for income taxes 6,333 1,717 (50) Loss in investee 0 0 (1,776) ------------------------------------------ Loss from continuing operations (9,198) (22,296) (2,122) Income from discontinued operations, net of income taxes 0 0 30 First Data transaction expenses, including income 0 0 (2,431) taxes ------------------------------------------ Loss from discontinued operations 0 0 (2,401) ------------------------------------------ Net loss (9,198) (22,296) (4,523) Less preferred stock dividends 0 (14,921) 0 ------------------------------------------ Net loss applicable to common stock $ (9,198) $ (37,217) $(4,523) ==========================================
(CONTINUED) 24 25 ENVOY Corporation Consolidated Statements of Operations (Continued) (In thousands, except per share data)
YEAR ENDED DECEMBER 31, 1997 1996 1995 ------------ ----------- --------- Basic and diluted net loss per common share: (RESTATED - (RESTATED - SEE NOTE 2) SEE NOTE 2) Loss from continuing operations $ (0.47) $ (2.25) $ (0.14) Loss from discontinued operations 0 0 (0.17) -------- --------- --------- Basic and diluted net loss per common share $ (0.47) $ (2.25) $ (0.31) ======== ========= ========= Weighted average shares outstanding 19,686 16,519 14,739 ======== ========= ========= Pro forma net loss data (unaudited), reflecting pro forma tax provision on income of ExpressBill companies (see Notes 4 and 16): Historical loss from continuing operations applicable to common stock $ (9,198) $ (37,217) $ (2,122) pro forma adjustment to provision for income taxes 1,032 165 0 -------- --------- --------- Pro forma loss from continuing operations applicable to common stock (10,230) (37,382) (2,122) Loss from discontinued operations 0 0 (2,401) -------- --------- --------- Pro forma net loss applicable to common $(10,230) $(37,382) $(4,523) stock ======== ========= ========= Basic and diluted pro forma loss per common share Pro forma loss-continuing $(0.52) $(2.26) $(0.14) operations Pro forma loss-discontinued operations 0 0 (0.17) -------- --------- --------- Basic and diluted pro forma net loss per common share $(0.52) $(2.26) $(0.31) ======== ========= =========
See accompanying notes. 25 26 ENVOY Corporation Consolidated Statements of Shareholders' Equity (In thousands)
ADDITIONAL COMMON STOCK PREFERRED STOCK PAID-IN SHARES AMOUNT SHARES AMOUNT CAPITAL ------- -------- ----- --------- ------ Balance at December 31, 1994 14,514 $11,081 $35,190 Stock options exercised 271 271 349 Income tax benefit realized on exercise of stock 0 0 46 options First Data merger: Stock option compensation charge 0 0 0 Equity transfer 0 0 (28,430) Capital distributions of ExpressBill 0 0 0 Capital contributions of ExpressBill 4 3 28 Net loss 0 0 0 ------- -------- ----- --------- ------ Balance at December 31, 1995 14,789 11,355 7,183 Stock options exercised 163 510 0 Stock issued in connection with acquisitions 413 6,650 3,730 $40,100 0 Conversion of debt to common stock 170 1,786 0 0 0 Proceeds from issuance of stock 3,320 82,964 0 0 0 Capital distributions of ExpressBill 0 0 0 0 0 Capital contributions of ExpressBill 0 0 0 0 10 Accretion of Series B preferred stock dividends 0 0 0 14,921 0 Net loss 0 0 0 0 0 ------- -------- ----- --------- ------ Balance at December 31, 1996 (Restated - See Note 2) 18,855 103,265 3,730 55,021 7,193 Stock options exercised 437 1,844 0 0 0 Income tax benefit realized on exercise of stock 0 1,249 0 0 0 options Conversion of debt to common stock 781 8,214 0 0 0 Proceeds from issuance of stock 3 80 0 0 0 Capital distributions of ExpressBill 0 0 0 0 0 Capital contributions of ExpressBill 0 0 0 0 15 Net loss 0 0 0 0 0 ------- -------- ----- --------- ------ Balance at December 31, 1997 (Restated - See Note (2) 20,076 $114,652 3,730 $55,021 $7,208 ======= ======== ===== ========= ======
RETAINED TOTAL EARNINGS DEFERRED SHAREHOLDERS' (DEFICIT) COMPENSATION EQUITY ------- --------- ------- Balance at December 31, 1994 $8,558 $(1,264) $53,565 Stock options exercised 0 0 620 Income tax benefit realized on exercise of stock 0 0 46 options First data merger: Stock option compensation charge 0 1,264 1,264 Equity transfer (6,989) 0 (35,419) Capital distributions of ExpressBill (212) 0 (212) Capital contributions of ExpressBill 0 0 31 Net loss (4,523) 0 (4,523) ------- --------- ------- Balance at December 31, 1995 (3,166) 0 15,372 Stock options exercised 0 0 510 Stock issued in connection with acquisitions 0 0 46,750 Conversion of debt to common stock 0 0 1,786 Proceeds from issuance of stock 0 0 82,964 Capital distributions of ExpressBill (671) 0 (671) Capital contributions of ExpressBill 0 0 10 Accretion of Series B preferred stock dividends (14,921) 0 0 Net loss (22,296) 0 (22,296) ------- --------- ------- Balance at December 31, 1996 (Restated - See Note 2) (41,054) 0 124,425 Stock options exercised 0 0 1,844 Income tax benefit realized on exercise of stock 0 0 1,249 options Conversion of debt to common stock 0 0 8,214 Proceeds from issuance of stock 0 0 80 Capital distributions of ExpressBill (1,547) 0 (1,547) Capital contributions of ExpressBill 0 0 15 Net loss (9,198) 0 (9,198) ------- --------- ------- Balance at December 31, 1997 (Restated - See Note (2) $(51,799) $0 $125,082 ======== ========= ========
See accompanying notes. 26 27 ENVOY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, 1997 1996 1995 ----------------- ----------------- --------- (Restated - see Note 2) (Restated - see Note 2) OPERATING ACTIVITIES: NET LOSS $ (9,198) $ (22,296) $ (4,523) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 34,432 25,507 3,807 Stock option compensation expense 0 0 1,264 Provision for losses on accounts receivable 1,461 1,112 430 Deferred income tax provision (benefit) (995) 339 11 Write-off of certain assets and investments 6,600 10,281 820 Changes in assets and liabilities, net of First Data transaction and acquired businesses: Decrease (increase) in accounts receivable (9,782) (8,709) 66 Decrease (increase) in inventories 388 (543) (1,643) Decrease (increase) in other current assets 981 (1,887) (619) Increase (decrease) in accounts payable, accrued expenses and other current liabilities (1,900) (621) 2,180 --------- --------- --------- Net cash provided by operating activities 21,987 3,183 1,793 INVESTING ACTIVITIES Net (increase) decrease in short-term investments 0 5,103 (5,103) Purchases of property and equipment (8,744) (5,356) (8,507) Decrease (increase) in other assets (1,998) 0 1,047 Investment in EMC 0 0 (750) Payments for businesses acquired, net of cash acquired of $5,543 in 1996 (40,412) (93,744) 0 --------- --------- --------- Net cash used in investing activities (51,154) (93,997) (13,313) FINANCING ACTIVITIES Proceeds from issuance of preferred stock 0 40,100 0 Proceeds from issuance of common stock 3,174 88,474 623 Capital distributions of Express Bill (1,391) (671) (212) Capital contributions of Express Bill 15 10 0 Proceeds from long-term debt 0 44,267 10,457 Payments on long-term debt (304) (44,387) (1,447) Proceeds from (payments on) short-term debt (466) 639 741 Payment of deferred financing costs 0 (1,200) 0 Cash transferred in First Data transaction 0 0 (2,743) --------- --------- --------- Net cash provided by financing activities 1,028 127,232 7,419 --------- --------- --------- Net increase (decrease) in cash and cash equivalents (28,139) 36,418 (4,101) Cash and cash equivalents at beginning of year 36,737 319 4,420 --------- --------- --------- Cash and cash equivalents at end of year $ 8,598 $ 36,737 $ 319 ========= ========= =========
(Continued) 27 28 ENVOY Corporation Consolidated Statements of Cash Flows (continued) (In thousands)
YEAR ENDED DECEMBER 31, 1997 1996 1995 ------------------------------------------------ (Restated - (Restated - see Note 2) see Note 2) SUPPLEMENTAL CASH FLOW INFORMATION Interest paid $ (238) $ (2,357) $ (659) Interest received 1,250 1,024 380 Income taxes paid (5,952) (371) (496) NONCASH TRANSACTIONS First Data transaction: Book value of assets transferred, excluding cash $ 0 $ 0 $ 36,083 Liabilities transferred 0 0 (3,407) Equity transferred 0 0 (35,419) ------------------------------------------------- Cash transferred $ 0 $ 0 $ (2,743) ================================================= ACQUISITIONS Working capital $ 0 $ 302 $ 0 Intangible assets 0 1,348 0 Common stock issued 0 (1,650) 0 ------------------------------------------------ Cash transferred $ 0 $ 0 $ 0 ================================================ CONVERSION OF DEBT TO COMMON STOCK $ 8,214 $ 1,786 $ 0 ================================================
See accompanying notes. 28 29 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") (see Note 3). 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. For accounting purposes, the Company's financial statements for 1995 include financial information for its predecessor, Old ENVOY, with the financial services electronic processing business (the "Financial Business") shown as discontinued operations. For purposes of the notes to the consolidated financial statements, the "Company" refers to Old ENVOY and New ENVOY for the period prior to June 6, 1995. 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 for 1997, 1996 and 1995 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. SHORT-TERM INVESTMENTS Short-term investments include investments in fixed rate securities consisting primarily of bonds and corporate notes. These investments have maturity dates of one to five years from the date of purchase and are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." All short-term investments were sold prior to December 31, 1996. Proceeds, gross realized gains and gross realized losses from the sale of available-for-sale securities were $6,126,000, $1,911, and $39,138, respectively, in 1996 and $9,470,000, $288,000, and $9,000, respectively, in 1995. The cost of securities sold is based on the specific identification method. 29 30 ENVOY Corporation Notes to Consolidated Financial Statements CONCENTRATION OF CREDIT RISK The Company has one customer that accounted for approximately 12% of the Company's consolidated revenues for 1997 and accounted for approximately 16% of consolidated accounts receivable. No single customer accounted for more than 10% of consolidated revenues in 1996 or 1995. 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 $6,141,000, $4,920,000 and $2,674,000 for 1997, 1996 and 1995, respectively. OTHER ASSETS Other assets consist primarily of goodwill and other intangible assets as follows (in thousands):
December 31, Amortization 1997 1996 Period -------------------------------------- ------------ Goodwill $ 105,059 $ 59,466 3-15 years Less accumulated amortization (38,058) (16,474) ------------------------------------- $ 67,001 $ 42,992 ====================================== Submitter and payor relationships $ 12,700 $ 12,400 9 years Customer contracts 13,554 8,554 9-10 years Developed technology 4,300 2,100 2 years Covenants not to compete 4,081 4,133 2 years Trademarks and tradenames 350 0 3-7 years Assembled work force 3,140 2,600 3-7 years ------------------------------------- 38,125 29,787 Less accumulated amortization (10,741) (4,105) ------------------------------------- $ 27,384 $ 25,682 ======================================
Amortization expense related to such intangible assets for the years ended December 31, 1997, 1996 and 1995 was $28,292,000, $20,578,000 and $39,000, respectively. 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, 1997, in the opinion of management, there has been no such impairment. 30 31 ENVOY Corporation Notes to Consolidated Financial Statements REVENUE RECOGNITION Processing services revenue is recognized as the transactions are processed. The Company recognizes revenue from software sales in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position 91-1, "Software Revenue Recognition." Revenue from software product sales is recognized upon delivery to the customer provided the collection of the sales proceeds is deemed probable and no significant vendor obligations remain. 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. In October 1997, the AICPA issued Statement of Position 97-2 ("SOP 97-2"), "Software Revenue Recognition." SOP 97-2 is effective for fiscal years beginning after December 15, 1997, and is not expected to have a material impact on the Company's financial statements. Effective January 1, 1998, the Company adopted SOP 97-2. LOSS PER COMMON SHARE In 1997, the Company adopted the provisions of SFAS No. 128, "Earnings per Share." SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. The adoption of SFAS No. 128 had no impact on the Company's computation of earnings per share for the current or prior periods. RESEARCH AND DEVELOPMENT Research and development expenses of $2,192,000 in 1997, $1,779,000 in 1996 and $1,466,000 in 1995 were charged to expense as incurred until technological feasibility had been established for the 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. 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, 31 32 ENVOY Corporation Notes to Consolidated Financial Statements ("APB No. 25") "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense. RECLASSIFICATIONS Certain reclassifications have been made in the 1996 and 1995 consolidated financial statements to conform with the 1997 presentation. RESTATEMENT OF FINANCIAL STATEMENTS Restatement for Beneficial Conversion Feature The results of operations presented in the financial statements for the year ended December 31, 1996 have been restated to give effect to the accounting treatment announced by the Securities and Exchange Commission at the March 13, 1997 meeting of the Emerging Issues Task Force relevant to the Company's Series B Convertible Preferred Stock (the "Series B Preferred Stock") (see Notes 4 and 13) which has a "beneficial conversion" feature. The purchase price for the Series B Preferred Stock ($10.75 per share) was established on October 25, 1996, when the letter of intent related to the financing of the acquisition of National Electronic Information Corporation ("NEIC") was executed. The Series B Preferred Stock Purchase Agreement (the "Stock Purchase Agreement") was executed on November 30, 1995, at which time the fair value of the Common Stock was $14.75 per share and, pursuant to the terms of the Stock Purchase Agreement, was convertible into Common Stock on the date of issuance on a one-for-one basis. The discount between the issuance price of $40.1 million or $10.75 per share and the fair value on the date of the Stock Purchase Agreement of $55.0 million or $14.75 per share gives rise to a beneficial conversion feature. Under the accounting treatment discussed above, the value of the discount has been reflected in the restated financial statements as preferred dividends and has been accreted on the date of issuance, March 6, 1996, which is also the first possible conversion date. Accordingly, the entire discount is treated as a dividend on the Series B Preferred Stock for the year ended December 31, 1996. The restatement has no effect on cash flows of the Company. Restatement Related to Acquired In-Process Technology The management of the Company and the staff of the Securities and Exchange Commission have had discussions with respect to the methods used to value acquired in-process technology recorded and written off at the date of acquisition. As a result of these discussions, the Company has modified the methods used to value acquired in-process technology in connection with the Company's 1996 acquisition of NEIC and 1997 acquisitions of Healthcare Data Interchange Corporation ("HDIC") and Diverse Software Solutions ("DSS"). Initial calculations of value of the acquired in-process technology were based on the cost required to complete each project, the after-tax cash flows attributable to each project, and the selection of an appropriate rate of return to reflect the risk associated with the stage of completion of each project. Revised calculations of the value of the acquired in-process technology are based on adjusted after-tax cash flows that give explicit consideration to the Staff's views on in-process research and development as set forth in its September 15, 1998 letter to the AICPA, and the Staff's comments for the Company to consider (i) the stage of completion of the in-process technology at the dates of acquisition, (ii) contributions of the Company's own distinct and unique proprietary advantages, and (iii) the estimated total project costs of the in-process research and development in arriving at the valuation amount. As a result of this modification the Company has decreased the amount of the purchase price allocated to acquired in-process technology in the NEIC acquisition from $30 million to $8 million, in the HDIC acquisition from $35 million to $6 million, and in the DSS acquisition from $3 million to $600,000. As a result, the Company increased other intangibles by $5 million (for customer contracts) and goodwill by $48.4 million. 32 33 ENVOY Corporation Notes to Consolidated Financial Statements Summary of Effects of Restatements The effects of the restatement for the beneficial conversion feature and the effects of the restatement related to acquired in-process technology resulted in the following impact on the Company's results of operations for the years ended December 31, 1997 and 1996 and its financial position at December 31, 1997 and 1996 (in thousands).
1997 1996 ---------- --------- Results of operations: Loss from continuing operations before income taxes as previously reported $(25,928) $(36,590) Adjustment related to acquired in-process technology* 23,063 16,011 -------- -------- Restated $ (2,865) $(20,579) ======== ======== Net loss, as previously reported $(20,710) $(38,307) Adjustment related to acquired in-process technology* 11,512 16,011 Adjustment related to beneficial conversion feature -- (14,921) -------- -------- Restated net loss applicable to common stock $ (9,198) $(37,217) ======== ======== Loss per share: As previously reported $ (1.05) $ (2.32) Adjustment related to acquired in-process technology* 0.58 0.97 Adjustment related to beneficial conversion feature -- (0.90) -------- -------- Restated $ (0.47) $ (2.25) ======== ========
*The adjustment results from the decrease in the value assigned to acquired in-process technology and the increased amortization of goodwill and other intangibles. 33 34 ENVOY Corporation Notes to Consolidated Financial Statements
1997 1996 --------- ---------- Financial Position: Goodwill, as previously reported $ 32,719 $ 26,981 Adjustment related to acquired in-process technology 34,282 16,011 -------- -------- Restated $ 67,001 $ 42,992 ======== ======== Other intangibles, as previously reported $ 22,592 $ 25,682 Adjustment related to acquired in-process technology 4,792 -- -------- -------- Restated $ 27,384 $ 25,682 ======== ======== Deferred tax asset (liability), as originally reported $ 9,972 $ (1,988) Adjustment related to acquired in-process technology (11,551) -- -------- -------- Restated $ (1,579) $ (1,988) ======== ======== Retained deficit, as previously reported $(79,322) $(57,065) Adjustment related to acquired in-process technology * 27,523 16,011 -------- -------- Restated $(51,799) $(41,054) ======== ========
* The adjustment results from the decrease in the value assigned to acquired in-process technology and the increased amortization of goodwill and other intangibles. 3. DISCONTINUED OPERATIONS--TRANSACTION WITH FIRST DATA CORPORATION On June 6, 1995, the Company completed a merger of its Financial Business with First Data (the "First Data Merger"). Pursuant to a management services agreement entered into in connection with the First Data Merger, the Company received a fee from First Data of $1,500,000 per annum, payable in quarterly installments of $375,000, during the first two years following the First Data Merger. Management fees of $650,000, $1,500,000 and $850,000 for the years ended December 31, 1997, 1996 and 1995 are classified in revenues in the consolidated statements of operations. The net assets of the Financial Business were merged with and into First Data and were accounted for as discontinued operations. Revenues of the Financial Business were $12,828,000 for the period January 1, 1995 through June 6, 1995. The Company incurred $1,997,000 in expense related to the Distribution and First Data Merger for the year ended December 31, 1995. These expenses consisted primarily of legal, accounting and financial advisor fees. As set forth in the merger agreement, First Data paid 50% of the costs of the transactions up to a maximum expense to First Data of $2,000,000. The $1,997,000 incurred by the Company is net of the $2,000,000 paid by First Data. The costs associated with the First Data Merger have been included in discontinued operations including applicable income taxes of $434,000 for the year ended December 31, 1995 and reflect the reversal of tax benefits previously recognized for such charges. 34 35 ENVOY Corporation Notes to Consolidated Financial Statements 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 ENVOY Common Stock ("Common Stock"). Shareholders of XpiData, based in Scottsdale, Arizona, received 1,365,000 shares and shareholders of POS and its affiliated company, ARM, both of which are based in Toledo, Ohio, received an aggregate of 2,135,000 shares. The ExpressBill patient statement services include electronic data transmission and formatting, statement printing and mailing services for health care providers and practice management system vendors. These transactions have been accounted for as poolings of interests. Accordingly, the Company's historical consolidated financial statements for 1997, 1996 and 1995 have been restated to include the accounts and results of operations of the ExpressBill Companies. A reconciliation of previously reported revenues and earnings, restated to reflect the modifications referred to in Note 2, appears below:
YEAR ENDED DECEMBER 31, 1997 1996 1995 --------- --------- --------- (In thousands, except per share data) REVENUES: ENVOY $ 113,693 $ 76,584 $ 26,055 ExpressBill Companies 23,912 13,988 8,142 --------- --------- --------- Combined $ 137,605 $ 90,572 $ 34,197 ========= ========= ========= Net income (loss)from continuing operations applicable to common stock ENVOY $ (12,251) $ (37,810) $ (2,000) ExpressBill Companies 3,053 593 (122) --------- --------- --------- Combined $ (9,198) $ (37,217) $ (2,122) ========= ========= ========= Net loss per common share from continuing operations ENVOY $ (0.76) $ (2.90) $ (0.18) Combined $ (0.47) $ (2.25) $ (0.14)
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 On March 6, 1996, the Company's shareholders approved the acquisition of NEIC for an aggregate purchase price of approximately $94,301,000, consisting of $88,354,000 paid to the NEIC stockholders and certain other transaction and acquisition costs of $5,947,000, summarized as follows (in thousands): 35 36 ENVOY Corporation Notes to Consolidated Financial Statements Purchase price $ 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 =======
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 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. 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. 36 37 ENVOY Corporation Notes to Consolidated Financial Statements 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 yielding a purchase price of approximately $1,500,000, summarized as follows (in thousands): 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 =======
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. 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 and the assumption of certain liabilities, summarized as follows (in thousands): 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 =======
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. 37 38 ENVOY Corporation Notes to Consolidated Financial Statements PROFESSIONAL OFFICE SYSTEMS, INC. ("POSI") On October 31, 1996, the Company acquired all the issued and outstanding capital stock of POSI, the electronic data interchange clearinghouse for Blue Cross and Blue Shield of the National Capital Area, for approximately $6,400,000 in cash and the assumption of certain liabilities, summarized as follows (in thousands): 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 =======
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. DIVERSE SOFTWARE SOLUTIONS, INC. On March 11, 1997, the Company completed the acquisition of certain assets of DSS for $4,000,000 in cash, plus a variable payment based upon revenue earned during a specified period following the acquisition, and the assumption of certain liabilities, summarized as follows (in thousands): Purchase price $ 4,000 Add liabilities assumed: Current liabilities 2,490 Variable payment 2,200 -------- 4,690 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 $ 6,224 ========
Goodwill of $6,224,000 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. At December 31, 1997, the Company had recorded a liability of $2,200,000 related to the variable payments, which were paid in February 1998. This obligation is included in accrued expenses at December 31, 1997. 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 38 39 ENVOY Corporation Notes to Consolidated Financial Statements 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. HEALTHCARE DATA INTERCHANGE CORPORATION 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 and the assumption of approximately $14,800,000 of liabilities, summarized as follows (in thousands): Purchase price $ 36,400 Add liabilities assumed: Unfavorable contracts 13,800 Other liabilities 993 -------- 14,793 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 $ 38,080 ========
Goodwill of $38,080,000 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 $13,800,000 relating to the assumption of unfavorable contracts. At December 31, 1997, the remaining liability for unfavorable contracts was $13,073,000, with $9,163,000 classified as a non-current liability, and $3,910,000 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. 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, 1996 and 1995 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): 39 40 ENVOY Corporation Notes to Consolidated Financial Statements
YEAR ENDED DECEMBER 31, 1997 1996 1995 ---------- --------- ------- Revenues $144,099 $115,978 $87,104 Net loss applicable to common stock (13,985) (45,744) (40,431) Net loss per common share (0.71) (2.72) (2.67)
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 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 40 41 ENVOY Corporation Notes to Consolidated Financial Statements 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. Following the termination of the Management Agreement and the Option, certain shareholders of EMC filed a lawsuit in March 1996 against the Company asserting claims for breach of contract and negligent conduct. On October 18, 1996, the Company settled this lawsuit for $300,000. Concurrent with the settlement of the lawsuit, the Company completed the acquisition of the remaining 82.5% interest in EMC for approximately $2,000,000 in cash. The EMC acquisition was accounted for under the purchase method of accounting applying the provisions of APB No. 16 and, as a result, the Company recorded the assets and liabilities at their estimated fair values. 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):
DECEMBER 31, 1997 1996 ------------------------- Current portion of liability for unfavorable contracts $3,910 $0 Liability to former owners of DSS 2,200 0 Unearned income 1,942 0 Accrued communication expense 1,982 2,263 Accrued income taxes 1,679 1,898 Accrued salaries and benefits 2,348 2,104 Accrued vendor incentives 1,808 1,110 Customer deposits 1,894 833 Other 7,599 4,946 ------------------------- $25,362 $13,154 =========================
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. 41 42 ENVOY Corporation Notes to Consolidated Financial Statements 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 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, 1997, 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 consists of the following (in thousands):
DECEMBER 31, --------------------------- 1997 1996 --------------------------- Convertible note $ 0 $ 8,214 Other debt and capital lease obligations, payable through 2002, interest ranging from 9.25% to 22% secured by assets 790 1,099 --------------------------- 790 9,313 Less current portion (263) (387) --------------------------- $ 527 $ 8,926 ===========================
42 43 ENVOY Corporation Notes to Consolidated Financial Statements Annual long-term debt and capital lease obligations principal requirements are as follows (in thousands): 1998 $263 1999 307 2000 163 2001 50 2002 7 ---- $790 ====
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, 1997, 1996 and 1995 was approximately $2,207,000, $1,955,000 and $1,304,000, respectively. Future minimum rental payments at December 31, 1997 under operating lease arrangements are as follows (in thousands): 1998 $ 3,099 1999 3,207 2000 2,872 2001 2,438 2002 1,603 Thereafter 1,055 ------- Total minimum lease payments $14,274 =======
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," 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. 43 44 ENVOY Corporation Notes to Consolidated Financial Statements At December 31, 1997, the Company had reserved 4,214,640 shares of Common Stock for issuance in connection with the stock option plans. Summaries of stock options outstanding are as follows:
WEIGHTED- NUMBER OF OPTION PRICE PER AVERAGE SHARES SHARE EXERCISE PRICE Outstanding, December 31, 1994 1,477,000 $1.83-$7.00 $2.61 Granted 1,829,000 2.19-18.00 9.54 Exercised (271,000) 1.83-3.79 2.28 ------------------------------------------------------ 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) 7.75-30.00 19.92 ------------------------------------------------------ Outstanding, December 31, 1997 3,402,000 $1.83-$37.00 $13.58 ======================================================
The number of stock options exercisable and the weighted average exercise price of these options was 1,147,500 and $5.76 and 1,254,000 and $3.47 at December 31, 1997 and 1996, respectively. The weighted-average fair value of options granted during 1997 and 1996 was $10.96 and $13.93, 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 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, 1997, options for the purchase of 2,691,000 shares were outstanding 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, 1997, options for the purchase of 24,000 shares were outstanding 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. Because 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 44 45 ENVOY Corporation Notes to Consolidated Financial Statements 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, 1997, options for the purchase of 687,000 shares were outstanding and fully exercisable under these plans. The Compensation Committee of the Board of Directors amended the 1992 Incentive Plan in August 1994 to provide that all options thereunder would vest immediately preceding the expiration of such option grant or earlier upon the attainment of certain performance criteria. This amendment resulted in the recording of deferred compensation and additional paid-in capital of approximately $1,974,000. The deferred compensation was recognized as an expense over the vesting period. As a result of the First Data Merger, the vesting of all outstanding options was accelerated and all options became fully vested as of the effective date of the First Data Merger. Accordingly, during the year ended December 31, 1995, the remaining deferred compensation expense of $1,264,000 was recognized. 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 1997 and 1996, respectively: risk-free interest rates of 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 .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):
1997 1996 1995 ----------------------------------------------- Pro forma net loss applicable to common stock $(12,435) $(38,957) $(4,960) Proforma loss per common share (0.63) (2.36) (.34)
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 45 46 ENVOY Corporation Notes to Consolidated Financial Statements Stock for issuance under the ESPP. As of December 31, 1997, approximately 3,000 shares had been issued under the ESPP. 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 Notes 2 and 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. 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 connection with the First Data Merger, 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. 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 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. 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. 46 47 ENVOY Corporation Notes to Consolidated Financial Statements 16. INCOME TAXES The provision for income taxes was comprised of the following (in thousands):
DECEMBER 31, 1997 1996 1995 -------------------------------- Current: Federal $ 4,957 $ 271 $ 359 State 2,429 1,107 55 ------- ------- ----- Total current 7,386 1,378 414 Deferred: Federal 421 1,139 16 State (1,474) (800) (4) ------- ------- ----- Total deferred (1,053) 339 12 ------- ------- ----- Provision for income taxes $ 6,333 $ 1,717 $ 426 ======= ======= =====
The reconciliation of income tax computed by applying the U.S. federal statutory rate to the actual income tax provision follows (in thousands):
DECEMBER 31, 1997 1996 1995 ---------------------------------- Income tax benefit at U.S. federal statutory rate $(1,003) $(6,997) $(1,388) Nondeductible merger costs 0 2,979 679 Nondeductible goodwill amortization 7,066 5,447 0 State income taxes, net of federal benefit 630 203 34 Change in valuation allowance 238 163 1,130 Other,net (598) (78) (29) ------- ------- ------- Income tax provision $ 6,333 $ 1,717 $ 426 ======= ======= =======
47 48 ENVOY Corporation Notes to Consolidated Financial Statements The classification of the provision for income taxes in the consolidated statements of operations is as follows (in thousands):
DECEMBER 31, 1997 1996 1995 ----------------------------- Income tax provision (benefit) attributable to continuing operations $6,333 $1,717 $ (50) Discontinued operations: Income from operations 0 0 42 First Data transaction expense 0 0 434 ------ ------ ----- Total provision from discontinued operations 0 0 476 ------ ------ ----- Total income tax provision $6,333 $1,717 $ 426 ====== ====== =====
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): 48 49 ENVOY Corporation Notes to Consolidated Financial Statements
DECEMBER 31, 1997 1996 ------------------ Deferred tax liability: Difference between book and tax depreciation and amortization related to property and equipment $(2,348) $(2,211) Difference between book and tax amortization related to goodwill and other intangibles (3,517) (6,158) ------- ------- Total deferred tax liabilities (5,865) (8,369) ------- ------- Deferred tax assets: Difference between book and tax amortization related to write-off of acquired in-process technology 2,432 0 Difference between book and tax treatment of leased assets 585 516 Reserves and accruals not currently deductible 1,683 1,250 Net operating loss 398 4,629 Difference between book and tax treatment of investments 900 880 Difference between book and tax treatment of compensation expense 408 581 Tax credits 583 503 Other 119 118 ------- ------- Total deferred tax assets 7,108 8,477 Valuation allowance for deferred tax assets (1,025) (787) ------- ------- Net deferred tax assets 6,083 7,690 ------- ------- Net deferred tax assets(liability) $ 218 $ (679) ======= =======
At December 31, 1997, the Company had federal and state net operating loss carryforwards of approximately $12,400,000 and $17,800,000, respectively. All of the federal and approximately $7,400,000 of the state net operating losses relate to the exercise of employee stock options and the tax benefit will be allocated to equity when realized on the Company's tax returns. These losses begin to expire in 2003. Of the $12,400,000 federal net operating losses, $10,800,000 are attributable to pre-acquisition years of NEIC and their use is limited by the Code to approximately $4,700,000 per year. The remaining $1,600,000 of federal net operating losses are attributable to pre-acquisition years of EMC and their use is limited by the Code to approximately $141,000 per year. The Company evaluates the amounts recorded for the valuation allowance for deferred tax assets each year. The valuation allowance at December 31, 1996 relates to the loss on the investment in EMC. The valuation allowance at December 31, 1997 relates to the loss on the investment in EMC plus certain tax credits that expire in 1997 and might not be realized on the Company's 1997 tax returns. The allowance was increased in 1997 to include these credits. In evaluating the requirement for the valuation allowance, the Company considered its deferred tax liabilities, which were $5,865,000 and $8,369,000 at December 31, 1997 and 1996, respectively, as a possible 49 50 ENVOY Corporation Notes to Consolidated Financial Statements source of taxable income. In addition, the Company considered its taxable income as reported on its 1996 tax return, approximately $4,300,000, and its projected taxable income for 1997. Management believes that it is more likely than not that the deferred tax assets in excess of the valuation reserves will be realized. As previously discussed, 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 1997, 1996 and 1995, income tax expense (benefit) from continuing operations under the provisions of SFAS No. 109 would have been $7,365,000, $1,882,000, and $(50,000), 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. The amount of expense for the Company contribution for all plans was approximately $613,000, $583,000 and $112,000 for the years ended December 31, 1997, 1996 and 1995, 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. 50 51 ENVOY Corporation Notes to Consolidated Financial Statements 19. LOSS PER COMMON SHARE The following table sets forth the computation of loss per common share (in thousands, except per share data):
1997 1996 1995 ------------------------------------ Numerator for loss per common share: Loss from continuing operations $ (9,198) $(22,296) $ (2,122) Income from discontinued operations, net of income taxes 0 0 30 First Data transaction expenses, including income taxes 0 0 (2,431) ---------------------------------------- Loss from discontinued operations 0 0 (2,401) ---------------------------------------- Net loss (9,198) (22,296) (4,523) Less preferred stock dividends -- (14,921) -- ---------------------------------------- Net loss applicable to common shares $ (9,198) $(37,217) $ (4,523) ======================================== Denominator: Weighted average shares (1) 19,686 16,519 14,739 ======================================== Loss per common share: Continuing operations $ (0.47) $ (2.25) $ (0.14) Discontinued operations 0 0 (0.17) ======================================== Net loss per common share $ (0.47) $ (2.25) $ (0.31) ========================================
(1) Stock options to purchase 3,035,000, 3,229,000, and 3,402,000 shares of common stock in 1997, 1996, and 1995, 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 0, 629,281, and 950,570 shares of Common Stock in 1997, 1996, and 1995, respectively) 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. 51 52 ENVOY Corporation Notes to Consolidated Financial Statements 20. QUARTERLY FINANCIAL DATA (UNAUDITED)
1997 -------------------------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER -------------------------------------------------------------------- (In thousands, except per share data) Revenues As previously reported $ 26,092 $ 26,416 $ 28,590 $ 32,595 Adjustment (a) 4,671 5,753 6,103 7,385 As restated 30,763 32,169 34,693 39,980 Gross profit As previously reported $ 13,226 $ 13,484 $ 14,779 $ 17,181 Adjustment (a) and (b) 3,031 3,660 3,593 4,404 As restated $ 16,257 $ 17,144 $ 18,372 $ 21,585 Net loss applicable to common stock As previously reported $ (2,233) $ (165) $ (21,210) $ (155) Adjustment (a) and (c) (82) (773) 16,575 (1,155) As restated $ (2,315) (d) $ (938) $ (4,635) (e) $ (1,310) Net loss per common share As previously reported $ (0.14) $ (0.01) $ (1.28) $ (0.01) As restated $ (0.12) (d) $ (0.05) $ (0.23) (e) $ (0.07)
1996 ---------------------------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ---------------------------------------------------------------------- (In thousands, except per share data) Revenues As previously reported $ 10,330 $ 19,590 $ 21,502 $ 25,162 Adjustment (a) 2,654 3,090 3,873 4,371 As restated 12,984 22,680 25,375 29,533 Gross profit As previously reported $ 5,027 $ 9,842 $ 10,729 $ 12,734 Adjustment (a) and (b) 1,692 1,942 2,372 2,734 As restated $ 6,719 $ 11,784 $ 13,101 $ 15,468 Net loss applicable to common stock As previously reported $ (33,910) $ (1,417) $ (1,963) $ (1,610) Adjustment (a), (c) and (f) 6,763 (1,554) (1,505) (2,021) As restated $ (27,147) (f),(g) $ (2,971) $ (3,468) (h) $ (3,631) Net loss per common share As previously reported $ (2.97) $ (0.12) $ (0.14) $ (0.11) As restated $ (1.82) (f),(g) $ (0.20) $ (0.20) (h) $ (0.19)
52 53 ENVOY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (a) Amounts include effects of the restatement for the Company's business combinations with the ExpressBill Companies which were accounted for as poolings-of-interests (See Note 4). (b) Reflects the reclassification of research and development expenses from the cost of revenue to separately classify such expenses in accordance with SFAS No.2. The amounts reclassified for the first, second, third, and fourth quarters of 1997 were $716,000, $521,000, $452,000, and $503,000, respectively, after restatement for the poolings with the ExpressBill Companies. The amounts reclassified for the first, second, third, and fourth quarters of 1996 were $441,000, $442,000, $447,000, and $449,000, respectively, after restatement for the pooling with the ExpressBill Companies. (c) Amounts include effects of the restatement referred to in Note 2 and reflect the decrease in the value of acquired in-process technology and the increased amortization of goodwill and other intangibles. The adjustments for the restatement of the write-off of acquired in-process technology resulted in an increase to income of $2,400,000 in the first quarter of 1997 related to DSS, $29,000,000 in the third quarter of 1997 related to HDIC and $22,000,000 in the first quarter of 1996 related to NEIC. The adjustments for the restatement of amortization of goodwill and other intangibles resulted in decreases to income of $1,842,000, $1,873,000, $2,223,000, and $2,398,000 in the first, second, third, and fourth quarters of 1997, respectively, $489,000 in the first quarter of 1996, and $1,833,000 each quarter in the second, third, and fourth quarters of 1996. The related effects of these adjustments on the provision for income taxes resulted in increases in (decreases to) net income of ($909,000), $15,000, ($10,872,000), and $215,000 in the first, second, third, and fourth quarters of 1997, respectively. There were no related tax effects resulting from the adjustments in 1996. (d) The Company recorded a $600,000 write-off of acquired in-process technology related to the DSS acquisition (see Note 2 and Note 4). (e) 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 2 and Note 4). (f) Amounts include the effect of the accounting treatment announced by the staff of the Securities and Exchange Commission at the March 13, 1997 meeting of the Emerging Issues Task Force relevant to the Company's Series B Convertible Preferred Stock having a "beneficial conversion" feature. For the three months ended March 31, 1996, the adjustment resulted in an increase in preferred dividends and net loss applicable to common stock of $14,921,000 (see Note 2 and Note 13). (g) The Company recorded a $8,700,000 write-off of acquired in-process technology related to the NEIC and Teleclaims acquisitions (see Note 2 and Note 4). (h) The Company recorded a $300,000 charge related to the settlement of the EMC lawsuit (see Note 7). 53 54 ENVOY Corporation Notes to Consolidated Financial Statements 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. Rentals paid were approximately $92,000 annually in each of the years in the three year period ended December 31, 1997. During 1997, the Company entered into a lease, which extends through February 2013, for a new operating facility with this same partnership, with rentals to commence in March 1998. Annual rentals under this new lease will be $457,500 through February 2003, $503,250 through February 2008, and $553,575 through February 2013. 22. SUBSEQUENT EVENTS Class action complaints were filed on each of August 20, 1998, August 21, 1998 and September 15, 1998 (the "Complaints"), in the United States District Court, Middle District of Tennessee, Nashville Division, against the Company and certain of its executive officers. The Court has ordered that the three Complaints be consolidated into a single class action lawsuit in the United States District Court, Middle District of Tennessee, Nashville Division. The Complaints allege, among other things, that from February 12, 1997 to August 18, 1998 (the "Class Period") the defendants issued materially false and misleading statements about the Company, its business, operations and financial position and failed to disclose material facts necessary to make defendants' statements not false and misleading in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. Plaintiffs allege that the Company failed to disclose that the Company's financial statements were not prepared in accordance with generally accepted accounting principles due to the improper write-off of certain acquired in-process technology, resulting in the Company's stock trading at allegedly artificially inflated prices during the Class Period. The Complaints seek unspecified compensatory damages, attorney's fees and other relief. The Company believes that these claims are without merit and intends to defend the allegations vigorously. 54 55 ENVOY Corporation Notes to Consolidated Financial Statements Schedule II Valuation and Qualifying Accounts December 31, 1995
Balance at Charged to Balance Beginning Charged to Other Accounts- Deductions End of Description of Period Costs & Expenses Describe Describe Period - ----------------------------------------------------------------------------------------------------------------------------------- Allowance for Doubtful Accounts $ 518,256 647,938 0 a 464,231 $ 701,963 ---------------------------------------------------------------------------------------- $ 518,256 647,938 0 464,231 $ 701,963 ========================================================================================
December 31, 1996
Balance at Charged to Balance Beginning Charged to Other Accounts- Deductions End of Description of Period Costs & Expenses Describe Describe Period - ----------------------------------------------------------------------------------------------------------------------------------- Allowance for Doubtful Accounts $ 701,963 1,112,360 c 499,014 b 85,672 $ 2,227,665 ---------------------------------------------------------------------------------------- $ 701,963 1,112,360 499,014 85,672 $ 2,227,665 ========================================================================================
December 31, 1997
Balance at Charged to Balance Beginning Charged to Other Accounts- Deductions End of Description of Period Costs & Expenses Describe Describe Period - ---------------------------------------------------------------------------------------------------------------------------------- Allowance for Doubtful Accounts $ 2,227,665 1,518,716 c 600,000 b 705,036 $ 3,641,345 ----------------------------------------------------------------------------------------- $ 2,227,665 1,518,716 600,000 705,036 $ 3,641,345 =========================================================================================
a. Of this amount, $264,231 represents allowance for doubtful accounts associated with the spin-off of the Financial Business which was transferred to First Data. The remaining $200,000 represents a write-off of known uncollectible receivables against the allowance account. b. This amount represents a write-off of known uncollectible receivables against the allowance account. c. These amounts represent amounts recorded in connection with the opening balances of the Acquired Businesses. See Notes 4 and 7 of Notes to Consolidated Financial Statements. 55 56 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: November 16, 1998 /s/ Kevin M. McNamara ---------------------------- Kevin M. McNamara Senior Vice President and Chief Financial Officer 56 57 EXHIBIT INDEX Exhibit - ------- 23.1 Consent of Ernst & Young LLP 23.2 Consent of Arthur Andersen LLP 27 Financial Data Schedule 57 EX-23.1 2 CONSENT OF ERNST & YOUNG LLP 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-8 333-2824), the Employee Stock Purchase Plan (Form S-8 333-33207), and the 1998 Stock Incentive Plan, 1998 Synergy Stock Option Plan, and 1998 ExpressBill Stock Option Plan (Form S-8 333-56887) of ENVOY Corporation of our report dated March 5, 1998, except for the business combinations accounted for as poolings of interests referred to in Notes 1 and 4, as to which the date is April 29, 1998; the restatement for the beneficial conversion feature referred to in Note 2, as to which the date is June 26, 1998; and the restatement related to acquired in-process technology referred to in Note 2 and the subsequent event referred to in Note 22, as to which the date is November 9, 1998, with respect to the consolidated financial statements and schedule of ENVOY Corporation included in the Amendment No. 2 to Current Report on Form 8-K dated November 16, 1998, filed with the Securities and Exchange Commission. Ernst & Young LLP /s/ Ernst & Young LLP Nashville, Tennessee November 16, 1998 EX-23.2 3 CONSENT OF ARTHUR ANDERSON LLP 1 Exhibit 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports dated February 11, 1998 and January 30, 1998 included in this Current Report on Form 8-K of ENVOY Corporation into the Company's previously filed Registration Statement File Numbers 33-93542, 333-2824, 333-33207 and 333-56887. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Nashville, Tennessee November 12, 1998 EX-27 4 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 8,598 0 37,151 3,641 2,585 48,301 41,089 21,581 166,625 30,274 527 0 55,021 114,652 (44,591) 166,625 0 137,605 0 64,247 75,958 0 1,577 (2,865) 6,333 (9,198) 0 0 0 (9,198) (0.47) (0.47)
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