Item 1. BUSINESS
MedQuist is a national provider of medical transcription services, a key component in the provision of healthcare services. Transcription is the process by which dictation is converted into an electronic medical report. The timely production of accurate reports is necessary for patient care and for healthcare providers to receive reimbursement. Through our approximately 9,800 transcriptionists, proprietary software, sophisticated digital dictation equipment and ability to interface with healthcare providers' computer systems, we provide customized solutions to shorten our customers' billing cycles and reduce their overhead and other administrative costs. We serve approximately 3,200 clients nationwide through our client service centers. We also provide reimbursement coding services, systems interfacing and equipment sales.
As a result of internal growth and acquisitions, our revenue has increased from $84.6 million in 1997 (before restatements for acquisitions accounted for as pooling of interests) to $405.3 million in 2001, of which over 97% is from medical transcription. Our experienced management team and operating structure have enabled us to grow and take advantage of efficiencies such as a larger network of transcriptionists and increased negotiating power with our vendors.
History
MedQuist was incorporated in New Jersey in 1984 and reorganized in 1987 as a group of outpatient healthcare businesses affiliated with a non-profit healthcare provider. In May 1994, we acquired our first medical transcription business, Transcriptions, Ltd. By the end of 1995, we had divested all of our non-medical transcription businesses, and through December 31, 2001, we had acquired 44 companies.
Industry Overview
Medical transcription is the process by which free-form dictated patient information is recorded and converted into a useable format, electronically routed to the appropriate location and added to a patient's medical record. Physicians and other healthcare providers use this information for delivery of patient care. Administrative personnel use the information for billing and other administrative purposes. Accurate and prompt transcribed records are required for reimbursement and to avoid healthcare fraud and abuse penalties. We expect that, as the percentage of medical records that are stored electronically continues to grow, the information management uses for such records will increase.
The majority of dictated reports are generated within the medical records departments of hospitals. Historically, transcription services were performed by hospital employees and were costly and difficult to manage. Examples of these reports include patient histories, discharge summaries, operative reports and consultation reports. Increasingly, other hospital departments, such as radiology, emergency, oncology, pediatrics and cardiology, are dictating reports to improve delivery of care and administrative functions. Health maintenance organizations (HMO's), outpatient clinics and physician practice groups are also expanding their use of transcribed medical reports.
Medical document management includes medical transcription plus other services related to health care information management, such as digital dictation systems and reimbursement coding services.
We believe the market for medical document management services will expand due in part to the following trends:
Consolidation. As healthcare providers consolidate and increase in size, their information management needs become more complex and they increasingly require larger and more sophisticated vendors.
Connectivity. The exchange of patient information and the delivery of patient care must be coordinated among many entities, including physicians, hospitals and managed care companies. Increasingly, healthcare organizations are centralizing patient data into an accessible system creating economies of scale to reduce overall healthcare costs and to improve the efficient delivery of patient care. Accurate medical transcription and distribution and storage of transcribed records and other document management services are critical to such coordination.
Cost Containment. Outsourcing services in the healthcare industry is a means to reduce administrative burdens and fixed costs. Hospitals and other healthcare organizations often choose to outsource their electronic transcription of dictated patient records as their information needs and volume of dictated reports expand. Outsourcing medical document management services permits providers:
o to reduce overhead and other administrative costs;
o to improve the quality of reports;
o to access leading technologies without development and investment risk; and
o to obtain the expertise to implement and manage a system tailored to the providers' specific requirements.
Compliance. Government agencies are increasingly focused on fraud and abuse in the healthcare industry. For example, under Medicare, providers must submit detailed documentation in order to receive reimbursement. In many instances, providers have been fined and penalized for failing to substantiate claims for reimbursement in an audit. As a result, Medicare, the insurance industry and, in some cases healthcare accreditation organizations, are requiring transcribed reports:
o to support claims for reimbursement;
o to facilitate communication between various parts of a healthcare network;
o to improve the quality and efficiency of patient care; and
o to retain and provide reliable information in the event of malpractice litigation.
Strategy
Our objective is to maintain our position as the leading national provider of medical transcription services and to enhance that position as the information needs of healthcare providers continue to expand and evolve.
The key elements of our strategy include the following:
Expand Existing Client Relationships. We provide most of our transcription services to hospital medical records departments. We seek to increase our share of transcription services through our close and continuing client relationships as these departments outsource more of their transcription requirements and as the volume of patient records continues to grow. In addition, we will continue to penetrate the direct care departments at hospitals such as radiology, emergency, oncology, pathology, pediatrics and cardiology, within our existing client base. Historically, these departments have not dictated their patient data or outsourced the transcription of their patient data to the same extent as medical records departments.
Offer New Medical Document Management Services. We have developed, both internally and through acquisition, the capability of providing additional medical document management products and services such as digital dictation systems and reimbursement coding services. We intend to further develop the depth and breadth of this product and service line-up to better serve our healthcare provider client base.
Extend Current Client Base. We will continue to extend our base of traditional hospital clients and to pursue additional clients such as HMO's, outpatient clinics and physician practice groups which we believe will represent a growing percentage of the available market. Based upon input from new clients, we believe that references from our existing client base represent a key component of our sales and marketing efforts.
Capitalize on Operating Expertise. Our experienced management team and our operating structure have enabled us to grow our business and increase cash flow from operations. We will continue to capitalize on our management experience and operating expertise.
Pursue Strategic Relationships. We have initiated relationships with developers and end-users of emerging technologies to create enhanced services for our clients. We will continue to incorporate advances in technology to improve the efficiency of our operations, reduce our costs, expand the breadth and functionality of our services and enhance our competitive position.
Pursue Strategic Acquisitions. The medical transcription industry is highly fragmented with more than 1,500 providers of outsourced medical transcription services. The coding reimbursement industry is also highly fragmented. Most of these are small companies that lack the financial resources or the technological capabilities necessary to provide services nationwide. We will continue to pursue acquisitions that will expand our client base, network of qualified transcriptionists and other employees and geographic presence. We will also explore select opportunities to acquire leading technologies, which may enhance our service offering.
MedQuist Services
Through our approximately 9,800 transcriptionists, proprietary software, sophisticated digital dictation equipment and ability to interface with healthcare providers' computer systems, we provide customized solutions to shorten our customers' billing cycles and reduce their overhead and other administrative costs. In addition to hospital medical records departments, our target markets include patient care departments, such as radiology, emergency rooms, oncology, pathology, pediatrics and cardiology departments, HMO's, physician practice groups and out-patient clinics.
We record free-form medical dictation, transcribe the dictation into reports, and electronically receive, review and distribute final reports to a client. Authorized individuals at multiple locations can access this electronic information when needed for administrative, billing and patient care purposes.
We have designed our system to enable clients and individual healthcare providers to review the status of particular patient data and transcribed reports at any point in time and to advise us whether the production of a particular report requires acceleration. In addition, our system permits us to monitor our on-time performance, especially with respect to critical reports requiring turnaround times of less than 24 hours.
We serve approximately 3,200 clients through 89 client service centers nationwide. Due to the large number of trained transcriptionists and our ability to allocate work among them efficiently, we believe that we are able to reduce the production turnaround times for transcribed medical reports. An in-house staff or small transcription company generally cannot achieve these efficiencies to the extent that we can. Our system provides editing and electronic review capabilities, such as specific reference to pages or clauses to alert clients to potential deficiencies, that increase accuracy and reliability.
Our system provides flexibility to address individual client needs. We are capable of modifying the system to interface with existing client systems. Our technical staff works closely with our clients, both before and after installation, to develop system modifications and refinements.
MedQuist has started to offer reimbursement coding services for our hospital customers. Coding reimbursement services involve the software assisted manual assignment of numerical codes to identify the diagnosis, treatment and severity of a medical episode for reimbursement purposes. Coded documents, such as CPT and ICD-9 forms, are required for reimbursement by the government, HMO's and insurance companies. In the future, MedQuist anticipates the addition of a more automated coding service offering made available by the use of developing technologies.
MedQuist also provides our healthcare customers with an industry leading digital dictation systems solution as a result of our February 1, 2001 acquisition of Digital Voice, Inc.
Medical Transcriptionist Recruitment
One of the most significant challenges to our continued growth is the successful recruitment and retention of qualified transcriptionists. To address this challenge, we have enhanced our recruitment process, increased training and formed strategic relationships with various schools across the country.
Sales and Marketing Efforts
Our existing client base is a key component of our marketing and sales strategy. Based on input from new clients, we believe that new clients have utilized our services in large part due to recommendations and references by our existing national client base. All office managers and operational vice presidents, as well as many of our senior management personnel, including our Chairman and Chief Executive Officer, Mr. Cohen, have sales responsibilities.
We utilize a consultative sales and marketing approach by establishing a working relationship with our clients through a series of direct meetings with the chief financial officer, health information manager, chief information officer and other key individuals at the client's organization. In this manner, we obtain information concerning the particular needs of a client and educate the client as to how our services can be customized to meet those needs. As part of our marketing efforts, we also advertise in national healthcare trade publications (including those sponsored by the American Health Information Management Association) and participate in industry conventions.
Business Partners and Relationships
We are always evaluating emerging technologies and apply them as appropriate to make our services more reliable, efficient and cost-effective, and to assist our clients in meeting their transcription and document management needs. We have initiated relationships with developers and end-users of emerging technologies, such as voice-recognition, data mining and outcomes analysis and Internet based telecommunications to create value added services for our clients and to participate in the development of the computer based patient record. Our Senior Vice President-New Business Development oversees our strategic partnerships and manages our new business development department that integrates these partnerships into useable product and service offerings.
Item 2.
Item 2. PROPERTIES
The Company owns one property in Madison, Wisconsin, which was acquired through the stock purchase of L&H Medical Solutions Holding, Inc. Otherwise, the Company leases office and other space for its service centers nationally. The Company's typical service center ranges in size from 1,000 to 20,000 square feet and is leased for a term ranging from three to ten years. The Company's executive offices comprise 25,000 square feet and has two years remaining on its lease. Management believes that there is adequate office space available should the Company need to move or expand and that minimal leasehold improvements are required in order to open a new location.
Item 3.
Item 3. LEGAL PROCEEDINGS
Although the Company from time to time in the course of the operation of its business is subject to various legal proceedings, the Company is not currently a party to any material pending legal proceeding nor, to the knowledge of management, is any material legal proceeding currently threatened.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
Item 5.
Item 5. MARKET PRICE FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol "MEDQ". The following table sets forth the high and low reported prices for our Common Stock for the last two fiscal years and for the first quarter of 2002. The bid quotations for the Nasdaq National Market reflect inter-dealer prices, do not include retail mark-ups, mark-downs or commissions and may not necessarily reflect actual transactions.
High Low First Quarter $ 28.75 $ 19.94 Second Quarter 44.13 27.25 Third Quarter 34.81 17.94 Fourth Quarter 19.75 11.06
First Quarter $22.13 $15.88 Second Quarter 29.99 20.00 Third Quarter 33.14 23.95 Fourth Quarter 30.62 21.30
First Quarter (through March 19, 2002) 30.45 27.47
On March 19, 2002, the closing sale price for the Common Stock, as reported on the Nasdaq National Market, was $30.31 per share.
We have never declared or paid any cash dividends on our Common Stock. We expect to retain any future earnings to fund operations and the continued development of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following financial information is derived from our audited financial statements which have been restated to reflect our 1998 acquisitions accounted for as pooling of interests. This information is only a summary and you should read it in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations", our audited financial statements and related notes and other information that we have filed with the SEC.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are the leading national provider of medical transcription services. Over 97% of our revenue in 2001 was derived from the provision of medical transcription services, which we recognize when we render services and deliver reports. These services are based primarily on contracted rates. We also derive revenue from services other than traditional transcription services, such as coding revenue, interfacing fees, equipment rentals, equipment sales, referral fees and commissions from strategic partners. Revenues from these other sources are recognized when earned.
For purposes of our discussion and analysis of our results of operations we distinguish our revenue growth as "core growth" and growth from large acquisitions. Core growth includes revenue from all of the above sources and revenue from acquisitions with annual sales under $5 million, prior to the date of acquisition. Revenues arising from acquisitions having annual revenue in excess of $5 million, prior to the date of acquisition, is discussed separately in our analysis of revenue growth.
Cost of revenue consists of all direct costs associated with providing transcription-related services, including payroll, telecommunications, technology development, repairs and maintenance, rent and other direct costs. However, cost of revenue does not include depreciation. Most of our cost of revenue is variable in nature, but includes certain fixed components. Selling, general and administrative expenses include costs associated with our senior executive management, marketing, accounting, legal and other administrative functions. Selling, general and administrative expenses are mostly fixed in nature, but include certain variable components.
From 1995 through 2001, we completed 44 acquisitions. Six acquisitions, including the December 1998 acquisition of MRC, were accounted for as pooling of interests. Four of these acquisitions were material and, accordingly, we restated our financial statements.
Results of Operations
The following table sets forth, for the periods indicated, certain financial data as a percentage of revenue, as restated for our acquisitions accounted for as a pooling of interests:
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenues. Revenues increased 11.3% from $364.1 million in 2000 to $405.3 million in 2001. The $41.2 million increase resulted from increased sales to existing customers, sales to new customers and strategic partners and additional revenue from acquisitions. The $41.2 million increase resulted from $13.6 million of core growth and $27.6 million from large acquisitions.
Cost of Revenues, excluding depreciation. Cost of revenues increased 12.5% from $265.8 million in 2000 to $299.1 million in 2001. As a percentage of revenues, cost of revenue increased from 73.0% in 2000 to 73.8% in 2001 due primarily to an increase in payroll expense in 2001.
Selling, General and Administrative. Selling, general and administrative expenses increased 18.4% from $11.1 million in 2000 to $13.1 million in 2001. As a percentage of revenue, selling, general and administrative costs increased from 3.0% in 2000 to 3.2% in 2001. The increase primarily resulted from increased spending to support our existing and new business.
Depreciation. Depreciation increased 15.5% from $14.7 million in 2000 to $17.0 million in 2001. As a percentage of revenue, depreciation increased from 4.0% in 2000 to 4.2% in 2001. The increase resulted from increased capital expenditures and fixed assets acquired in purchase business acquisitions in 2000 and 2001.
Amortization of Intangible Assets. Amortization of intangible assets was $7.3 million in 2000 compared to $9.4 million in 2001. The increase is attributable to the amortization of intangible assets associated with the Company's acquisitions which were accounted for using the purchase method in 2000 and 2001.
Restructuring Charges (Credits). In December 2001 we approved a restructuring plan associated with the roll out of our new transcription platform. When the plan was approved, we recorded a $1.5 million charge, of which $1.4 million related to non cancelable lease obligations and $100,000 related to employee severance. As of December 31, 2001, $1.5 million was included in accrued expenses related to this restructuring.
In November 2001, we completed the purchase of a medical transcription company. In connection with this acquisition, we established a restructuring reserve of $1.8 million. The reserve consists of $1.6 million for remaining payments on non cancelable leases and $200,000 for severance.
In December 1998 a restructuring plan associated with the MRC acquisition was approved. When the plan was approved we recorded a $6.5 million charge. As of December 31, 2001, $671,000 was included in accrued expenses related to the restructuring.
In 1997, MRC incurred a restructuring charge of $2.1 million related to the closure and consolidation of less profitable or redundant client service centers and other non-recurring acquisition and integration costs incurred in connection with MRC's acquisition of Medical Records Corp. In 2001 and 2000, MedQuist revised its estimate of the required reserves and reversed $430,000 and $542,000, respectively of the 1997 restructure charge. As of December 31, 2001, the accrual has been fully utilized.
Interest Income Net. We had net interest income of $3.9 million in 2000 and interest income of $3.8 million in 2001. The decrease is due to decreased rates of return on liquid investments, partially offset by a greater amount of cash available for investment.
Other (Income) Expense. During 2001, we settled a lawsuit, in our favor, for a non-recurring gain of $3.0 million, net of legal expenses.
Income Tax Provision. The income tax provision decreased from $28.8 million or 42.6% of pre-tax income in 2000 to $27.9 million or 38.5% of pre-tax income in 2001. The decrease primarily resulted from the majority of the tender offer costs incurred in 2000 not being deductible for tax purposes, and state tax planning.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Revenues. Revenues increased 10.3% from $330.0 million in 1999 to $364.1 million in 2000. The $34.1 million increase resulted from increased sales to existing customers, sales to new customers and strategic partners and additional revenue from acquisitions. The $34.1 million increase resulted from $28.7 million of core growth and $5.4 million from large acquisitions.
Cost of Revenues, excluding depreciation. Cost of revenues increased 11.6% from $238.2 million in 1999 to $265.8 million in 2000. As a percentage of revenues, cost of revenue increased from 72.2% in 1999 to 73.0% in 2000 due primarily to an increase in transcription related payroll and benefit expense in 2000, partially offset by cost reductions resulting from consolidation of duplicative facilities.
Selling, General and Administrative. Selling, general and administrative expenses decreased 5.8% from $11.8 million in 1999 to $11.1 million in 2000. As a percentage of revenue, selling, general and administrative costs decreased from 3.6% in 1999 to 3.0% in 2000. The decrease was due primarily to administrative staff reductions made in association with the merger with MRC, and our ability to spread the fixed portion of our overhead over a larger revenue base.
Depreciation. Depreciation increased 22.7% from $12.0 million in 1999 to $14.7 million in 2000. As a percentage of revenue, depreciation increased from 3.6% in 1999 to 4.0% in 2000. The increase resulted from increased capital expenditures and fixed assets acquired in purchase business acquisitions in 1999 and 2000.
Amortization. Amortization of intangible assets was $5.3 million in 1999 compared to $7.3 million in 2000. The increase is attributable to the amortization of intangible assets associated with the Company's acquisitions which were accounted for using the purchase method in 1999 and 2000.
Restructuring Charges (Credits). In December 1998, our board of directors approved a restructuring plan associated with the MRC acquisition. When the board approved the plan, we recorded a $6.5 million charge, of which $3.8 million related to non cancelable lease obligations on duplicate facilities, $1.6 million related to employee severance and $1.1 million related to contract cancellations and other exit costs. As of December 31, 2000, $993,000 of noncancellable leases had been paid, $1.3 million of the employee severance and $427,000 in other restructuring costs had been paid. At December 31, 2000, $1.0 million was included in accrued expenses related to the restructuring.
Other (Income) Expense. In July 2000, Koninklijke Philips Electronics, N.V. (Philips) completed a tender offer in which they acquired approximately 60 percent of MedQuist's outstanding common stock for $51.00 per share. In association with this tender offer, MedQuist incurred approximately $6.3 million of costs, primarily related to investment banker fees. In 1998, $11.0 million of transaction costs associated with the 1998 pooling of interest combinations was recorded. In 1999, $315,000 of these costs were reversed in connection with adjustments to our accruals and reserves.
Gain on Sale of Securities. During 1999 and 2000, we had a gain of $309,000 and $3.7 million, respectively, on the sale of securities resulting from the exercise of warrants to purchase Lernout & Hauspie stock and subsequent sale of the stock.
Interest Income, Net. We had interest income, net of $2.0 million in 1999 and interest income, net of $3.9 million in 2000. The increase was a result of the investment of excess cash balances in 2000.
Income Tax Provision. The income tax provision increased from $27.4 million or 40.6% of pre-tax income in 1999 to $28.8 million or 42.6% of pre-tax income in 2000. The increase resulted largely from the majority of the tender offer costs incurred in 2000, not being deductible for tax purposes.
Liquidity and Capital Resources
At December 31, 2001, we had working capital of $135.7 million, including $86.3 million of cash and cash equivalents. During the twelve months ended December 31, 2001, our operating activities provided cash of $81.7 million and during the twelve months ended December 31, 2000 our operating activities provided cash of $60.5 million. The increase primarily resulted from increased net income and liquidation of accounts receivable and prepaid expenses and an increase in accrued expenses, partially offset by a reduced tax benefit for exercise of employee stock options.
During the twelve months ended December 31, 2001, we used cash in investing activities of $93.0 million, consisting of $14.1 million of capital expenditures, and $77.3 million for acquisitions accounted for under the purchase method. During the twelve months ended December 31, 2000, we used cash in investing activities of $28.0 million, consisting of $17.5 million of capital expenditures, $6.1 million investments in A-Life Medical, Inc. securities, $8.1 million for acquisitions accounted for under the purchase method and $728,000 for the purchase of securities, offset by $4.4 million in cash proceeds from the sale of securities.
During the twelve months ended December 31, 2001, net cash provided by financing activities was $231,000, consisting of $938,000 for repayment of long term debt, partially offset by $1.2 million in proceeds from the issuance of common stock including option exercises and issuances in connection with the employee benefits plan. During the twelve months ended December 31, 2000, net cash provided by financing activities was $2.8 million, consisting of $19.8 million in proceeds from the issuance of common stock including option exercises and issuances in connection with employee benefit plans, partially offset by $15.5 million from the purchase and retirement of MedQuist stock and $1.6 million for repayment of long-term debt.
In April 2000, we made a $6.1 million investment in A-Life Medical, Inc., a leader in advanced natural language processing technology for the medical industry. In September 2001, we advanced A-Life Medical, Inc. $1.0 million as a prepayment on a license agreement. In December 2001, we advanced $674,000 to A-Life Medical, Inc. in connection with an additional investment which closed in January 2002. Our investment in A-Life Medical, Inc. is inherently risky due to the nature of its early stage development technology and related uncertain near term opportunities. We will continue to monitor this investment on a periodic basis. In the event the carrying value of the investment exceeds the fair value of the investment and the decline is determined to be other-than-temporary, an impairment charge will be recorded. Fair value for A-Life Medical, Inc. is based on estimates and assumptions used in forecasted financial models. In order to determine whether a decline in value is other-than-temporary, we evaluate, among other factors: the duration and extent to which the fair value has been less than carrying value; the financial condition of the company, including key operational and cash flow metrics; current market conditions, future trends and the business outlook for the company; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value.
We have previously accounted for the investment in A-Life under the cost method. As a result of our increased ownership percentage from the January 2002 financing transaction, we will begin to account for the investment under the equity method.
We believe that our cash and cash equivalent, on hand, and cash flow generated from operations and our borrowing capacity will be sufficient to meet our current working capital and capital expenditure requirements.
Impact of New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all business combinations consummated after June 30, 2001 be accounted for under the purchase method of accounting. SFAS No. 142 requires goodwill and intangible assets with indefinite lives will no longer be amortized, but are reviewed at least annually for impairment. The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, we are required to adopt SFAS No. 142 effective January 1, 2002. Application of the non-amortization provisions of SFAS No. 142 for goodwill is expected to result in a decrease in amortization expense of approximately $3.5 million in 2002. At December 31, 2001, we had goodwill of approximately $110.6 million and during the twelve months ended December 31, 2001 we incurred approximately $3.4 million in amortization associated with goodwill. Subsequent to June 30, 2001, we completed two purchase business combinations resulting in goodwill of $21.3 million. Pursuant to SFAS No. 142, we will test goodwill for impairment upon adoption and we do not expect that the impairment test will result in any significant losses.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (effective for fiscal years beginning after June 15, 2002). SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and retirement of assets. We do not expect the adoption of SFAS No. 143 will have a significant impact on our financial position and results of operations.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which establishes a single accounting model, based on the framework established in SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of", and resolves significant implementation issues related to SFAS No. 121. SFAS No. 144 superceded SFAS No. 121 and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of a Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". We are required to adopt SFAS No. 144 for the fiscal year ending December 31, 2002, however, early application is permitted. We do not believe that the adoption of SFAS No. 144 will have a material impact on our financial condition or results of operations.
Quantitative And Qualitative Disclosure About Market Risk
We generally do not use derivative financial instruments in our investment portfolio. We make investments in instruments that meet credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, and type of instrument. We do not expect any material loss with respect to our investment portfolio.
The following table provides information about our investment portfolio at December 31, 2001. For investment securities, the table presents principal amounts and related weighted average interest rates (dollars in thousands).
Cash and cash equivalents $86,334
Average interest rate 3.6%
At December 31, 2001, there exists $2.2 million in debt consisting primarily of notes payable resulting from acquisitions, which will be paid out in 2002 and 2003.
Inflation
We believe that the effects of inflation and changing prices generally do not have a material adverse effect on our results of operations or financial condition.
Forward-Looking Statements
Some of the information in this Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. We also may have referred you to this note in other written or oral disclosures we have made, such as our quarterly earnings conference calls. These statements include forward-looking language such as "will likely result," "may," "are expected to," "is anticipated," "estimated," "projected," "intends to" or other similar words. Our actual results are likely to differ, and could differ materially, from the results expressed in, or implied by, these forward-looking statements. There are many factors that could cause these forward-looking statements to be incorrect, including but not limited to the following risks: risks associated with (1) our ability to recruit and retain qualified transcriptionists and other employees; (2) inability to complete and assimilate acquisitions of businesses, especially acquisitions of non-medical transcription businesses, because we have no prior experience in such businesses; (3) dependence on our senior management team and new senior management from non-medical transcription acquisitions; (4) the impact of new services or products on the demand for our existing services; (5) our current dependence on medical transcription for substantially all of our business; (6) our ability to expand our customer base; (7) our ability to maintain our current growth rate in revenue and earnings; (8) the volatility of our stock price; (9) our ability to compete with others; (10) changes in law, including, without limitation, the impact the Health Information Portability and Accountability Act ("HIPAA") will have on our business; (11) infringement on the proprietary rights of others; (12) our failure to comply with confidentiality requirements; and (13) risks inherent in diversifying into other businesses, such as from the acquisition of DVI (digital dictation equipment) and entering into the medical record coding reimbursement business. When considering these forward-looking statements, you should keep in mind these risk factors and the other cautionary statements we may make in connnection with any such statements, and you should recognize that those forward-looking statements speak only as of the date made. MedQuist does not undertake any obligation to update any forward-looking statement included in this Form 10-K or elsewhere.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements. The information called for by this Item is set forth on Pages through.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission in connection with the 2002 Annual Meeting.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission in connection with the 2002 Annual Meeting.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission in connection with the 2002 Annual Meeting.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission in connection with the 2002 Annual Meeting.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
During the fourth quarter of 2001, the Company filed the following Reports on Form 8-K;
October 24, 2001 relating to the Company's earnings release for the quarter ended September 30, 2001.
* Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized, in the City of Marlton, State of New Jersey, on March 20, 2002.
MedQuist Inc.
By: /s/David A. Cohen ------------------------------------------- David A. Cohen, Chief Executive Officer and Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons as of March 20, 2002.
Each person below, in so signing, also makes, constitutes and appoints David A. Cohen his true and lawful attorney-in-fact, with full power and substitution and resubstitution, in his name, place and stead to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this Report.
Signatures Title
/s/David A. Cohen Chairman and Chief Executive Officer - ----------------------------- (principal executive officer) David A. Cohen
/s/Brian J. Kearns Senior Vice President, Treasurer and Chief - ----------------------------- Financial Officer (principal financial Brian J. Kearns officer and principal accounting officer)
Director - ----------------------------- Hans M. Barella
/s/Belinda W. Chew Director - ----------------------------- Belinda W. Chew
/s/William E. Curran Director - ----------------------------- William E. Curran
/s/Wim Punte Director - ----------------------------- Wim Punte
/s/Stephen H. Rusckowski Director - ----------------------------- Stephen H. Rusckowski
/s/A. Fred Ruttenberg Director - ----------------------------- A. Fred Ruttenberg
/s/Richard H. Stowe Director - ----------------------------- Richard H. Stowe
/s/John H. Underwood Director - ----------------------------- John H. Underwood
Director - ----------------------------- Erik J. Westerink
MedQuist Inc. and Subsidiaries
Consolidated financial statements As of December 31, 2001 and 2000 Together with auditors' report
Report of independent public accountants
To MedQuist Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of MedQuist Inc. (a New Jersey corporation) and Subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MedQuist Inc. and Subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Philadelphia, Pennsylvania January 30, 2002
MedQuist Inc. and Subsidiaries
Consolidated balance sheets As of December 31, 2001 and 2000 ..........................................1
Consolidated statements of operations For the years ended December 31, 2001, 2000 and 1999 ......................2
Consolidated statements of shareholders' equity For the years ended December 31, 2001, 2000 and 1999 ......................3
Consolidated statements of cash flows For the years ended December 31, 2001, 2000 and 1999 ......................4
Notes to consolidated financial statements December 31, 2001, 2000 and 1999 ..........................................5
MedQuist Inc. and Subsidiaries Consolidated balance sheets As of December 31, 2001 and 2000 (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MedQuist Inc. and Subsidiaries Consolidated statements of operations For the years ended December 31, 2001, 2000 and 1999 (in thousands, except per-share amounts)
2001 2000 1999 -------- -------- -------- Revenues $405,308 $364,149 $330,008 -------- -------- -------- Costs and expenses: Cost of revenues, excluding depreciation 299,102 265,817 238,180 Selling, general and administrative 13,117 11,078 11,763 Depreciation 17,001 14,720 12,000 Amortization of intangible assets 9,398 7,335 5,333 Restructuring charges (credits) 868 (1,013) (2,333) Other (income) expense (3,000) 6,255 (315) -------- -------- -------- Total costs and expenses 336,486 304,192 264,628 -------- -------- -------- Operating income 68,822 59,957 65,380 Gain on sale of securities -- 3,672 309 Interest income, net 3,754 3,874 1,955 -------- -------- -------- Income before income taxes 72,576 67,503 67,644 Income tax provision 27,940 28,773 27,439 -------- -------- -------- Net income $ 44,636 $ 38,730 $ 40,205 ======== ======== ======== Basic net income per common share $ 1.21 $ 1.07 $ 1.14 ======== ======== ======== Diluted net income per common share $ 1.18 $ 1.04 $ 1.09 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
MedQuist Inc. and Subsidiaries Consolidatedd statements of shareholders' equity For the years ended December 31, 2001, 2000 and 1999 (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MedQuist Inc. and Subsidiaries Consolidated statements of cash flows For the years ended December 31, 2001, 2000 and 1999 (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MedQuist Inc. and Subsidiaries Notes to consolidated financial statements December 31, 2001, 2000 and 1999 (in thousands, except per-share amounts)
1. Background and summary of significant accounting policies:
Background
MedQuist Inc. (the Company or MedQuist) is the leading national provider of medical transcription services to the healthcare industry in the United States. MedQuist entered this business in May 1994 through the acquisition of a medical transcription services company, and since this date has completed an additional 44 acquisitions and has integrated the acquired business into its operations.
The Company is a majority-owned subsidiary of Koninklijke Philips Electronics N.V. (Philips) (see Note 13).
Principles of consolidation
The accompanying consolidated financial statements include the accounts of MedQuist and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
Translation of foreign currency
The Company established a foreign subsidiary in the United Kingdom in 2001 which uses the pound sterling as its functional currency. Assets and liabilities of this subsidiary are translated at exchange rates in effect at the balance sheet date, and income and expense accounts and cash flow items are translated at average exchange rates during the period. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income within shareholders' equity. Foreign exchange rate gains and losses included in operating results are not material in 2001.
Use of estimates and assumptions
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported assets and liabilities and contingency disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents include cash and highly liquid investments purchased with an original maturity of three months or less, and consist primarily of cash on deposit with banks. At times, cash balances held at financial institutions are in excess of federally insured limits. The Company places its temporary cash investments with high-credit, quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Management believes that no significant concentration of credit risk exists with respect to these cash investments.
Interest income earned on investments in cash equivalents was $3,524, $3,915 and $2,123 for the years ended December 31, 2001, 2000 and 1999, respectively.
Cash equivalent with related party
Cash equivalent with related party consisted of cash deposited with Philips for the purpose of optimizing income from temporary excess cash. In the fourth quarter of 2000, the Company began participating in a deposit facility established by Philips which allowed investments up to $100 million to earn interest at LIBOR less 0.125 percent, for periods up to 365 days. At December 31, 2000, the Company had $20,044 in such an investment. As the original maturity of this investment was less than three months, the investment was classified as a cash equivalent with related party in the accompanying consolidated balance sheet as of December 31, 2000. The Company withdrew all funds invested in this related-party deposit facility in the second quarter of 2001 and, at December 31, 2001, the Company had no such investment.
Interest income earned on cash deposited with Philips was $403 and $44 for the years ended December 31, 2001 and 2000, respectively.
Investments in marketable securities
Investments in marketable securities are accounted for in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In 2000 and 1999, the Company had investments in marketable securities that were classified as available-for-sale. As such, the securities were carried at fair value, based on quoted market prices, with unrealized gains and losses reported as a component of accumulated other comprehensive income within shareholders' equity.
During 2000 and 1999, the Company sold the marketable securities resulting in gains of $3,672 and $309, respectively. No investments in marketable securities were held at December 31, 2001 and 2000.
Property and equipment
Property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, which range from two to seven years for furniture, equipment and software, and the lesser of the lease term or useful life for leasehold improvements. Repairs and maintenance costs are charged to expense as incurred, while additions and betterments are capitalized. Gains or losses on disposals are charged to operations.
Intangible assets
Intangible assets consist primarily of goodwill, customer lists, noncompete agreements and employee bases. The goodwill related to the first acquisition of a medical transcription business, which was completed in 1994, is being amortized over 40 years. The goodwill related to subsequent acquisitions completed from 1995 through June 30, 2001 is being amortized on a straight-line basis over 20-30 years. Goodwill related to acquisitions subsequent to June 30, 2001 is not being amortized in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Customer lists are amortized over 10-20 years. Noncompete agreements are amortized over the contractual terms, ranging from 1.5 to 4 years, and other intangibles are amortized over 3-5 years.
Long-lived assets
Pursuant to the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets and for Long-Lived Assets to Be Disposed of," management continually evaluates whether events and circumstances have occurred that indicate that the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, an estimate of the related undiscounted cash flows is used in measuring whether the long-lived asset should be written down to fair value. Measurement of the amount of the impairment is based on generally accepted valuation methodologies, as deemed appropriate. As of December 31, 2001, management believes that no revision to the remaining useful lives or write-down of long-lived assets is required.
Revenue recognition
The Company's revenue consists primarily of fees generated from providing medical transcription services. Fees for medical transcription services are generally based on contracted rates and revenue is recognized upon the rendering of services and delivery of transcribed reports. Revenues are also derived from equipment sales, coding services, interfacing fees, equipment rentals and referral fees and commissions from strategic partners. Revenues from these other sources are recognized as earned and are immaterial both individually and in the aggregate to consolidated revenues.
Advertising costs
The Company charges advertising costs to expense as incurred. Advertising expense was $857, $626 and $524 for the years ended December 31, 2001, 2000 and 1999, respectively.
Income taxes
The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings per share
The Company follows SFAS No. 128, "Earnings per Share," which requires a dual presentation of "basic" and "diluted" earnings per share on the face of the income statement. Basic earnings per share is calculated by dividing net income by the weighted-average number of shares of Common stock outstanding for the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of shares of Common stock outstanding for the period as adjusted for the dilutive effect of Common stock equivalents, which consist primarily of stock options, using the treasury stock method.
Fair value of financial instruments
Cash and cash equivalents, cash equivalent with related party, accounts receivable, accounts payable and accrued expenses are reflected in the accompanying consolidated financial statements at fair value due to the short-term nature of these instruments. The carrying amount of debt obligations approximates fair value at the balance sheet dates.
Stock options
The Company accounts for its stock option plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," under which no compensation cost has been recognized for options issued at fair market value on the date of grant. In 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 established a fair value based method of accounting for stock-based compensation plans. SFAS No. 123 requires that a company's financial statements include certain disclosures about a stock-based employee compensation arrangement regardless of the method used to account for the plan.
Comprehensive income
The Company follows SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in financial statements. The Company's comprehensive income consists of net income, unrealized holding gains on available-for-sale securities and currency translation adjustments. The Company's comprehensive income is presented within the accompanying Consolidated Statements of Shareholders' Equity. At December 31, 1999, the Company had an unrealized pretax gain on available-for-sale securities of $950, and the tax expense recorded on the unrealized gain was $246. These securities were sold in 2000 and a gain was realized. At December 31, 2001, the Company had a currency translation adjustments of $54 relating to a subsidiary in the United Kingdom.
Segment information
The Company operates in one reportable segment.
Statements of cash flow information
For the years ended December 31, 2001, 2000 and 1999, the Company paid interest of $86, $46 and $125, respectively, and income taxes of $21,222, $17,007 and $15,016, respectively.
The following table displays the net noncash financing activities resulting from the Company's business acquisitions (see Note 2):
Year ended December 31 --------------------------- 2001 2000 1999 -------- ------ ------- Noncash net assets acquired $ 79,837 $8,102 $51,388 Less- Seller notes and payables (2,100) -- (1,757) Common stock issued -- -- (1,226) -------- ------ ------- Net cash paid for business acquisitions $ 77,737 $8,102 $48,405 ======== ====== =======
Recent accounting pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires the use of the purchase method of accounting for business combinations initiated after June 30, 2001, and expands the definition of intangible assets that are to be recorded separately from goodwill. SFAS No. 142 requires that goodwill and certain intangible assets with an indefinite useful life to no longer be amortized, but such intangibles are to be reviewed for impairment at least annually and written down in periods in which the recorded value exceeds fair value.
For goodwill and other intangible assets resulting from acquisitions completed prior to July 1, 2001, the Company is required to follow the provisions of SFAS No. 142 as of January 1, 2002, and, accordingly, goodwill will no longer be amortized and impairment reviews will be periodically performed to assess whether any write downs are required. The Company's consolidated balance sheet at December 31, 2001 includes $89,290 (which is net of $14,543 of accumulated goodwill amortization) of goodwill recognized as a result of the acquisitions completed prior to July 1, 2001. In accordance with the provisions of these statements, the Company continued to amortize this goodwill through the end of 2001, recognizing approximately $3,371, $2,680 and $2,410 of goodwill amortization expense for the years ended December 31, 2001, 2000 and 1999, respectively. Subsequent to June 30, 2001, the Company completed two purchase business combinations which resulted in goodwill of $21,294. In accordance with the provisions of SFAS No. 142, no goodwill amortization expense has been recorded on these transactions.
While the Company has not yet completed all of the valuation and other work necessary to adopt these accounting standards, management believes that, except for the impact of discontinuing the amortization of goodwill, there will not be a significant impact on the Company's consolidated financial position and results of operations.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and retirement of assets. Management does not expect that the adoption of SFAS No. 143 will have a significant impact on the Company's consolidated financial position and results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which establishes a single accounting model, based on the framework established in SFAS No. 121. SFAS No. 144 superceded SFAS No. 121 and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of a Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The Company is required to adopt SFAS No. 144 for the year ending December 31, 2002; however, early application is permitted. Management does not believe that the adoption of SFAS No. 144 will have a significant impact on the Company's consolidated financial position and results of operations.
Reclassifications
Certain reclassifications have been made to the 1999 consolidated statement of operations to conform to the current year presentation, as well as the 2000 and 1999 consolidated statement of cash flows.
2. Acquisitions:
In 2001, the Company completed seven acquisitions for an aggregate purchase price of $79,417, consisting primarily of $77,317 in net cash payments and $2,100 in notes due to the sellers. The acquisitions in 2001 were accounted for under the purchase method of accounting.
In 2000, the Company completed eight acquisitions for an aggregate purchase price of $8,102, which were all cash transactions. The acquisitions in 2000 were accounted for under the purchase method of accounting.
In 1999, the Company completed 11 acquisitions, of which 10 were recorded under the purchase method of accounting while the other acquisition was accounted for as a pooling-of-interests. The 10 acquisitions accounted for under the purchase method had an aggregate purchase price of $52,255, consisting primarily of $49,272 in net cash, $1,757 in seller notes and 171 shares of Common stock with a fair value of $1,226. The Company completed one acquisition accounted for as a pooling-of-interests and prior period financial statements have not been restated for this acquisition due to the immateriality of this transaction.
A summary of the allocation of the purchase price to net assets acquired is as follows:
Year ended December 31, ------------------ 2001 2000 1999 ------ ----- ------ Purchase price: Cash paid for acquisition including transaction costs $ 77,737 $ 8,102 $ 48,405 Notes due to sellers 2,100 -- 1,757 Common stock issued -- -- 1,226 ---------- --------- ---------- $ 79,837 $ 8,102 $ 51,388 ========== ========= ========== Purchase price allocation: Accounts receivable $ 10,037 $ 238 $ 7,287 Prepaid and other 955 -- 150 Property and equipment 2,097 526 2,463 Deposits 109 2 145 Deferred taxes 24,018 -- (124) Intangible assets 53,793 7,427 46,365 Accounts payable (3,100) -- (180) Accrued expenses (7,534) (50) (4,246) Debt (538) (41) (472) ---------- --------- ---------- $ 79,837 $ 8,102 $ 51,388 ========== ========= ==========
Pro forma information is not presented as these acquisitions are not material to the consolidated statements of operations.
3. Restructuring charges:
In December 2001, management approved a restructuring plan associated with the rollout of a new transcription platform. The plan includes the closure of several operating facilities in order to improve operating efficiencies. Costs associated with the plan of approximately $1,468 were recognized in 2001 in accordance with Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." The components of the restructuring charge consist of $1,343 for remaining payments on noncancelable leases and $125 for severance.
In November 2001, the Company completed the purchase of a medical transcription company. In connection with this acquisition, the Company established a restructuring reserve of $1,790. The reserve consists of $1,599 for remaining payments on noncancelable leases and $191 for severance.
In December 1998, the Company's board of directors approved management's restructuring plan associated with the merger with another entity, which merger transaction was accounted for as a pooling-of-interests. The plan related primarily to the closure of several redundant operating facilities as well as certain corporate offices in order to improve operating efficiencies. Costs associated with the plan of approximately $6,539 were recognized in 1998 in accordance with EITF 94-3. The significant components of the restructuring charge consist of $3,835 for remaining payments on noncancelable leases, $1,618 for severance and $1,086 for noncancelable contracts and other exit costs. The severance costs are attributable to 41 individuals from various levels of operational and senior management.
From the date the restructuring charge was recorded in 1998 through December 31, 2001, the Company paid costs of $1,158 for noncancelable leases, $1,310 for severance and $427 for noncancelable contracts and other exit costs.
In 1999, management revised the estimate of the required reserves and reversed $2,333 of the 1998 restructuring charges relating to $1,492 of noncancelable leases, $182 for severance and $659 for noncancelable contracts and other exit costs. In 2000 and 2001, management further revised the estimate of the required reserves and reversed $471 and $170, respectively, of the 1998 restructuring charge. All of the reversal in 2000 relates to noncancelable leases as well as $44 in 2001, while the balance in 2001 of $126 relates to severance.
In 1997, an acquired entity had approved a separate management plan to close and/or merge several redundant operating facilities in order to reduce costs and improve operating efficiencies. The plan was completed during 1998 and included the cost of exiting certain facilities, primarily related to noncancelable leases, the disposition of fixed assets and employee severance costs. Costs associated with the plan of approximately $2,075 were recognized in 1997 in accordance with EITF 94-3. Included in this amount is approximately $705 for the disposal of assets and approximately $800 in severance and employee contract buy-outs. The balance is primarily related to noncancelable lease costs. The severance costs are attributable to eight individuals from various levels of operational and senior management. In 2000 and 2001, management revised its estimate of the required reserves and reversed $542 and $430, respectively, of the 1997 restructuring charge. At December 31, 2001, the accrual has been fully utilized.
4. Property and equipment: December 31 ------------------ 2001 2000 ------- ------- Furniture, equipment and software $ 95,845 $ 82,270 Leasehold improvements 3,673 2,971 -------- -------- 99,518 85,241 Less- Accumulated depreciation and amortization (65,351) (50,228) -------- -------- $ 34,167 $ 35,013 ======== ========
Depreciation and amortization expense was $17,001, $14,720 and $12,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
5. Intangible assets: December 31 ------------------------ 2001 2000 -------- -------- Goodwill (amortizable) $103,833 $ 86,884 Goodwill (non-amortizable) 21,294 -- Customer lists 59,909 51,594 Noncompete agreements 10,663 7,016 Other 7,704 4,116 -------- -------- 203,403 149,610 Less- Accumulated amortization (35,600) (26,202) -------- -------- $167,803 $123,408 ======== ========
December 31, 2001 ------------------------------------------------------- Accumulated Net book Life Cost amortization value ------------ -------- ------------ -------- Goodwill (amortizable) 20-40 years $103,833 $ (14,543) $ 89,290 Goodwill (non- amortizable) -- 21,294 -- 21,294 Customer lists 10-20 years 59,909 (9,758) 50,151 Noncompete agreements 1.5-4 years 10,663 (6,673) 3,990 Other 3-5 years 7,704 (4,626) 3,078 -------- --------- -------- $203,403 $ (35,600) $167,803 ======== ========= ========
Amortization of all intangible assets was $9,398, $7,335 and $5,333 for the years ended December 31, 2001, 2000 and 1999, respectively.
6. Investment:
On April 6, 2000, the Company made a $6,051 investment in A-Life Medical, Inc. (A-Life), a privately held entity that is a leader in advanced natural language processing technology for the medical industry. The investment has been recorded under the cost method of accounting as the Company owns 19.5 percent of A-Life's outstanding voting shares and has no control of this entity.
In September 2001, the Company advanced $1,000 to A-Life as a prepayment on a license agreement. In December 2001 and January 2002, the Company advanced an aggregate of $783 to A-Life in connection with an additional equity investment that closed in January 2002. The initial investment and the subsequent advances have been classified as other assets in the accompanying consolidated balance sheet.
In January 2002, the Company's investment increased to 28 percent of the outstanding voting shares of A-Life and, as such, the investment will be accounted for under the equity method of accounting. As A-Life's net book value is negative, the $6,834 carrying value of the equity investments made will be allocated to intangible assets. The intangible assets, other than goodwill, will be amortized over the estimated useful life of such assets beginning in January 2002. In the event the carrying value of the investment exceeds the fair value of the investment and the decline is determined to be other-then-temporary, an impairment charge will be recorded.
The Company received approximately $16 and $100 of services from A-Life during the years ended December 31, 2001 and 2000, respectively.
7. Accrued expenses: December 31 ------------------- 2001 2000 ------ ------ Accrued payroll and related taxes $15,764 $12,075 Restructuring charges 3,844 1,449 Income taxes payable 1,271 -- Other employee related expenses 2,318 2,318 Insurance reserves 236 2,100 Other 7,890 6,043 ------- ------- $31,323 $23,985 ======= =======
8. Valuation account and restructuring accruals:
Year ended December 31 ------------------------------- 2001 2000 1999 ------- ------- ------ Allowance for doubtful accounts: Balance at beginning of year $ 4,674 $ 4,668 $ 2,274 Provision 940 1,015 4,258 Acquisitions (Note 2) 541 -- 648 Charges (1,007) (1,009) (2,512) ------- ------- -------- Balance at end of year $ 5,148 $ 4,674 $ 4,668 ======= ======= ======== Restructuring accruals (Note 3): Balance at beginning of year $ 1,449 $ 3,055 $ 6,775 ------- ------- -------- Provision 1,468 -- -- Adjustments- 1998 restructuring (170) (471) (2,333) 1997 restructuring (430) (542) -- ------- ------- -------- Net charge to operations 868 (1,013) (2,333) ------- ------- -------- Acquisition 1,790 -- -- ------- ------- -------- Charges- 2001 restructuring (85) -- -- 1998 restructuring (165) (576) (1,177) 1997 restructuring (13) (17) (210) ------- ------- -------- Total charges (263) (593) (1,387) ------- ------- -------- Balance at end of year $ 3,844 $ 1,449 $ 3,055 ======= ======= ========
The restructuring accruals at December 31, 2001 consist of the following components:
Restructuring reserve ------------------------------- 2001 1998 1997 Total ------ ---- ----- ------ Severance $ 316 $ -- $ -- $ 316 Noncancelable leases 2,857 671 -- 3,528 ------ ---- ----- ------ $3,173 $671 $ -- $3,844 ====== ==== ===== ======
9. Long-term debt: December 31 ----------------- 2001 2000 ----- ----- Seller notes $2,100 $ 357 Capital lease obligations 15 73 Other 40 25 ------ ----- 2,155 455 Less- Current portion (1,067) (433) ------- ----- $1,088 $ 22 ====== =====
The Company had a credit facility that provided for a $10 million unsecured senior revolving line of credit. The credit facility expired on April 23, 2000.
Interest expense on debt obligations was $173, $85 and $168 for the years ended December 31, 2001, 2000 and 1999, respectively.
Long-term debt as of December 31, 2001, matures as follows:
2002 $1,067 2003 1,034 2004 29 2005 25 ------ $2,155 ======
10. Commitments and contingencies:
Rent expense for operating leases was $8,233, $6,969 and $5,410 for the years ended December 31, 2001, 2000 and 1999, respectively. Minimum annual rental commitments for noncancelable operating leases having terms in excess of one year as of December 31, 2001, are as follows:
2002 $ 8,421 2003 5,884 2004 2,997 2005 1,515 2006 813 2007 and thereafter 1,299 ---------- $ 20,929 ==========
The Company has an employment agreement, as amended, with a former chief executive officer. The agreement entitles this individual to receive retirement benefits of $75 per year for life plus certain other benefits, as defined. Included in other long-term liabilities is $629 and $704 at December 31, 2001 and 2000, respectively, related to these retirement benefits. The employment agreement also requires the Company to loan the former chief executive officer's estate the necessary funds to exercise any options owned by the individual at the time of his death.
The Company has employment agreements with six executive officers, which expire at various times through June 2003, subject to renewal. These agreements provide an aggregate base compensation of $1,475 both in the years ended December 31, 2002 and 2003, plus incentive compensation based on a percentage of the executive's salary. These agreements also provide for certain other fringe benefits and payments upon termination of the agreements.
The Company has severance agreements with certain executive officers that provide for one-time payments in the event of a change in control, as defined, if the officer is terminated within 12 months of the change. The payments range from 18-24 months of cash compensation paid to the executive officers in the fiscal year immediately prior to the change in control event. If the change in control had occurred on December 31, 2001, and the executive officers had been terminated the payments would have aggregated $3,686.
In the normal course of business, the Company is party to various claims and legal proceedings. Although the ultimate outcome of these matters is presently not determinable, management of the Company, after consultation with legal counsel, does not believe that the resolution of these matters will have a material effect upon the Company's consolidated financial position and results of operations.
11. Shareholders' equity:
In May 1999, the Company consummated a secondary public offering of its Common stock, selling 800 shares at $33.63 per share. In June 1999, the underwriters exercised their over allotment option for an additional 505 shares. After deducting the underwriters' discount and offering expenses, the net proceeds to the Company were $41,858.
During the year ended December 31, 2000, the Company repurchased 600 shares of outstanding Common stock for $15,466 at an average of $25.78 per share. All Common stock acquired was subsequently retired.
In 2000 and 1999, the Company issued 22 and 2 shares of Common stock to members of the board of directors, respectively. The fair value of the stock grants was $311 in 2000 and $68 in 1999.
The Company also has a plan whereby certain non-employee members of the Board of Directors have been granted Common stock but the shares will not be issued until the director terminate membership on the Board. Stock granted in 2001, 2000 and 1999 were 3, 1 and 1, respectively, with a value of $54, $36 and $36. Total accrued costs for this plan are $170 at December 31, 2001.
12. Stock option plans:
The Company has six stock option plans that provide for the granting of options to purchase shares of Common stock to eligible employees (including officers) and nonemployee directors of the Company. Options may be issued at the fair market value of the Common stock on the date of grant or at a price determined by a committee of the Company's board of directors. The stock options vest and are exercisable over periods determined by the committee.
In February 1998, an entity acquired by the Company, which acquisition was accounted for as a pooling-of-interests, issued 165 stock options to employees with exercise prices below the fair market value of the Common stock on the date of grant. Accordingly, deferred compensation totaling $1,078 was recorded, of which $97, $163 and $247 was amortized to expense in 2001, 2000 and 1999, respectively, and $31 remains unamortized at December 31, 2001.
Information with respect to the Company's Common stock options is as follows:
Exercise price Aggregate Shares per share proceeds ------ --------------- -------- Outstanding, December 31, 1998 4,433 $ 1.34 - 31.19 $ 53,109 Granted 91 28.31 - 44.00 3,365 Exercised (1,153) 1.34 - 31.19 (9,316) Canceled (202) 5.21 - 31.19 (4,253) ------ --------------- -------- Outstanding, December 31, 1999 3,169 1.34 - 31.19 42,905 Granted 2,056 17.06 - 70.00 105,380 Exercised (1,381) 1.67 - 44.00 (19,305) Canceled (244) 5.21 - 70.00 (7,295) ------ --------------- -------- Outstanding, December 31, 2000 3,600 2.17 - 70.00 121,685 Granted 1,190 16.00 - 43.50 26,675 Exercised (51) 5.21 - 24.94 (670) Canceled (165) 10.48 - 70.00 (7,410) ------ --------------- -------- Outstanding, December 31, 2001 4,574 $ 2.17 - 70.00 $140,280 ====== =============== ========
At December 31, 2001, there were 2,037 exercisable options with an aggregate exercise price of $42,032 and 1,622 additional options available for grant under the plans. Exercisable options at December 31, 2000 and 1999 were 1,523 and 1,691 with an aggregate exercise price of $21,024 and $16,275, respectively.
A summary of outstanding options and exercisable options at December 31, 2001 is as follows:
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and the related interpretations in accounting for its stock option plans. Had compensation cost for the Company's Common stock options been determined based upon the fair value of the options at the date of grant, as prescribed under SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income and net income per share would have been reduced to the following pro forma amounts:
Year ended December 31 ------------------------- 2001 2000 1999 ------ ------- ------- Net income: As reported $44,636 $38,730 $40,205 Pro forma 35,934 34,447 35,945 Basic net income per share: As reported 1.21 1.07 1.14 Pro forma 0.98 0.95 1.02 Diluted net income per share: As reported 1.18 1.04 1.09 Pro forma 0.95 0.93 0.98
The above pro forma amounts may not be indicative of future amounts because option grants prior to January 1, 1995 have not been included and because future option grants are expected.
The fair value of the options granted is estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Year ended December 31 ---------------------------------- 2001 2000 1999 ------- ------- ------- Risk-free interest rate 5.92% 6.17% 5.87% Volatility 56% 55% 55% Expected dividend yield 0% 0% 0% Expected option life 5 years 5 years 5 years
13. Other income (expense):
In the first quarter of 2001, the Company received net proceeds of $3,000 in connection with the settlement of a lawsuit.
In the third quarter of 2000, Philips completed a tender offer in which it acquired approximately 60 percent of the Company's outstanding Common stock for $51.00 per share. In connection with this tender offer, the Company incurred approximately $6,255 of costs, primarily related to investment banker fees. Since July 2000, Philips has purchased additional shares in the open market, at various prices, thereby increasing its ownership in the Company to approximately 70 percent.
In 1999, the Company reversed $315 of transaction costs previously accrued in connection with an acquisition completed in 1998 that was accounted for under the pooling-of-interest method of accounting.
14. Income taxes:
The income tax provision consists of the following:
Year ended December 31 ----------------------------- 2001 2000 1999 ------ ------ ------ Current: State and local $ 3,099 $ 3,196 $ 4,256 Federal 24,784 22,780 24,654 ------- ------- ------- 27,883 25,976 28,910 ------- ------- ------- Deferred: State and local 462 263 (18) Federal (405) 2,534 (1,453) ------- ------- ------- 57 2,797 (1,471) ------- ------- ------- $27,940 $28,773 $27,439 ======= ======= =======
A reconciliation of the statutory federal income tax rate to the Company's effective income tax rate is as follows:
Year ended December 31 ---------------------- 2001 2000 1999 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 35.0% Nondeductible transaction costs -- -- (0.2) State income taxes, net of federal benefit 3.4 3.5 4.1 Other 0.1 4.1 1.7 ---- ---- ---- 38.5% 42.6% 40.6% ===== ===== =====
The tax affected temporary differences that give rise to deferred income taxes are as follows: December 31 ------------------- 2001 2000 ------ ------ Deferred tax assets: Fixed assets $ 184 $ -- Intangibles 22,372 5,474 Foreign net operating loss carryforwards 2,049 -- Restructuring accruals 822 586 Accruals and reserves 3,548 5,192 Deferred compensation 456 279 Other 387 -- ------- ------- Total deferred tax assets 29,818 11,531 ------- ------- Deferred tax liabilities: Fixed assets -- (1,759) Intangibles -- (4,943) Other (406) (1,995) ------- ------- Total deferred tax liabilties (406) (8,697) ------- ------- Valuation allowance (3,037) -- ------- ------- Net deferred tax assets $26,375 $ 2,834 ------- -------
In connection with a purchase business combination completed in November 2001, the Company acquired $24,018 in net deferred tax assets. Management believes that $3,037 of these acquired deferred tax assets will not be realized. Accordingly, the Company recorded a valuation allowance for this amount. This allowance was established in purchase accounting.
In prior years, the Company completed two acquisitions that were accounted for as poolings-of-interest for financial reporting purposes and as taxable purchase transactions for income tax purposes. Deferred tax assets were recognized upon consummation of these transactions with an offsetting credit to equity. The Company is deducting the amortization of the intangible assets recorded for tax purposes and recording a reduction of current taxes payable and the deferred tax assets previously recorded.
Realization of the Company's remaining net deferred tax assets is dependent on future taxable income. Management believes that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time.
15. Earnings per share:
The table below sets forth the reconciliation of the numerators and denominators of the Company's basic and diluted income per share computations for the years ended December 31, 2001, 2000 and 1999.
Per share Net income Shares amount ---------- ------ --------- Basic $ 44,636 36,842 $ 1.21 ========= Effect of dilutive securities -- 876 ---------- ------ Diluted $ 44,636 37,718 $ 1.18 ========== ====== ========= Basic $ 38,730 36,154 $ 1.07 ========= Effect of dilutive securities -- 1,015 ---------- ------ Diluted $ 38,730 37,169 $ 1.04 ========== ====== ========= Basic $ 40,205 35,120 $ 1.14 ========= Effect of dilutive securities -- 1,609 ---------- ------ Diluted $ 40,205 36,729 $ 1.09 ========== ====== =========
For the years ended December 31, 2001, 2000 and 1999, 2,608, 2,055 and 72 Common stock options, respectively, were excluded from the diluted computation because the effect would be anti-dilutive.
16. Employee benefit plans:
Savings plan
The Company offers a savings plan under section 401(k) of the Internal Revenue Code. This savings plan allows eligible employees to contribute up to 15 percent of their compensation on a pretax basis. The Company matches 50 percent of the participant's contribution, up to 5 percent of the participant's total compensation. The matching contribution is made on a quarterly basis using the Company's Common stock. The charge to operations for the Company's matching contributions was $941, $867 and $177 in 2001, 2000 and 1999, respectively. The Company issued 34 shares in 2001, 27 shares in 2000 and 5 in 1999, in connection with the Company's matching contribution, with a value of $809, $707 and $185, respectively. The Company's matching contribution for the fourth quarter of 2001 will be made in the first quarter of 2002.
Stock purchase plan
All full-time employees except those who own 5 percent or more of the stock of the Company are eligible to participate in the Company's Employee Stock Purchase Plan (SPP). The SPP provides that participants may authorize the Company to withhold up to 10 percent of their earnings for the purchase of the stock. The purchase price of the Common stock is determined by the Compensation Committee but shall not be less than 85 percent of the fair market value of the Common stock. Through the SPP, 35, 21 and 8 Common shares were purchased in 2001, 2000 and 1999 at a total purchase price of $499, $504 and $236, respectively.
17. Related-party transactions:
In April 2001, the Company began procuring liability insurance through Philips. In addition, the Company entered into an agreement with Philips which allows the Company to purchase certain products at a discount from Philips. The Company paid $50 under this agreement in 2001.
The Company also paid Philips $1,933 and $500 during 2001 and 2000, respectively, related to a licensing agreement entered into to provide for the integration and use of certain of Philips' speech recognition technology into the Company's business. This agreement was amended effective January 1, 2002 and requires the Company to make an upfront payment of $150 and a fee based on a per payroll line basis. The amended agreement expires on May 22, 2005.
A member of the Company's board of directors is a partner in a law firm that has engaged to act as special counsel in certain matters. During the years ended December 31, 2001, 2000 and 1999, the Company paid this firm $1,055, $373 and $79, respectively.
18. Quarterly supplemental financial data (unaudited):
The following tables present certain unaudited consolidated quarterly financial information for each of the eight quarters in the period ended December 31, 2001. In the opinion of management, this quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the information for the periods presented. The results of operations for any quarter are not necessarily indicative of the results for the full year or for any future period.
The Company recorded a pretax gain of $3,000 in the first quarter of 2001 in connection with the settlement of a lawsuit (see Note 13) and recorded a pretax restructuring charge of $1,468 in the fourth quarter of 2001 (see Note 3). In the third quarter of 2000 the Company recorded pretax tender offer costs of $6,255 (see Note 13).