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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period Commission file number
ended September 30, 2003 0-19941
MedQuist Inc.
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(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
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(Address of principal executive offices) (Zip Code)
(856) 810-8000
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(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: 37,214,143 shares of
common stock, no par value, as of October 31, 2003.
MEDQUIST INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PAGE NO.
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PART I. FINANCIAL INFORMATION
- ------- ---------------------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 2003 (Unaudited) and December 31, 2002 1
Consolidated Statements of Income for the Nine Months Ended September 30, 2003 and
2002 (Unaudited) 2
Consolidated Statements of Income for the Three Months Ended September 30, 2003
and 2002 (Unaudited) 3
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003
and 2002 (Unaudited) 4
Notes to Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk 17
Item 4. Controls and Procedures 17
Special Note Concerning Forward Looking Statements 17
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form S-K 18
SIGNATURE 19
- ---------
Part I. Financial Information
Item 1. Consolidated Financial Statements
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
2003 2002
------------- ------------
(Unaudited) Audited
Assets
Current assets:
Cash and cash equivalents $ 143,866 $ 103,392
Accounts receivable, net of allowance of $5,532 and
$ 5,606 78,824 86,465
Inventories 5,554 4,563
Prepaid expenses and other current assets 1,725 3,673
Deferred income taxes 6,238 6,238
------------- ------------
Total current assets 236,207 204,331
Property and equipment, net 37,667 37,804
Goodwill, net 137,039 136,127
Other intangible assets, net 71,154 73,798
Deferred income taxes 13,813 15,524
Other assets 7,638 7,287
------------- ------------
$ 503,518 $ 474,871
============= ============
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of long-term debt $ 30 $ 31
Accounts payable 8,596 9,908
Accrued expenses 31,605 33,701
Deferred revenue 18,019 18,789
------------- ------------
Total current liabilities 58,250 62,429
------------- ------------
Long-term debt 25 54
------------- ------------
Other liabilities 2,045 1,427
------------- ------------
Commitments and contingencies (Note 7)
Shareholders' equity:
Common stock, no par value, 60,000 shares authorized,
37,212 and 37,091 issued and outstanding 230,653 229,149
Retained earnings 211,552 181,216
Accumulated other comprehensive income 993 596
------------- ------------
Total shareholders' equity 443,198 410,961
------------- ------------
$ 503,518 $ 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)
Nine Months Ended
September 30,
2003 2002
------------ ------------
Revenues -
Services $ 314,562 $ 339,810
Solutions 54,710 17,545
------------ ------------
Total revenues 369,272 357,355
------------ ------------
Cost of revenues, excluding depreciation -
Services 237,941 256,277
Solutions 36,625 12,043
------------ ------------
Total cost of revenues, excluding depreciation 274,566 268,320
Selling, general and administrative 23,329 14,073
Research and development 4,423 1,426
Depreciation 14,209 13,697
Amortization of intangible assets 5,728 5,086
Restructuring (223) --
Gain on sale of building (814) --
------------ ------------
Total costs and expenses 321,218 302,602
------------ ------------
Operating income 48,054 54,753
Equity in losses of investee (429) (674)
Interest income, net 696 950
------------ ------------
Income before income taxes 48,321 55,029
Income taxes 17,985 21,186
------------ ------------
Net income $ 30,336 $ 33,843
============ ============
Basic net income per common share $ 0.82 $ 0.91
============ ============
Diluted net income per common share $ 0.80 $ 0.89
============ ============
See Accompanying Notes to Consolidated Financial Statements.
2
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended
September 30,
2003 2002
------------ ------------
Revenues -
Services $ 102,472 112,205
Solutions 18,694 17,545
------------ ------------
Total revenues 121,166 129,750
------------ ------------
Cost of revenues, excluding depreciation -
Services 78,990 87,013
Solutions 12,457 12,043
------------ ------------
Total cost of revenues, excluding depreciation 91,447 99,056
Selling, general and administrative 7,934 6,891
Research and development 1,676 1,426
Depreciation 4,828 5,113
Amortization of intangible assets 1,985 1,772
Restructuring (223) --
------------ ------------
Total costs and expenses 107,647 114,258
------------ ------------
Operating income 13,519 15,492
Equity in losses of investee (113) (243)
Interest income, net 222 261
------------ ------------
Income before income taxes 13,628 15,510
Income taxes 4,628 5,971
------------ ------------
Net income $ 9,000 $ 9,539
============ ============
Basic net income per common share $ 0.24 $ 0.26
============ ============
Diluted net income per common share $ 0.24 $ 0.25
============ ============
See Accompanying Notes to Consolidated Financial Statements.
3
MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Nine Months Ended
September 30,
2003 2002
------------ ------------
Operating activities:
Net income $ 30,336 $ 33,843
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 19,937 18,783
Gain on sale of building (814) --
Equity in losses of investee 429 674
Pension contributions payable in Common Stock -- 277
Amortization of deferred compensation -- 23
Tax benefit for exercise of employee stock options 496 802
Changes in assets and liabilities, excluding effects of acquisitions
Accounts receivable, net 7,641 7,556
Inventories (991) --
Prepaid expenses and other current assets 1,951 (611)
Other assets (780) (72)
Accounts payable (1,312) 794
Accrued expenses (25) (2,428)
Deferred revenue (1,377) (989)
Other long-term liabilities 618 155
------------ ------------
Net cash provided by operating activities 56,109 58,807
------------ ------------
Investing activities:
Purchases of property and equipment (14,035) (12,116)
Investment in A-Life Medical, Inc. -- (892)
Proceeds from sale of property 814 --
Acquisitions, net of cash acquired (3,568) (48,518)
------------ ------------
Net cash used in investing activities (16,789) (61,526)
------------ ------------
Financing activities:
Repayments of long-term debt (30) (2,138)
Proceeds from exercise of Common Stock options 549 488
Proceeds from issuance of Common Stock 459 1,864
------------ ------------
Net cash provided by financing activities 978 214
------------ ------------
Effect of exchange rate changes 176 143
------------ ------------
Net increase in cash and cash equivalents 40,474 (2,362)
Cash and cash equivalents, beginning of period 103,392 86,334
------------ ------------
Cash and cash equivalents, end of period $ 143,866 $ 83,972
============ ============
Supplemental disclosure of cash flow information:
Cash paid during period for -
Interest expense $ 5 $ 160
============ ============
Income taxes $ 17,369 $ 18,758
============ ============
See Accompanying Notes to Consolidated Financial Statements.
4
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 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, unless
otherwise indicated. 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 September 30, 2003 are not necessarily
indicative of the results 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. 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, "Accounting for
Stock-Based Compensation", 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, the Company's net
income and net income per share would have been reduced to the following pro
forma amounts:
5
Nine months ended Three months ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income: $ 30,337 $ 33,843 $ 9,000 $ 9,539
As reported
Add stock-based employee
compensation expense included
in reported net income, net of tax -- 15 -- 5
Impact of total stock-based
compensation expense determined
under fair-value based method for
all rewards, net of tax (5,070) (5,961) (1,629) (1,920)
---------- ---------- ---------- ----------
Pro forma net income $ 25,267 $ 27,897 $ 7,371 $ 7,624
========== ========== ========== ==========
Basic net income per share:
As reported $ 0.82 $ 0.91 $ 0.24 $ 0.26
========== ========== ========== ==========
Pro forma $ 0.68 $ 0.75 $ 0.20 $ 0.21
========== ========== ========== ==========
Diluted net income per share:
As reported $ 0.80 $ 0.89 $ 0.24 $ 0.25
========== ========== ========== ==========
Pro forma $ 0.67 $ 0.74 $ 0.19 $ 0.20
========== ========== ========== ==========
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.
Note 3. Acquisitions
The Company completed an acquisition in March 2003. 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 2,834
Accrued expenses (26)
Deferred revenue (607)
----------
Purchase price for 2003 acquisition 2,491
Refund of escrow from 2002 acquisition (245)
Earnout payment on 2002 acquisition 720
Earnout payment on 2001 acquisition 611
----------
Net cash paid for acquisition
including transaction costs $ 3,577
==========
6
During the nine months ended September 30, 2003, the Company negotiated
the return of an escrow related to an acquisition completed in 2002. This escrow
refund was applied as a reduction to the goodwill recorded in acquisition
accounting (See note 4). In addition, the Company made earnout payments on one
acquisition completed in 2001 and one acquisition completed in 2002 as certain
established goals were achieved. There are no additional potential earnout
payments required on any other completed acquisition transactions.
During 2002, we completed five acquisitions and cost paid for the acquisitions,
including transaction costs, was $48,657.
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
2003 and 2002 were not material to the Company.
Nine Months Ended
September 30, 2002
------------------
Revenue $ 398,139
Net Income 33,763
Basic net income
per common share $ 0.91
Diluted net income
per common share $ 0.89
Note 4. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the period ended
September 30, 2003 are as follows:
Balance at December 31, 2002 $ 136,127
Earnout payment on 2002 acquisition 720
Earnout payment on 2001 acquisition 611
Refund of escrow from 2002 acquisition (245)
Other adjustments (174)
---------
Balance at September 30, 2003 $ 137,039
=========
The carrying amount of acquired other intangible assets as of September
30, 2003 is as follows:
Weighted Average
Amortization Gross Carrying Accumulated Net Book
Period Amount Amortization Value
---------------- -------------- ------------ ----------
Customer Lists 19 years $ 76,960 $ 16,091 $ 60,869
Noncompete Agreements 4 years 4,992 2,404 2,588
Other 3 years 9,513 4,516 4,997
---------------- -------------- ------------ ----------
14 years 91,465 23,011 68,454
Nonamortizable intangible asset:
Tradename -- 2,700 -- 2,700
-------------- ------------ ----------
Total $ 94,165 $ 23,011 $ 71,154
============== ============ ==========
7
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. Restructuring Charges
In 1998 and 2001, the Company approved various restructuring plans
related to closure of facilities, the rollout of our new transcription platform
and the rationalization of several operating facilities. During the nine month
period ended September 30, 2003, the Company made payments of $611 on remaining
obligations for non-cancelable leases and $40 in severance payments.
Additionally, management revised the estimate of required reserves and reversed
$223 related to non-cancelable leases and severance. The accrual balance at
September 30, 2003 is $293, which amount is included in accrued expenses and
represents lease obligations for non-cancelable leases.
Note 7. Commitments and Contingencies
During the nine months ended September 30, 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 8. 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.
The table below sets forth the reconciliation of the numerators and
denominators of the basic and diluted net income per share computations:
Nine Months Ended September 30,
---------------------------------------------------------------------------
2003 2002
------------------------------------ ------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
---------- ---------- ---------- ---------- ---------- ----------
Basic $ 30,336 37,152 $ 0.82 $ 33,843 36,987 $ 0.91
Effect of dilutive securities -- 593 -- 958
---------- ---------- ---------- ----------
Diluted $ 30,336 37,745 $ 0.80 $ 33,843 37,945 $ 0.89
========== ========== ========== ========== ========== ==========
8
For the nine months ended September 30, 2003 and 2002, options to
acquire 3,552 and 3,203 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.
Three Months Ended September 30,
---------------------------------------------------------------------------
2003 2002
------------------------------------ ------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
---------- ---------- ---------- ---------- ---------- ----------
Basic $ 9,000 37,192 $ 0.24 $ 9,539 37,045 $ 0.26
Effect of dilutive securities -- 635 -- 872
---------- ---------- ---------- ----------
Diluted $ 9,000 37,827 $ 0.24 $ 9,539 37,917 $ 0.25
========== ========== ========== ========== ========== ==========
For the three months ended September 30, 2003 and 2002, options to
acquire 3,556 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 9. Related Party Transactions
In March and August 2003, the Company agreed to amend a licensing
agreement with Philips Speech Processing. These amendments adjust the fees to be
charged to the Company for the use of the Philips speech product, define the
terms for paying Philips for further development of the product and provide an
exclusivity right, when the product is developed. Through September 30, 2003,
the Company paid $280 related to the consulting work provided by Philips and
$620 toward the exclusivity right.
Presently, all business insurance coverages, with the exception of
worker's compensation, are provided by Philips. For the nine months ended
September 30, 2003, the Company paid $324 in premiums to Philips for these
policies.
Philips also sells dictation related equipment to MedQuist and for the
nine months ended September 30, 2003, the Company paid $419 in costs for such
equipment.
There are several other transactions with Philips which total $73 for
the nine months ended September 30, 2003.
Management believes that the transactions with Philips are on an
arms-length basis.
Note 10. 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 sales 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.
9
Nine Months Ended September 30,
Intersegment
2003 Services Solutions Items Consolidated
- ---- ------------ ------------ ------------ ------------
Revenue $ 314,562 $ 55,648 $ (938) $ 369,272
Cost of revenue,
excluding depreciation 237,941 37,108 (483) 274,566
------------ ------------ ------------ ------------
Gross profit $ 76,621 $ 18,540 $ (455) $ 94,706
============ ============ ============ ============
2002
- -----
Revenue $ 339,810 $ 17,633 $ (88) $ 357,355
Cost of revenue,
excluding depreciation 256,277 12,131 (88) 268,320
------------ ------------ ------------ ------------
Gross profit $ 83,533 $ 5,502 -- $ 89,035
============ ============ ============ ============
Three Months Ended September 30,
Intersegment
2003 Services Solutions Items Consolidated
- ---- ------------ ------------ ------------ ------------
Revenue $ 102,472 $ 19,351 $ (657) $ 121,166
Cost of revenue,
excluding depreciation 78,990 12,805 (348) 91,447
------------ ------------ ------------ ------------
Gross profit $ 23,482 $ 6,546 $ (309) $ 29,719
============ ============ ============ ============
2002
- -----
Revenue $ 112,205 17,633 (88) $ 129,750
Cost of revenue,
excluding depreciation 87,013 12,131 (88) 99,056
------------ ------------ ------------ ------------
Gross profit $ 25,192 5,502 -- $ 30,694
============ ============ ============ ============
A reconciliation of MedQuist's consolidated segment gross profit to
operating income is as follows:
Nine Months Ended Three Months Ended
September 30, September 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Consolidated segment gross profit $ 94,706 $ 89,035 $ 29,719 30,694
Selling, general and administrative (23,329) (14,073) (7,934) (6,891)
Research and development (4,423) (1,426) (1,676) (1,426)
Depreciation (14,209) (13,697) (4,828) (5,113)
Amortization of intangible assets (5,728) (5,086) (1,985) (1,772)
Restructure 223 -- 223 --
Gain on sale of building 814 -- -- --
---------- ---------- ---------- ----------
Operating income $ 48,054 $ 54,753 $ 13,519 $ 15,492
========== ========== ========== ==========
10
Note 11. New Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("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. The adoption of
this consensus did not have an impact on the 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 does not believe that the adoption
of this Interpretation will have a material impact on the Company's Consolidated
Financial Statements.
The FASB has recently issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" and SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." The adoption of these accounting pronouncements did not have an impact
on the Company's Consolidated Financial Statements.
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.
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 the sale and implementation of voice capture and data
management solutions 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.
11
Bad Debt
We estimate an allowance for doubtful accounts receivables based on
historical experience and evaluation of the financial condition of our clients.
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 or 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. In May 2003, we performed this test and
determined there has been no impairment.
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.
12
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:
Nine Months Ended Three Months Ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenue 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue, excluding depreciation 74.4 75.1 75.5 76.3
Selling, general and administrative 6.3 4.0 6.5 5.3
Research and development 1.2 0.4 1.4 1.1
Depreciation 3.8 3.8 4.0 4.0
Amortization of intangible assets 1.6 1.4 1.6 1.4
Restructuring (0.1) -.- (0.2) -.-
Gain on sale of building (0.2) -.- -.- -.-
---------- ---------- ---------- ----------
Operating income 13.0 15.3 11.2 11.9
Equity in losses of investee (0.1) (0.2) (0.1) (0.2)
Interest income, net 0.2 0.3 0.1 0.2
---------- ---------- ---------- ----------
Income before income taxes 13.1 15.4 11.2 11.9
Income taxes 4.9 5.9 3.8 4.6
---------- ---------- ---------- ----------
Net income 8.2% 9.5% 7.4% 7.3%
========== ========== ========== ==========
Nine Months Ended September 30, 2003
Revenues. Revenues increased 3.3% from $357.4 million for the nine months ended
September 30, 2002 to $369.3 million for the comparable 2003 period. Revenues
for the services segment decreased 7.4% from $339.8 million for the nine months
ended September 30, 2002 to $314.6 million for the comparable 2003 period. The
decrease is largely the result of reductions in contracted service rates and
attrition due to competitive pricing pressure. Revenues for the solutions
segment increased 212% from $17.6 million for the nine months ended September
30, 2002 to $54.7 million for the comparable 2003 period. The increase is the
result of recording nine months of revenue for this segment in 2003 versus three
months in 2002 as the acquisition took place on July 1, 2002. There were $938
thousand in revenues between the two segments, which have been eliminated in
consolidation.
Cost of Revenues, excluding depreciation. Cost of revenues increased 2.3% from
$268.3 million for the nine months ended September 30, 2002 to $274.6 million
for the comparable 2003 period. Cost of revenues for the services segment was
$256.3 million, or 75.4% of revenues, and $237.9 million, or 75.6% of revenues,
for the nine month periods ended September 30, 2002 and September 30, 2003,
respectively. The decrease in actual costs was due to a large portion of the
costs of this segment being variable and declining as revenues declined. Cost of
revenues for the solutions segment was $12.0 million, or 68.6% of revenues, and
$36.6 million, or 66.9% of revenues, for the nine month periods ended September
30, 2002 and September 30, 2003, respectively. The increase in actual cost of
revenue is the result of recording nine months of costs for this segment in 2003
versus three months in 2002, as the acquisition took place on July 1, 2002.
13
Selling, general and administrative. Selling, general and administrative
expenses increased 65.8% from $14.1 million for the nine months ended September
30, 2002 to $23.3 million for the comparable 2003 period. As a percentage of
revenues, selling, general and administrative expenses increased from 4.0% for
the nine months ended September 30, 2002 to 6.3% for the comparable 2003 period.
The increase in expenses between comparable periods was the result of the Lanier
acquisition and largely relates to the cost of the sales force.
Research and development. Research and development costs increased from $1.4
million for the nine months ended September 30, 2002 to $4.4 million for the
comparable 2003 period. The increase between comparable periods was the result
of the Lanier acquisition.
Depreciation. Depreciation expense increased 3.7% from $13.7 million for the
nine months ended September 30, 2002 to $14.2 million for the comparable 2003
period. As a percentage of revenues, depreciation was consistent at 3.8% of
revenues for both periods.
Amortization of intangible assets. Amortization of intangible assets increased
from $5.1 million for the nine months ended September 30, 2002 to $5.7 million
for the comparable 2003 period. The increase is attributable to the Company's
acquisitions in 2002 and 2003.
Restructuring (credits). During the nine months ended September 30, 2003, we
revised our accrual estimates and $223 thousand of restructure accruals were
reversed in connection with the revision.
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 $674 thousand
and $429 thousand in a loss in investment for the nine month periods ended
September 30, 2002 and September 30, 2003, respectively. These losses were the
result of amortization of $250 thousand related to $1 million of the investment
being allocated to acquired software and the remainder related to our share of
A-Life's operating loss in both periods.
Interest income, net. We had net interest income of $950 thousand for the nine
months ended September 30, 2002 and net interest income of $696 thousand for the
comparable 2003 period. The decrease was due to decreased rates of return on
liquid investments.
Income taxes. Income taxes decreased from $21.2 million for the nine months
ended September 30, 2002 to $18.0 million for the comparable 2003 period. The
decrease in income taxes resulted from decreased pre-tax earnings, an adjustment
of $752 thousand to a reserve on deferred taxes, partially offset by an increase
in our effective tax rate.
Three Months Ended September 30, 2003
Revenues. Revenues decreased 6.6% from $129.8 million for the three months ended
September 30, 2002 to $121.2 million for the comparable 2003 period. Revenues
for the services segment decreased 8.7% from $112.2 million for the three months
ended September 30, 2002 to $102.5 million for the comparable 2003 period. The
decrease is largely the result of reduction in contract service rates and
attrition due to competitive pricing pressure. Revenues for the solutions
segment increased 6.5% from $17.5 million for the three months ended September
30, 2002 to $18.7 million for the comparable 2003 period. The increase is
largely the result of stronger product sales. There were $657 thousand in
revenues between the two segments, which have been eliminated in consolidation.
14
Cost of Revenues, excluding depreciation. Cost of revenues decreased 7.7% from
$99.1 million for the three months ended September 30, 2002 to $91.4 million for
the comparable 2003 period. Cost of revenue for the services segment was $87.0
million, or 77.5% of revenue, and $79.0 million, or 77.1% of revenue, for the
three-month periods ended September 30, 2002 and September 30, 2003,
respectively. The decrease in actual costs was due to a large portion of the
costs of this segment being variable and declining as revenues declined. Cost of
revenues for the solutions segment was $12.0 million, or 68.6% of revenues, and
$12.5 million, or 66.6% of revenues, for the three-month periods ended September
30, 2002 and September 30, 2003, respectively. The increase in actual cost of
sales is the result of the higher level of revenue for the three months ended
September 30, 2003, partially offset by lower average per unit costs associated
with the sales.
Selling, general and administrative. Selling, general and administrative
expenses increased 15.1% from $6.9 million for the three months ended September
30, 2002 to $7.9 million for the comparable 2003 period. As a percentage of
revenues, selling, general and administrative expenses increased from 5.3% for
the three months ended September 30, 2002 to 6.5% for the comparable 2003
period. The increase in expenses between comparable periods is largely the
result of one-time severance payments and bonus costs related to recent
management changes.
Research and development. Research and development costs increased 17.5% from
$1.4 million for the three months ended September 30, 2002 to $1.7 million for
the comparable 2003 period. The increase is largely the result of costs
associated with development of the Careflow product acquired in March 2003.
Depreciation. Depreciation expense decreased 5.6% from $5.1 million for the
three months ended September 30, 2002 to $4.8 million for the comparable 2003
period. As a percentage of revenues, depreciation remained consistent.
Amortization of intangible assets. Amortization of intangible assets increased
from $1.8 million for the three months ended September 30, 2002 to $2.0 million
for the comparable 2003 period. The increase is attributable to the Company's
acquisitions in 2002 and 2003.
Restructuring (credits). During the three months ended September 30, 2003, we
revised our accrual estimates and $223 thousand of restructure accruals were
reversed in connection with the revision.
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 $243 thousand
and $113 thousand in a loss in investment for the periods ended September 30,
2002 and September 30, 2003, respectively. These losses were the result of
amortization of $83 thousand related to $1 million of the investment being
allocated to acquired software and the remainder related to our share of
A-Life's operating loss in both periods.
Interest income, net. We had net interest income of $261 thousand for the three
months ended September 30, 2002 and net interest income of $222 thousand for the
comparable 2003 period. The decrease was due to decreased rates of return on
liquid investments.
Income taxes. Income taxes decreased from $6.0 million for the three months
ended September 30, 2002 to $4.6 million for the comparable 2003 period. The
decrease in income taxes resulted from decreased pre-tax earnings, an adjustment
of $752 thousand to a reserve on deferred taxes, partially offset by an increase
in our effective tax rate.
15
Liquidity and Capital Resources
At September 30, 2003, we had working capital of $178.0 million,
including $143.9 million of cash and cash equivalents. During the nine months
ended September 30, 2003, our operating activities provided cash of $56.1
million and during the nine months ended September 30, 2002 our operating
activities provided cash of $58.8 million. The decrease is primarily due to a
decrease in net income and increase in inventories partially offset by a
decrease in prepaid expenses and other current assets.
During the nine months ended September 30, 2003, we used cash in
investing activities of $16.8 million, consisting of $14.0 million of capital
expenditures and $3.6 million for an acquisition, partially offset by $814
thousand in proceeds from the sale of a building. During the nine months ended
September 30, 2002, we used cash for investing activities of $61.5 million,
consisting of $12.1 million of capital expenditures, $48.5 million for
acquisitions and $892 thousand for an additional investment in A-Life Medical.
During the nine months ended September 30, 2003, net cash provided by
financing activities was $978 thousand. During the nine months ended September
30, 2002, cash provided by financing activities was $214 thousand. Cash flows
from financing activities primarily relate to the exercise of stock options and
proceeds from issuance of common stock.
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 nine months ended September 30, 2003, there have been no
items that significantly impact our commitments and contingencies and off
balance sheet arrangements as discussed in the notes to the 2002 Annual
Financial Statements as filed on Form 10-K.
New Accounting Pronouncements
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. The adoption of the consensus did not have an
impact on the 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 after January
31, 2003 and to variable interests in variable interest entities obtained after
January 31, 2003. Management does not believe the adoption of this
Interpretation will have a material impact on the Company's Consolidated
Financial Statements.
The FASB has recently issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" and SFAS No. 150, "Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." The adoption of these accounting pronouncements did not have an impact
on the Company's Consolidated Financial Statements.
16
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We generally do not use derivative financial instruments. 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 investments.
Item 4. Controls and Procedures
The Company's management, with the participation of the Company's
Principal Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures as of
September 30, 2003. Based on this evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective for gathering, analyzing and disclosing
the information the Company is required to disclose in the reports it files
under the Securities Exchange Act of 1934, within the time periods specified in
the SEC's rules and forms. Such evaluation did not identify any change in the
Company's internal control over financial reporting that occurred during the
quarter ended September 30, 2003 that materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Changes in internal controls. There have been no 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
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 grow
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; (14) risks inherent
in diversifying into other businesses; and (15) inherent uncertainties in
general relating to predicting future financial results and events. 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.
17
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
Item 6. - Exhibits and Reports on Form 8-K
a) Exhibits:
Exhibit 31.1 - Certification of the Principal Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
Exhibit 31.2 - Certification of the Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of the Principal Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Exhibit 32.2 - Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b) The Company filed the following Reports on Form 8-K
File Date Item Reported
--------- -------------
July 25, 2003 Regulation FD Disclosure in
connection with earnings release and
conference call
18
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: November 5, 2003 By: /s/ Brian J. Kearns
---------------------------------
Brian J. Kearns
Chief Financial Officer
19