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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
_________________
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
_________________
For the quarterly period Commission file number
ended March 31, 2003 0-19941
MedQuist Inc.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 22-2531298
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
Five Greentree Centre, Suite 311, Marlton, NJ 08053
----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(856) 810-8000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act) Yes X No
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 37,140,976 shares of
common stock, no par value, as of May 9, 2003.
MEDQUIST INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at March 31, 2003 (Unaudited) and 1
December 31, 2002
Consolidated Statements of Income for the Three Months Ended March 31,
2003 and 2002 (Unaudited) 2
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 3
2003 and 2002 (Unaudited)
Notes to Consolidated Financial Statements (Unaudited) 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 17
Item 4. Controls and Procedures 18
Special Note Concerning Forward Looking Statements 18
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings 19
Item 2. Changes in Securities and Use of Proceeds 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form S-K 19
SIGNATURE 20
- ---------
SECTION 302 CERTIFICATIONS 21
- --------------------------
Part I. Financial Information
-----------------------------
Item 1. Consolidated Financial Statements
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, December 31,
2003 2002
----------- ------------
(Unaudited) Audited
Assets
Current assets:
Cash and cash equivalents $124,838 $103,392
Accounts receivable, net of allowance of $5,612 and
$5,606 79,299 86,465
Inventories 5,675 4,563
Prepaid expenses and other current assets 2,808 3,673
Deferred income taxes 6,238 6,238
-------- --------
Total current assets 218,858 204,331
Property and equipment, net 37,580 37,804
Goodwill, net 135,883 136,127
Other intangible assets, net 75,088 73,798
Deferred income taxes 15,415 15,524
Other assets 7,275 7,287
-------- --------
$490,099 $474,871
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of long-term debt $ 30 $31
Accounts payable 8,259 9,908
Accrued expenses 38,397 33,701
Deferred revenue 19,772 18,789
-------- --------
Total current liabilities 66,458 62,429
-------- --------
Long-term debt 54 54
-------- --------
Other liabilities 1,697 1,427
-------- --------
Commitments and contingencies
Shareholders' equity:
Common stock, no par value, 60,000 shares authorized,
37,113 and 37,091 issued and outstanding 229,542 229,149
Retained earnings 191,741 181,216
Accumulated other comprehensive income 607 596
-------- --------
Total shareholders' equity 421,890 410,961
-------- --------
$490,099 $474,871
======== ========
See Accompanying Notes to Consolidated Financial Statements.
1
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended
March 31,
2003 2002
--------- --------
Revenues
Services $106,816 $113,974
Solutions 17,846 ---
-------- --------
Total Revenues $124,662 $113,974
-------- --------
Cost of revenue, excluding depreciation
Services 80,484 85,010
Solutions 12,318 ---
-------- --------
Total cost of revenue, excluding depreciation 92,802 85,010
Selling, general and administrative 7,843 3,700
Research and development 1,357 ---
Depreciation 4,636 4,234
Amortization of intangible assets 1,759 1,701
Gain on sale of building (814) ---
-------- --------
Total costs and expenses 107,583 94,645
-------- --------
Operating income 17,079 19,329
Equity in losses of investee (184) (184)
Interest income, net 220 313
-------- --------
Income before income taxes 17,115 19,458
Income taxes provision 6,590 7,492
------- --------
Net income $ 10,525 $ 11,966
======== ========
Basic net income per common share $ 0.28 $ 0.32
======== ========
Diluted net income per common share $ 0.28 $ 0.32
======== ========
See Accompanying Notes to Consolidated Financial Statements.
2
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Three Months Ended
March 31,
2003 2002
-------- -------
Operating activities:
Net income $ 10,525 $ 11,966
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 6,395 5,935
Gain on sale of building (814) ---
Equity in losses of investee 184 184
Pension contributions payable in Common Stock --- 280
Amortization of deferred compensation --- 8
Tax benefit for exercise of employee stock options 72 191
Changes in assets and liabilities, excluding effects of acquisitions
Accounts receivable, net 7,166 (1,051)
Inventories (1,112) 32
Prepaid expenses and other current assets 868 (240)
Other assets (172) (121)
Accounts payable (1,649) 905
Deferred revenue 376 (28)
Accrued expenses 4,805 4,581
Other long-term liabilities 270 271
-------- --------
Net cash provided by operating activities 26,914 22,913
-------- --------
Investing activities:
Purchases of property and equipment (4,375) (3,861)
Investment in A-Life Medical, Inc. --- (109)
Proceeds from sale of property 814 ---
Acquisitions, net of cash acquired (2,238) (4,089)
-------- --------
Net cash used in investing activities (5,799) (8,059)
-------- --------
Financing activities:
Repayments of long-term debt (1) (1,097)
Proceeds from exercise of common stock options 228 527
Proceeds from issuance of Common Stock 93 232
-------- --------
Net cash provided by financing activities 320 338
-------- --------
Effect of exchange rate changes 11 (83)
-------- --------
Net decrease in cash and cash equivalents 21,446 14,433
Cash and cash equivalents, beginning of period 103,392 86,334
-------- --------
Cash and cash equivalents, end of period $124,838 $100,767
======== ========
Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest expense $ --- $ 133
======== ========
Income taxes $ 1,300 $ 1,077
======== ========
See Accompanying Notes to Consolidated Financial Statements.
3
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2003
(Unaudited - amounts in thousands, except per share amounts)
Note 1. Business and Basis of Presentation
- -------------------------------------------
MedQuist Inc. is a comprehensive provider of health information
solutions and services, which offerings meet the medical document management
needs of the Company's clients. Medical document management includes medical
transcription plus other services and products related to health care
information management such as coding, digital dictation systems, handheld units
and speech recognition.
MedQuist Inc. is a majority owned subsidiary of Koninklijke Philips
Electronics N.V. (Philips).
The information set forth in these statements is unaudited. The
information reflects all adjustments that, in the opinion of management, are
necessary to present a fair statement of the financial position, results
operations and cash flows of MedQuist Inc. and its consolidated subsidiaries for
the periods indicated. Results of operations and cash flow for the interim
period ended March 31, 2003 are not necessarily indicative of the results of
operations for the full year. Certain information in footnote disclosures
normally included in financial statements have been condensed or omitted in
accordance with the rules and regulations of the Securities and Exchange
Commission.
Note 2. Acquisitions
- ---------------------
During 2002, we completed five acquisitions. A summary of the
allocation of the purchase price to net assets acquired is as follows:
Accounts receivable $16,863
Inventories 3,750
Prepaid and other 2,685
Property and equipment 6,016
Deposits 5
Goodwill 22,774
Other intangible assets 23,406
Accounts payable (4,275)
Deferred revenue (16,520)
Accrued expenses (5,975)
Debt (72)
-------
Cash paid for acquisition
including transaction costs $48,657
=======
4
Included in the 2002 acquisitions was the acquisition of Lanier
Healthcare, LLC ("Lanier") on July 1, 2002, for $38.0 million in cash. The
following unaudited proforma information is presented as if the Lanier
acquisition had been completed on January 1, 2002. All other acquisitions in
2002 were not material to the Company.
Three Months Ended
March 31, 2002
------------------
Revenue $134,064
Net Income 11,524
Basic net income
per common share $0.31
Diluted net income
Per common share $0.30
During the three months ended March 31, 2003, we completed one
acquisition. A summary of the allocation of the purchase price to net assets
acquired is as follows:
Prepaid and other $ 3
Property and equipment 37
Noncompete agreements 250
Other intangible assets 2,799
Deferred revenue (607)
------
Purchase price 2,482
Refund of escrow from 2002
acquisition (244)
------
Net cash paid for acquisition
including transaction costs $2,238
======
During the three months ended March 31, 2003, we negotiated the return of an
escrow related to an acquisition completed in 2002. This escrow refund was
applied as a reduction to the goodwill created by the acquisition (See Note 4).
Note 3. Restructuring Charges
- ------------------------------
In December 2001, we approved a restructuring plan associated with the
roll out of our 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 and associated activity
are as follows:
5
Non-Cancelable
Leases Severance Total
-------------- --------- -----
2001 Restructuring charge $1,343 $125 $1,468
Revisions to estimate recorded in 2002 (319) --- (319)
Payments against restructuring accrual:
2002 (546) (45) (591)
2003 (46) --- (46)
------ ---- ------
Accrual at March 31, 2003 $ 432 $ 80 $ 512
====== ==== ======
In November 2001, we completed the purchase of a medical transcription
company. In connection with this acquisition, we established a restructure
reserve of $1,790. The components of the restructuring charge and associated
activity are as follows:
Non-Cancelable
Leases Severance Total
-------------- --------- -------
2001 Restructuring charge $1,599 $191 $1,790
Payments against restructuring accrual:
2001 (85) -- (85)
2002 (692) (181) (873)
2003 (160) -- (160)
Revisions to estimate recorded in 2002 (296) -- (296)
------ ---- ------
Accrual at March 31, 2003 $ 366 $ 10 $ 376
====== ==== ======
In December 1998, the Company's board of directors approved
management's restructuring plan associated with another acquired entity. The
components of the restructuring charge and associated activity are as follows:
Non-Cancelable
Non-Cancelable Contracts and
Leases Severance Other Exit Costs Total
-------------- --------- ---------------- -------
1998 Restructuring Charge $3,835 $1,618 $1,086 $6,539
Payments against Restructuring accrual:
1998 --- (567) (410) (977)
1999 (437) (723) (17) (1,177)
2000 (556) (20) --- (576)
2001 (164) --- --- (164)
2002 (343) --- --- (343)
2003 (8) --- --- (8)
Revision to estimate recorded in:
1999 (1,492) (182) (659) (2,333)
2000 (471) --- --- (471)
2001 (44) (126) --- (170)
2002 (257) --- --- (257)
------ ------ ------ ------
Accrual at March 31, 2003 $ 63 $ --- $ --- $ 63
====== ====== ====== ======
The remaining liability associated with the above restructuring plans is
recorded in accrued expenses.
6
Note 4. Goodwill and Intangible Assets
- --------------------------------------
The changes in the carrying amount of goodwill, net for the period
ended March 31, 2003, were as follows:
Balance at December 31, 2002 $136,127
Refund of escrow from 2002 acquisition (244)
--------
Balance at March 31, 2003 $135,883
========
The carrying amount of acquired intangible assets as of March 31, 2003
is as follows:
Weighted Average
Amortization Gross Carrying Accumulated Net Book
Period Amount Amortization Value
---------------- -------------- ------------ -------
Customer Lists 21 years $ 76,960 $14,187 $62,773
Noncompete Agreements 4 years 11,468 8,335 3,133
Other 4 years 13,603 7,121 6,482
-------- -------- ------- -------
17 years 102,031 29,643 72,388
Nonamortizable intangible asset:
Tradename --- 2,700 --- 2,700
-------- ------- -------
Total $104,731 $29,643 $75,088
======== ======= =======
Note 5. Investment in A-Life Medical, Inc.
- ------------------------------------------
In January 2002, the Company increased its ownership in A-Life Medical,
Inc. (A-Life) to 28.1% of the outstanding voting shares of A-Life. As such,
effective January 2002, the Company began accounting for the investment under
the equity method of accounting. Because A-Life had negative book value at the
time of the change to the equity basis of accounting, the entire investment was
allocated to intangible assets, of which $1 million was allocated to acquired
software. The acquired software is being amortized over three years. The
remaining amount was recorded as goodwill. In 2002, the Company's ownership was
further increased to 33.6%. Throughout this period, A-Life has operated at a
loss and the Company has recognized its portion of this loss, along with the
amortization of the software, as equity in losses of investee on the income
statement, with a corresponding reduction in the investment.
Note 6. Net Income Per Common Share
- -----------------------------------
Basic net income per share is calculated by dividing net income by the
weighted average number of shares of Common Stock outstanding for the period.
Diluted net income per share is calculated by dividing net income by the
weighted average number of shares of Common Stock outstanding for the period,
adjusted for the dilutive effective of Common Stock equivalents, which consist
of stock options, using the treasury stock method.
7
The table below sets forth the reconciliation of the numerators and
denominators of the basic and diluted net income per share computations:
Three Months Ended March 31,
------------------------------------------------------------------------------
2003 2002
----------------------------------- --------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
-------- -------- --------- ------- -------- ----------
Basic $10,525 37,110 $0.28 $11,966 36,932 $0.32
Effect of dilutive securities --- 520 --- 1,026
------- ------ ------- ------
Diluted $10,525 37,630 $0.28 $11,966 37,958 $0.32
======= ====== ===== ======= ====== =====
For the three months ended March 31, 2003 and 2002, options to acquire
4,428 and 3,206 shares of Common Stock, respectively, were outstanding but were
not included in the computation of diluted net income per share. These shares
were not included in the computation because the exercise prices of the options
were greater than the average market prices for Common Stock during the periods.
Note 7. Stock Based Compensation
- --------------------------------
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations, to account for its
fixed-plan stock options. Under this method, compensation expense is recorded on
the date of grant only if the current market price of the underlying stock
exceeds the exercise price. SFAS No. 123, "Accounting for Stock-Based
Compensation", established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123, as amended in SFAS No. 148, the Company has
elected to continue to apply the intrinsic-value-based method of accounting
described above, and has adopted only the disclosure requirements of SFAS No.
123 and SFAS No. 148.
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, as amended by SFAS No. 148, "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:
8
Three months ended March 31,
2003 2002
-------- --------
Net income:
As reported $10,525 $11,966
Add stock-based employee compensation
expense included in reported net income,
net of tax --- 5
Impact of total stock-based compensation
expense determined under fair-value
based method for all rewards, net of tax (1,950) (2,086)
------- -------
Pro forma $ 8,575 $ 9,885
======= =======
Basic net income per share:
As reported $ 0.28 $ 0.32
======= =======
Pro forma $ 0.23 $ 0.27
======= =======
Diluted net income per share:
As reported $ 0.28 $ 0.32
======= =======
Pro forma $ 0.23 $ 0.26
======= =======
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:
Three months ended March 31,
2003 2002
------ --------
Risk-free interest rate 2.99% 4.33%
Volatility 50% 57%
Expected dividend yield 0% 0%
Expection option life 5 years 5 years
Note 8. Related Party Transactions
- ----------------------------------
In March 2003, the Company agreed to amend the licensing agreement with
Philips Speech Processing. This amendment adjusts the fees to be charged to the
Company for the use of the Philips speech product as well as defined terms for
paying Philips for further development of the product, in addition to consulting
work which Philips is providing. Through March 31, 2003, the Company paid $54
related to the consulting work to Philips.
Presently, all business insurance coverages, with the exception of
worker's compensation, are provided by Philips. For the three months ended March
31, 2003, the Company paid $2 in premiums to Philips for these policies.
9
Philips also sells dictation related equipment to MedQuist and for the
three months ended March 31, 2003, the Company paid $141 in costs for such
equipment.
Management believes that the transactions with Philips are on an
arms-length basis.
Note 9. Commitments and Contingencies
- -------------------------------------
During the three months ended March 31, 2003 there have been no items
that significantly impact the Company's commitments and contingencies as
disclosed in the notes to the 2002 annual financial statements as filed on Form
10-K.
Note 10. New Accounting Pronouncements
- --------------------------------------
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligations associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development, and/or
normal use of the assets. The Company also records a corresponding asset that is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company adopted SFAS No. 143 on
January 1, 2003. The adoption of SFAS No. 143 did not have a material effect on
the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". SFAS No. 145 amends existing guidance on reporting gains and
losses on the extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become part of
the risk management strategy of many companies. SFAS No. 145 also amends SFAS
No. 13 to require sale-leaseback accounting for certain lease modifications that
have economic effects similar to sale-leaseback transactions. The provisions of
the Statement related to the rescission of Statement No. 4 is applied in fiscal
years beginning after May 15, 2002. The provisions of the Statement related to
Statement No. 13 were effective for transactions occurring after May 15, 2002.
The adoption of SFAS No. 145 did not have a material effect on the Company's
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity". The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of SFAS No.
146 did not have a material effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34". This
Interpretation elaborates on the disclosures to be made by a guarantor in its
10
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and did not
have a material effect on the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123". This Statement amends FASB Statement No. 123, "Accounting
for Stock-Based Compensation", to provide alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement No. 123 to require prominent disclosures in both
annual and interim financial statements. Certain of the disclosure modifications
are required for interim periods ending after December 15, 2002 and are included
in the notes to these consolidated financial statements.
In November 2002, the EITF finalized its tentative consensus on EITF
Issue 00-21, "Revenue Arrangements with Multiple Deliverables", which provides
guidance on the timing and method of revenue recognition for sales arrangements
that include the delivery of more than one product or service. EITF 00-21 is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. Management is currently evaluating the impact of
the adoption of this consensus on the Company's consolidated financial
statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. Management is currently evaluating the impact
of the adoption of this interpretation on the Company's consolidated financial
statements.
Note 11. Segment Information
- ----------------------------
MedQuist manages its business in two segments; services and solutions.
While the two segments are closely related, the services segment is largely
comprised of transcription and coding services, while the solution segment is
comprised of sale and service of voice products.
Segment information is presented in accordance with SFAS 131,
"Disclosure about Segments of an Enterprise and Related Information". This
Statement is based on a management approach, which requires segmentation based
on the Company's internal organization and disclosure of revenue and operating
income based on internal accounting methods. The Company's financial reporting
systems present various data for management to run the business, including
profit and loss statements. However, this Statement does not require an
enterprise to report information that is not prepared for internal use, if
reporting it would be impractical.
11
Three Months Ended March 31,
- ----------------------------
Intersegment
2003 Services Solutions Items Consolidated
- ---- -------- --------- ------------ ------------
Revenue $106,816 $17,945 $(99) $124,662
Cost of revenue,
excluding depreciation 80,484 12,353 (35) 92,802
-------- ------- ---- --------
Gross profit $ 26,332 $ 5,592 $(64) $ 31,860
======== ======= ==== ========
2002
- ----
Revenue $113,974 N/A -- $113,974
Cost of revenue,
excluding depreciation 85,010 -- -- 85,010
-------- ------- ---- --------
Gross profit $ 28,964 N/A -- $ 28,964
======== ======= ==== ========
A reconciliation of MedQuist's consolidated segment gross profit to
operating income is as follows:
Three Months Ended
March 31,
-----------------------
2003 2002
------- --------
Consolidated segment gross profit $31,860 $28,964
Selling, general and administrative (7,843) (3,700)
Research and development (1,357) ---
Depreciation (4,636) (4,234)
Amortization of intangible assets (1,759) (1,701)
Gain on sale of building 814 ---
------- -------
Operating income $17,079 $19,329
======= =======
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
- -------
Critical Accounting Policies and Estimates
- ------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results
of Operations is based on our Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions which affect the reported amounts
of assets, liabilities, revenue, expense, and related disclosures. Management
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities.
12
Management believes the following critical accounting policies affect
its more significant estimates and assumptions used in the preparation of its
consolidated financial statements. These critical accounting policies and
estimates have been discussed with the Company's audit committee.
Revenue Recognition
- -------------------
A substantial portion of our revenue is derived from providing medical
transcription services, which we recognize when services are rendered. These
services are based primarily on contracted rates. A portion of our revenue is
derived from the sale and implementation of voice-capture and document
management solutions, and maintenance service of these products. We recognize
revenue and profit on sales and implementation utilizing the percentage of
completion method. With regard to service contracts, which is arranged separate
from the product sale, the typical arrangement spans 12 months. We recognize
revenue on the service contracts on a straight line method over the term of the
underlying service contract. Deferred revenues represent cash received from
customers in advance of revenues being recognized for the related payment.
Bad Debt
- --------
We estimate an allowance for doubtful accounts receivables based on
historical experience and evaluation of the financial condition of the
customers. Historically, our estimates have been adequate to cover accounts
receivable exposure. If circumstances related to our estimates change, we may
need to record increases to the allowance.
Valuation of Goodwill, Other Intangible Assets and Other Long-Lived Assets
- --------------------------------------------------------------------------
In accordance with SFAS No. 144, "Accounting for Impairment of Disposal
of Long-Lived Assets", we assess long-lived assets, such as property, plant, and
equipment, and purchased intangibles subject to amortization, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.
We measure recoverability of assets to be held and used by comparing
the carrying amount of an asset to estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. Assets to be disposed of would be separately presented in the balance
sheet and reported at the lower of the carrying amount or fair value less costs
to sell, and would no longer be depreciated. The assets and liabilities of a
disposed group classified as held for sale would be presented separately in the
appropriate asset and liability sections of the balance sheet.
We test goodwill and intangible assets not subject to amortization
annually for impairment. Should events and circumstances indicate that the asset
might be impaired at some time prior to the annual test, we will test more
frequently. An impairment loss is recognized to the extent that the carrying
amount exceeds the asset's fair value.
13
Deferred Taxes
- --------------
We record a valuation allowance to reduce our deferred tax assets to
the amount that is more likely than not to be realized. We have considered
future taxable income and prudent and feasible tax planning strategies in
determining the need for a valuation allowance. In the event we were to
determine that we could not realize all or part of our net deferred tax assets
in the future, an adjustment to the deferred tax assets would be charged to
earnings in the period such determination is made. Likewise, if we later
determine that it is more likely than not that the net deferred tax assets would
be realized, the previously provided valuation reserve would be reversed.
Results of Operations
- ---------------------
The following table sets forth for the periods indicated certain financial data
in the Company's Unaudited Consolidated Statements of Income as a percentage of
net revenue:
Three Months Ended
March 31,
-----------------------
2003 2002
------ ------
Revenue 100.0% 100.0%
Costs and expenses:
Cost of revenue, excluding depreciation 74.4 74.6
Selling, general and administrative 6.3 3.2
Research and development 1.1 --
Depreciation 3.7 3.7
Amortization of intangible assets 1.4 1.5
Gain on sale of building (0.6) --
----- -----
Operating income 13.7 17.0
Equity in losses of investee (0.1) (0.2)
Interest income, net 0.1 0.3
----- -----
Income before income taxes 13.7 17.1
Income taxes 5.3 6.6
----- -----
Net income 8.4% 10.5%
===== =====
Three Months Ended March 31, 2003
- ---------------------------------
Revenue. Revenue increased 9.4% from $114.0 million for the three months ended
March 31, 2002 to $124.7 million for the comparable 2003 period. Revenues for
the services segment decreased 6.3% from $114.0 million for the three months
ended March 31, 2002 to $106.8 million for the comparable 2003 period. The
decrease is largely the result of attrition created by competitive pricing
pressure. Revenues for the solutions segment were $17.9 million for the three
months ended March 31, 2003 and were the result of the acquisition of Lanier
Healthcare LLC on July 1, 2002. There were $99 thousand in revenues between the
two segments, which have been eliminated in consolidation.
Cost of Revenue, excluding depreciation. Cost of revenue increased 9.2% from
$85.0 million for the three months ended March 31, 2002 to $92.8 million for the
comparable 2003 period. Cost of revenue for the services segment was $85.0
million, or 74.6% of revenue, and $80.5 million, or 75.3% of revenue, for the
14
three month periods ended March 31, 2002 and March 31, 2003, respectively. The
decrease in actual costs was due to a large portion of the costs of this segment
being variable and declining as revenue declined, partially offset by an
increase in payroll costs. Cost of revenue for the solutions segment was $12.4
million, or 68.8% of revenue, for the three months ended March 31, 2003, and was
the result of the acquisition of Lanier Healthcare LLC on July 1, 2002.
Selling, general and administrative. Selling, general and administrative
expenses increased 112.0% from $3.7 million for the three months ended March 31,
2002 to $7.8 million for the comparable 2003 period. As a percentage of
revenues, selling, general and administrative expenses increased from 3.2% for
the three months ended March 31, 2002 to 6.3% for the comparable 2003 period. Of
the increase in expenses between comparable periods, $3.4 million was the result
of the Lanier acquisition and largely relates to the cost of the sales force.
The remaining $700 thousand increase was the result of increased costs to
support the operations.
Research and development. Research and development costs were $1.4 million for
the three months ended March 31, 2003. These costs relate entirely to Lanier,
which was acquired on July 1, 2002.
Depreciation. Depreciation expense increased 9.5% from $4.2 million for the
three months ended March 31, 2002 to $4.6 million for the comparable 2003
period. As a percentage of revenues, depreciation was consistent at 3.7% of
revenue for both periods.
Amortization of intangible assets. Amortization of intangible assets increased
from $1.7 million for the three months ended March 31, 2002 to $1.8 million for
the comparable 2003 period. The increase is attributable to the Company's
acquisitions in 2002 and 2003.
Equity in losses of investee. We reflect our investment in A-Life Medical, Inc.
under the equity method of accounting. As such, we have recognized $184 thousand
in a loss in investment for the periods ended March 31, 2002 and March 31, 2003.
These losses were the result of amortization of $83 thousand related to $1
million of the investment being allocated to acquired software and $101 thousand
related to our share of A-Life's operating loss in both periods.
Interest income, net. We had net interest income of $313 thousand for the three
months ended March 31, 2002 and net interest income of $220 thousand for the
comparable 2003 period. The decrease was due to decreased rates of return on
liquid investments.
Income taxes. Income taxes decreased from $7.5 million for the three months
ended March 31, 2002 to $6.6 million for the comparable 2003 period. The
decrease in income taxes resulted from decreased pre-tax earnings.
Liquidity and Capital Resources
- -------------------------------
At March 31, 2003, we had working capital of $152.4 million, including
$124.8 million of cash and cash equivalents. During the three months ended March
31, 2003, our operating activities provided cash of $26.9 million and during the
three months ended March 31, 2002 our operating activities provided cash of
$22.9 million. The increase is primarily due to increased collections in
accounts receivable, partially offset by increases in inventories and a decrease
in accounts payable.
15
During the three months ended March 31, 2003, we used cash in investing
activities of $5.8 million, consisting of $4.4 million of capital expenditures
and $2.2 million for an acquisition, partially offset by $814 thousand in
proceeds from the sale of a building. During the three months ended March 31,
2002, we used cash for investing activities of $8.1 million, consisting of $3.9
million of capital expenditures, $4.1 million for acquisitions and $109 thousand
of additional investment in A-Life Medical.
During the three months ended March 31, 2003, net cash provided by
financing activities was $320 thousand. During the three months ended March 31,
2002, cash used in financing activities was $338 thousand.
We believe that our cash and cash equivalents generated from operations
and our borrowing capacity will be sufficient to meet our current working
capital and capital expenditure requirements.
During the three months ended March 31, 2003, there have been no items
that significantly impact our commitments and contingencies as discussed in the
notes to the 2002 Annual Financial Statements as filed on Form 10-K. In
addition, we have no significant off balance sheet arrangements.
New Accounting Pronouncements
- -----------------------------
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligations associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development, and/or
normal use of the assets. The Company also records a corresponding asset that is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company adopted SFAS No. 143 on
January 1, 2003. The adoption of SFAS No. 143 did not have a material effect on
the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". SFAS No. 145 amends existing guidance on reporting gains and
losses on the extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become part of
the risk management strategy of many companies. SFAS No. 145 also amends SFAS
No. 13 to require sale-leaseback accounting for certain lease modifications that
have economic effects similar to sale-leaseback transactions. The provisions of
the Statement related to the rescission of Statement No. 4 are applied in fiscal
years beginning after May 15, 2002. The provisions of the Statement related to
Statement No. 13 were effective for transactions occurring after May 15, 2002.
The adoption of SFAS No. 145 did not have a material effect on the Company's
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
16
Activity". The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of SFAS No.
146 did not have a material effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34". This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 did not have
a material effect on the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123". This Statement amends FASB Statement No. 123, "Accounting
for Stock-Based Compensation", to provide alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement No. 123 to require prominent disclosures in both
annual and interim financial statements. Certain of the disclosure modifications
are required for interim periods ending after December 15, 2002 and are included
in the notes to the Company's consolidated financial statements.
In November 2002, the EITF finalized its tentative consensus on EITF
Issue 00-21, "Revenue Arrangements with Multiple Deliverables", which provides
guidance on the timing and method of revenue recognition for sales arrangements
that include the delivery of more than one product or service. EITF 00-21 is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. Management is currently evaluating the impact of
the adoption of this consensus on the Company's consolidated financial
statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. Management is currently evaluating the impact
of the adoption of this interpretation on the Company's consolidated financial
statements.
Item 3. 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.
17
Item 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls. Within the
90 days prior to the filing date of this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" ("Disclosure Controls"). Disclosure
Controls are procedures that are designed with the objective of ensuring that
information required to be disclosed in our reports filed under the Securities
Exchange Act of 1934 (the "Exchange Act"), such as this Quarterly Report, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's ("SEC"). Disclosure Controls are
also designed with the objective of ensuring that such information is
accumulated and communicated to our management, including the Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO"), as appropriate to allow
timely decisions regarding required disclosure.
The Company's management, including the CEO and CFO, does not expect
that our Disclosure Controls will prevent all error and all fraud. A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions.
Based upon our Disclosure Controls evaluation, our CEO and CFO have
concluded that, subject to the limitations noted above, our Disclosure Controls
are effective to ensure that the information required to be disclosed by the
Company in its periodic reports is accumulated and communicated to our
management, including the CEO and CFO, as appropriate to allow timely decisions
regarding disclosure and is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms.
Changes in internal controls. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of the Disclosure Controls
evaluation.
Special Note Concerning Forward Looking Statements
- --------------------------------------------------
Some of the information in this Form 10-Q 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. 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
18
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 a majority 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 of 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; (13) the inability to predict future economic or
market conditions; and (14) risks inherent in diversifying into other
businesses, such as from the acquisitions of Lanier Healthcare (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 other cautionary statements we make in connection
with 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-Q or
elsewhere. Other risk factors and cautionary statements are set forth in our
other filings with the SEC, and you are encouraged to read those.
Part II. Other Information
--------------------------
Item 1. - Legal Proceedings - None
Item 2. - Changes in Securities and Use of Proceeds - None
Item 3. - Defaults upon Senior Securities - None
Item 4. - Submission of Matters to a Vote of Security Holders - None
Item 5. - Other Information
a) Section 202 Disclosure to Investors
Pursuant to Section 202 of the Sarbanes-Oxley Act of 2002, the
Company discloses that its audit committee has approved the
performance of tax services by its independent auditor.
Item 6. - Exhibits and Reports on Form S-K
a) Exhibits:
Exhibit 99.1 - Certification of CEO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 99.2 - Certification of CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
19
b) The Company filed the following Reports on Form 8-K
File Date Item Reported
--------- -------------
February 13, 2003 Regulation FD Disclosure in connection
with earnings release and conference call
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MedQuist Inc.
Registrant
Date: May 13, 2003 By: Brian J. Kearns
------------------------
Brian J. Kearns
Chief Financial Officer
20
I, David A. Cohen, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MedQuist Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 13, 2003
David A. Cohen
- -------------------------------------
David A. Cohen
President and Chief Executive Officer
21
I, Brian J. Kearns, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MedQuist Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 13, 2003
Brian J. Kearns
- -----------------------
Brian J. Kearns
Chief Financial Officer
22