UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2010

 

Commission file number 001-34435

 

EMDEON INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

(615) 932-3000

(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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

 

Emdeon Inc.

 

Table of Contents

 

 

 

Emdeon Inc.

 

Condensed Consolidated Balance Sheets

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

Emdeon Inc.

 

Condensed Consolidated Statements of Operations

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

Emdeon Inc.

 

Condensed Consolidated Statements of Equity

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

Emdeon Inc.

 

Condensed Consolidated Statements of Cash Flows

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements

(unaudited and amounts in thousands, except share and per share amounts)

 

 

Nature of Business

 

Emdeon Inc. (the “Company”), through its subsidiaries and affiliates, is a provider of revenue and payment cycle management solutions, connecting payers, providers and patients of the U.S. healthcare system. The Company’s product and service offerings integrate and automate key business and administrative functions for healthcare payers and healthcare providers throughout the patient encounter, including pre-care patient eligibility and benefits verification, clinical exchange capabilities, claims management and adjudication, payment distribution, payment posting and denial management, and patient billing and payment processing.

 

Organization

 

Prior to November 2006, the group of companies that comprised Emdeon Business Services (“EBS”) were owned by HLTH Corporation (“HLTH”). EBS Master LLC (“EBS Master”) was formed by HLTH to act as a holding company for EBS. EBS Master, through its 100% owned subsidiary, Emdeon Business Services LLC (“EBS LLC”), owns EBS.

 

In September 2006, EBS Acquisition LLC (“EBS Acquisition”) was formed as a Delaware limited liability company by affiliates of General Atlantic LLC (“General Atlantic”). On November 16, 2006, pursuant to the terms of an Amended and Restated Agreement and Plan of Merger, dated as of November 15, 2006, among HLTH and certain of its subsidiaries (including EBS Master) and EBS Acquisition and two of its subsidiaries, a subsidiary of EBS Acquisition merged into a subsidiary of HLTH. As a result of the merger, EBS Acquisition acquired a 52% interest in EBS Master, and HLTH received approximately $1.2 billion in cash and retained a 48% interest in EBS Master. The transactions through which EBS Acquisition acquired a 52% interest in EBS Master are referred to herein as the “2006 Transaction.” The 2006 Transaction was financed with $925,000 in bank debt and an equity investment of approximately $320,000 by EBS Acquisition. As the 2006 Transaction was deemed to be a highly leveraged transaction, the 2006 Transaction was accounted for in accordance with Emerging Issues Task Force Issue No. 88-16, Basis in Leveraged Buyout Transactions, and 52% of the net assets of EBS Master were stepped up to fair market value.

 

On February 8, 2008, HLTH sold its 48% noncontrolling interest in EBS Master to affiliates of General Atlantic and Hellman & Friedman LLC (“H&F”) for $575,000 in cash (the “2008 Transaction”). As a result, following the 2008 Transaction, EBS Master was owned 65.77% by affiliates of General Atlantic (including EBS Acquisition) and 34.23% by affiliates of H&F.

 

In September 2008, EBS Acquisition was converted into a Delaware corporation and its name was changed to Emdeon Inc.

 

Reorganization

 

On August 5, 2009 the Company completed a restructuring (collectively, the “reorganization transactions”) in anticipation of completing an initial public offering.

 

Prior to the reorganization transactions, the Company owned a 52% interest in EBS Master and affiliates of General Atlantic and H&F owned the remaining 48% interest in EBS Master. The Company did not engage in any business or other activities except in connection with its investment in EBS Master and the reorganization

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

transactions, and had nominal assets other than its interest in EBS Master. In the reorganization transactions, the Company became the sole managing member of EBS Master and acquired additional interests in EBS Master.

 

Prior to the reorganization transactions, the Company was authorized to issue a single class of common stock. In connection with the reorganization transactions, the Company amended and restated its certificate of incorporation and is currently authorized to issue two classes of common stock: Class A common stock and Class B common stock.

 

This reorganization and the changes to the capital structure are reflected in all periods presented.

 

Effective August 11, 2009, the Company priced its initial public offering of Class A common stock (the “IPO”).

 

 

Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of results for the unaudited interim periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. The results of operations for the interim period are not necessarily indicative of the results to be obtained for the full fiscal year. All material intercompany accounts and transactions have been eliminated in the unaudited condensed consolidated financial statements.

 

Reclassifications

 

Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.

 

Recent Accounting Pronouncements

 

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2009-13, an update to FASB ASC Revenue Recognition Topic, which amends existing accounting standards for revenue recognition for multiple-element arrangements. To the extent a deliverable within a multiple-element arrangement is not accounted for pursuant to other accounting standards, the update establishes a selling price hierarchy that allows for the use of an estimated selling price to determine the allocation of arrangement consideration to a deliverable in a multiple element arrangement where neither vendor-specific objective evidence nor third-party evidence is available for that deliverable. The update is to be applied prospectively for revenue arrangements entered into or materially modified after January 1, 2011 in the case of the Company. The Company is currently evaluating the impact, if any that the pending adoption of the update will have on the Company’s consolidated financial statements.

 

On January 1, 2010, the Company adopted the clarification and additional disclosure provisions of FASB Accounting Standards Update No. 2010-06, an update to FASB ASC Fair Value Measurements and Disclosures

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

Topic. This update clarifies that companies must provide fair value measurement disclosures for each class of assets and liabilities and expands the requirements to include disclosure of amounts and reasons for transfers among different levels within the fair value hierarchy and information within a reconciliation about purchases, sales, issuances and settlements on a gross basis. The adoption of the clarification and additional disclosure provisions of this update had no material impact on the Company’s consolidated financial statements for the quarter ended March 31, 2010. The disclosures required by this update are presented within Note 8 to the unaudited condensed consolidated financial statements. The remaining provisions become effective in the fiscal period beginning after December 31, 2010 (January 1, 2011 in the case of the Company). The Company is currently evaluating the impact, if any, that the pending adoption of the remaining provisions of the update will have on the Company’s disclosures in its consolidated financial statements.

 

 

The Company’s revenue is primarily generated in the United States. Changes in economic conditions, government regulations or demographic trends, among other matters, in the United States could adversely affect the Company’s revenue and results of operations.

 

The Company maintains its cash and cash equivalent balances in either insured depository accounts or money market mutual funds. The money market mutual funds are limited to investments in low-risk securities such as U.S. or government agency obligations, or repurchase agreements secured by such securities.

 

 

2009 Acquisitions

 

Sentinel Group Acquisition

 

On June 5, 2009, the Company acquired substantially all of the assets of The Sentinel Group from Optimal Business Services, Inc., a subsidiary of Trustmark Mutual Holding Company, for $3,067 in cash (which was funded with cash on hand). The Sentinel Group is a provider of payment integrity solutions.

 

eRx Acquisition

 

On July 2, 2009, the Company acquired all of the voting equity interests of eRx Network, L.L.C. (“eRx”). eRx is a provider of electronic pharmacy healthcare solutions. The Company valued the total consideration transferred for the eRx acquisition at approximately $100,707, which consisted of approximately $74,575 in cash, 1,850,000 EBS Units issued to certain members of eRx, valued at $13.92 per unit or approximately $25,754 in the aggregate, and a working capital settlement of approximately $378.

 

2010 Acquisitions

 

FVTech Acquisition

 

On January 26, 2010, the Company acquired all of the voting interest of FutureVision Investment Group, L.L.C. and substantially all of the assets of two related companies, FVTech, Inc. and FVTech Arizona, Inc. (collectively, “FVTech”). FVTech is a provider of outsourced services specializing in electronic data conversion and

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

information management solutions. This acquisition will allow the Company the ability to electronically process virtually all patient and third party healthcare payments regardless of the format in which payments are submitted.

 

The Company has preliminarily valued the total consideration transferred at $34,973, which consisted of $20,005 cash at closing, estimated contingent consideration of $14,910 and an estimated working capital settlement of $58. The contingent consideration arrangement requires the Company to pay additional consideration ranging from $0 to $40,000 based upon the financial performance of the acquired business for the two and three year periods following the acquisition. The Company has preliminarily valued the contingent consideration at the acquisition date, using a probability-weighted discounted cash flow model, at $14,910. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The key assumptions in applying the income approach are as follows: 11.6% discount rate and a probability adjusted FVTech performance measure during the earnout period of between approximately $1,500 and $27,000. As of March 31, 2010, there were no significant changes in the range of outcomes for the contingent consideration recognized as a result of the acquisition of FVTech, although the recognized amount increased to $15,200 as a result of the passage of time and the resulting reduced impact of discounting.

 

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. The preliminary values of the assets acquired and liabilities assumed (and resulting provisional goodwill) are subject to change based on the outcome of a working capital settlement (expected to occur later in 2010).

 

 

As of the acquisition date, FVTech had gross contractual accounts receivable of $1,774, of which approximately $44 is not expected to be collected.

 

The provisional goodwill recorded in the FVTech acquisition was assigned to the Company’s payer services and provider services segments based on revenue effects the acquisition is expected to have on each respective segment. The provisional goodwill recognized is attributable to expected synergies and the assembled workforce of FVTech. All of the goodwill attributable to the FVTech acquisition is expected to be deductible for income tax purposes.

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

As a result of the integration of the operations of FVTech into the Company’s operations, disclosure of revenue and earnings included in the accompanying statement of operations since the acquisition date is not practical.

 

Healthcare Technology Management Services Acquisition

 

On March 24, 2010 the Company acquired Healthcare Technology Management Services, Inc. (“HTMS”), a management consulting company focused primarily on the healthcare payer market. This acquisition will allow the Company to assist payers in evaluating their existing technology strategies, systems and technologies in order to help its customers implement effective solutions. Under the terms of the purchase agreement, the purchase price consisted of $8,500 (before the payment of HTMS obligations by the Company at closing of $659), Class A common stock valued under the terms of the purchase agreement at $2,500 and contingent payments of $0 to $14,000.

 

The Company has preliminarily valued the total consideration transferred at $19,859, which consisted of (i) $7,841 in cash and 152,532 shares of Class A common stock (fair value of $2,532) paid at closing, (ii) estimated contingent consideration of $9,060 and (iii) an estimated working capital settlement of $426. The contingent consideration arrangement requires the Company to pay, to the extent a financial performance target is achieved, additional specified amounts in cash related to each of the calendar years 2010, 2011 and 2012. The Company has preliminarily valued the contingent consideration at the acquisition date, using a probability-weighted discounted cash flow model, at $9,060. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The key assumptions in applying the income approach are as follows: 20.5% discount rate and a probability of achieving the specified financial target of 80%, 90%, and 90% for each of the calendar years 2010, 2011 and 2012, respectively. As of March 31, 2010, there were no significant changes in the range of outcomes for the contingent consideration recognized as a result of the acquisition of HTMS.

 

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. The preliminary values of the assets acquired and liabilities assumed (and resulting provisional goodwill) are subject to change based on the outcome of a working capital settlement (expected to occur later in 2010) and receipt of a final third party valuation of certain tangible and intangible assets.

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

As of the acquisition date, HTMS had gross contractual accounts receivable of $3,286, of which approximately $45 is not expected to be collected.

 

The provisional goodwill recorded in the HTMS acquisition was assigned to the Company’s payer services segment. The provisional goodwill recognized is attributable to expected synergies and the assembled workforce of HTMS. The Company has not yet determined the amount of goodwill that will be deductible for income tax purposes.

 

The Company has not separately disclosed revenue and net income recognized in its accompanying unaudited condensed consolidated statement of operations related to the HTMS acquisition as the impact to the operations of the Company was insignificant for the period due to the timing of the acquisition.

 

 

Goodwill activity during the three months ended March 31, 2010 was as follows:

 

 

Intangible assets subject to amortization as of March 31, 2010 consist of the following:

 

 

Amortization expense was $16,408 and $15,206 for the three months ended March 31, 2010 and 2009, respectively. Aggregate future amortization expense for intangible assets is estimated to be:

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

 

Long-term debt consists of the following:

 

 

In November 2006, EBS LLC entered into two credit agreements with several lenders that provided a $755,000 term loan (“First Lien Term Loan”), a $50,000 revolving credit agreement (“Revolver”) and a $170,000 term loan (“Second Lien Term Loan”). In connection with these credit agreements, EBS LLC paid fees of approximately $17,900 to the lenders of which the unamortized portion is classified as a reduction of the carrying value of the credit agreements in each period. Additionally, in connection with the 2008 Transaction, 48% of the carrying value of these credit agreements was adjusted to fair value which resulted in a discount of $66,395, the unamortized portion of which has similarly been classified as a reduction of the carrying value of the credit agreements.

 

The Revolver expires November 2012 and provides for revolving loans not to exceed $50,000, of which $12,000 may be used for letters of credit in support of payment obligations of the Company. As of March 31, 2010, the Company had no borrowings outstanding, undrawn letters of credit totaling $4,250 and $45,750 available for future borrowings under the Revolver. The Company pays a quarterly commitment fee on the unused portion of the Revolver that fluctuates, based upon certain leverage ratios, between 0.375% and 0.5% per annum.

 

The First Lien Term Loan is payable in quarterly principal installments of approximately $1,800, plus accrued interest, beginning in March 2007 through September 2013, with a balloon payment of the remaining principal amount outstanding due upon maturity in November 2013. These installment payments are subject to adjustment based upon optional and mandatory prepayment activity. Mandatory prepayments of principal related to excess cash flow, as defined, and other circumstances are also required.

 

The Second Lien Term Loan is subordinate to the First Lien Term Loan and matures in May 2014.

 

The credit agreements require EBS LLC to maintain certain financial covenants, including a maximum total leverage ratio and minimum interest coverage ratio. The credit agreements also impose restrictions related to capital expenditures, investments, additional debt or liens, asset sales, transactions with affiliates and equity interests, among other items. Additionally, the credit agreements include restrictions on the payment of dividends or distributions (other

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

than to fund income tax liabilities) to or advances or loans to parties that are not party to the credit agreements. In the case of dividends, the credit agreements generally limit payments to non-loan parties (including the Company) with such limitations increasing based on achievement of certain leverage ratios. Transactions with affiliates are limited to those which are approved by a majority of the non-interested members of the EBS LLC board of directors and whose terms are no less favorable than those available to an unrelated person. Substantially all of the Company’s net assets are subject to the restrictions of these credit agreements. EBS LLC believes it was in compliance with all debt covenants at March 31, 2010. This debt is secured by substantially all of the assets of EBS LLC.

 

Obligation Under Data Sublicense Agreement

 

On October 1, 2009, the Company acquired certain additional rights to specified uses of its data from HLTH in order to broaden the Company’s ability to pursue business intelligence and data analytics solutions for payers and providers. The Company previously licensed exclusive rights to this data to HLTH pursuant to an Amended and Restated Data License Agreement in connection with the 2008 Transaction. The Company has recorded an amortizable intangible asset and a corresponding obligation related to this agreement. Additionally, the Company has an option exercisable on or before April 30, 2010, with an effective date of between April 1, 2010 and September 30, 2011 as elected by the Company, to acquire additional data rights. The Company exercised this option in April 2010 (see Note 18).

 

 

Derivative financial instruments are used to manage the Company’s interest rate exposure. The Company does not enter into financial instruments for speculative purposes. Derivative financial instruments are accounted for in accordance with FASB ASC Derivatives and Hedging Topic and are measured at fair value and recorded on the balance sheet. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings (for example, in “interest expense” when the hedged transactions are interest cash flows associated with floating-rate debt). The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in interest expense in current earnings during the period of change.

 

 

Cash Flow Hedging Relationships

 

In December 2006, the Company entered into an interest rate swap agreement, which matures in December 2011, to reduce the variability of interest payments associated with its total long-term debt. The notional amount of the swap was $354,256 and $355,200 as of March 31, 2010 and December 31, 2009, respectively. Changes in the cash flows of the interest rate swap are intended to offset the changes in cash flows attributable to fluctuations in the three month variable base rates underlying the Company’s long-term debt obligations. As of March 31, 2010,

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

$14,676 of net losses associated with the existing cash flow hedge, which have been recorded within accumulated other comprehensive income, are expected to be reclassified to interest expense within the next twelve months.

 

The 2008 Transaction represented a redesignation event. As the Company’s interest rate swap did not meet all the criteria for hedge accounting at that time, changes in the fair value subsequent to the 2008 Transaction but prior to its redesignation as a cash flow hedge on September 30, 2008 were recorded within interest expense during the period from February 8, 2008 to September 30, 2008. Additionally, the amortization of the amounts reflected in other comprehensive income at the date of the 2008 Transaction related to the discontinued cash flow hedge are and continue to be reflected within interest expense in the unaudited condensed consolidated statement of operations. Amortization of amounts included in other comprehensive income related to the discontinued original hedge is expected to total approximately $5,400 over the next twelve months.

 

The effect of the derivative instrument on the unaudited condensed consolidated statements of operations for the three month periods ended March 31, 2010 and 2009, respectively, is summarized in the following table:

 

 

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The Company’s assets and liabilities that are measured at fair value on a recurring basis consist principally of the Company’s derivative financial instrument and contingent consideration associated with business combinations. The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

The valuation of the Company’s derivative financial instrument is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair value of the interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

 

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

 

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and by its counterparties. However, as of March 31, 2010, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

 

The valuation of the Company’s contingent consideration obligations is determined using a probability weighted discounted cash flow method. This analysis reflects the contractual terms of the purchase agreements (e.g. minimum and maximum payments, length of earn-out periods, manner of calculating any amounts due, etc.) and utilizes assumptions with regard to future cash flows, probabilities of achieving such future cash flows and a discount rate.

 

The table below presents a reconciliation of the fair value of our liabilities that use significant unobservable inputs (Level 3).

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

Assets and Liabilities Measured at Fair Value upon Initial Recognition

 

The carrying amount and the estimated fair value of financial instruments held by the Company as of March 31, 2010 were:

 

 

The carrying amounts of cash equivalents and accounts receivable approximate fair value because of their short-term maturities. The fair value of long-term debt is based upon market trades by investors in partial interests of these instruments.

 

 

In the normal course of business, the Company is involved in various claims and legal proceedings. While the ultimate resolution of these matters has yet to be determined, the Company does not believe that their outcomes will have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.

 

 

Common Stock

 

Under the Company’s amended and restated certificate of incorporation, the Company is authorized to issue 400,000,000 shares of Class A common stock and 52,000,000 shares of Class B common stock, each with a par value of $0.00001. The Class A common stock and Class B common stock each provide holders with one vote on all matters submitted to a vote of stockholders; however, the holders of Class B common stock do not have any of the economic rights (including rights to dividends and distributions upon liquidation) provided to the holders of the Class A common stock. Shares of Class B common stock, together with the corresponding EBS Units, may be exchanged with the Company for shares of Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. All shares of Class A common stock and Class B common stock generally vote together, as a single class, on all matters submitted to a vote of the Company’s stockholders.

 

Preferred Stock

 

Under the Company’s amended and restated certificate of incorporation, the Company is authorized to issue 25,000,000 shares of preferred stock, with a par value of $0.00001 per share.

 

Initial Public Offering

 

On August 11, 2009, the Company priced the IPO of its Class A common stock pursuant to a Registration Statement on Form S-1 (File No. 333-153451), as amended, and Registration Statement on Form S-1MEF (File No. 333-161270) (collectively, the “Registration Statements”) filed with the Securities and Exchange Commission. In the IPO, an aggregate of 27,255,000 shares of Class A common stock, consisting of 10,725,000 Class A shares registered on behalf of the Company and 16,530,000 Class A shares registered on behalf of selling stockholders

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

(including 3,555,000 Class A shares representing an over-allotment option granted by the selling stockholders to the underwriters in the IPO) were offered and sold to the public at a price per share of $15.50. The IPO closed on August 17, 2009, and the Company raised a total of approximately $166,238 in gross proceeds from the IPO, or $144,915 in net proceeds after deducting underwriting commissions and other associated costs (including approximately $3,100 of offering expenses paid in 2008).

 

Noncontrolling Interests

 

The Company has executed transactions that both increased and decreased its ownership interest in EBS Master. These changes are summarized in the following table:

 

 

 

During the three months ended March 31, 2010, the Company issued 264,450 restricted Class A common stock units and 1,362,200 options to purchase Class A common stock to certain of the Company’s employees with an aggregate grant date fair value of $14,836. These restricted Class A common stock units and options to purchase Class A common stock generally vest ratably over a four-year vesting period.

 

During the three months ended March 31, 2010 and 2009, the Company recognized equity-based compensation expense of $3,675 and $2,576, respectively.

 

 

Income taxes for the three months ended March 31, 2010 and 2009 amounted to an expense of $10,630 and $7,602, respectively. The Company’s effective tax rate was 71.4% for the three months ended March 31, 2010 compared with 69.8% during the same period in 2009. The Company’s effective tax rate is affected by deferred tax

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

expense resulting from differences between the book and income tax basis of its investment in EBS Master, as well by changes in the Company’s valuation allowances. The Company has recorded a valuation allowance against $295,756 of state net operating losses and $7,931 of capital losses as of March 31, 2010. Changes in these valuation allowance resulted in $4,363 of additional income tax expense for the three months ended March 31, 2010.

 

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

 

The Company increased its liability for uncertain tax positions by $668 during the three months ended March 31, 2010 which was primarily related to state net operating losses (recorded as an adjustment to the valuation allowance), that if recognized, would affect the effective income tax rate.

 

The Company does not currently anticipate that the total amount of unrecognized tax positions will significantly increase or decrease in the next twelve months.

 

The Company recognizes interest income and expense (if any) related to income taxes as a component of income tax expense.

 

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company’s U.S. federal and state income tax returns for the tax years 2006 and beyond remain subject to examination by the Internal Revenue Service. With respect to state and local jurisdictions and countries outside of the United States, the Company and its subsidiaries are typically subject to examination for a number of years after the income tax returns have been filed. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, interest and penalties have been provided for in the accompanying unaudited condensed consolidated financial statements for any adjustments that may be incurred due to state, local or foreign audits.

 

 

In connection with the IPO, the Company entered into tax receivable agreements which obligate the Company to make payments to certain parties affiliated with General Atlantic, H&F and former EBS Master Grant Unit holders generally equal to 85% of the applicable cash savings that the Company realizes as a result of tax attributes arising from the 2006 Transaction, the 2008 Transaction and the former EBS Master Grant Unit holders’ exchange of EBS Units for cash or shares of Class A common stock. The Company will retain the benefit of the remaining 15% of these tax savings.

 

All future exchanges of EBS Units for cash or shares of Class A common stock related to the affiliates of General Atlantic, H&F and the former EBS Master Grant Unit holders who are parties to the tax receivable agreements are expected to result in an additional tax receivable obligation for the Company with a corresponding offset to the Company’s additional paid in capital account. Subsequent adjustments of the tax receivable obligations due to certain events (e.g. realization of net operating losses, tax rate changes or the timing of cash settlement obligations) are expected to result in a corresponding adjustment of the Company’s net income. As a result of a

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

change in the Company’s income tax rate during the period, the Company recognized a change in estimate related to this obligation of approximately $1,480 (increase to pretax income) for the three months ended March 31, 2010.

 

 

The following tables sets forth the computation of basic and diluted net income per share of Class A common stock:

 

 

Due to their antidilutive effect, the following securities have been excluded from diluted net income per share for the respective periods:

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

 

During 2009, the Company ceased use of certain properties in Jessup, Maryland and Largo, Florida. During 2008, the Company ceased use of property subject to operating leases in Nashville, Tennessee and Scottsdale, Arizona.

 

The following table summarizes the activity related to these contract termination costs for three months ended March 31, 2010:

 

 

The estimate of the original loss, as well as all subsequent amortization associated with the abandonment of these operating leases, is classified within sales, general and administrative expense in the accompanying unaudited condensed consolidated statement of operations. As of March 31, 2010, the Company had incurred cumulative costs associated with the abandonment of these operating leases of $4,646.

 

 

Management views the Company’s operating results in three reportable segments: (a) payer services, (b) provider services and (c) pharmacy services. Listed below are the results of operations for each of the reportable segments. This information is reflected in the manner utilized by management to make operating decisions, assess performance and allocate resources. Segment assets are not presented to management for purposes of operational decision making, and therefore are not included in the accompanying tables. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the notes to the Company’s 2009 audited consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2009.

 

Payer Services Segment

 

The payer services segment provides claims management and payment distribution products and services to healthcare payers, both directly and through the Company’s channel partners, that simplify the administration of healthcare related to insurance eligibility and benefit verification, claims filing, payment integrity and claims and payment distribution. Additionally, the payer services segment provides management consulting services primarily to healthcare payers.

 

Provider Services Segment

 

The provider services segment provides revenue cycle management solutions, patient billing and payment services and clinical exchange capabilities to healthcare providers, both directly and through the Company’s channel partners, that simplify the providers’ revenue cycle, reduce related costs and improve cash flow.

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

Pharmacy Services Segment

 

The pharmacy services segment provides electronic prescribing services and other electronic solutions to pharmacies, pharmacy benefit management companies and government agencies related to prescription benefit claim filing, adjudication and management.

 

Other

 

Inter-segment revenue and expenses primarily represent claims management and patient statement services provided between segments.

 

Corporate and eliminations includes personnel and other costs associated with the Company’s management, administrative and other corporate services functions and eliminations to remove inter-segment revenues and expenses.

 

The revenue and total segment contribution for the reportable segments are as follows:

 

For the Three Months Ended March 31, 2010

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

For the Three Months Ended March 31, 2009

 

 

 

The following is a summary of the accumulated other comprehensive (loss) income balances, net of taxes and noncontrolling interest, as of and for the three months ended March 31, 2010.

 

Emdeon Inc.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

(unaudited and amounts in thousands, except share and per share amounts)

 

 

In April 2010, the Company exercised its option (with a specified effective date of May 1, 2010) to acquire certain additional rights to specified uses of its data from HLTH. The Company expects to record an additional amortizable intangible asset with an estimated life of approximately eight years and an obligation of approximately $6,300 based on the present value of the scheduled annual payments through 2018.

 

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and the accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q (“Quarterly Report”), together with the risk factors contained in the section titled “Risk Factors” Part II, Item 1A of this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2009 (“Form 10-K”) on file with the Securities and Exchange Commission (the “SEC”).

 

Unless stated otherwise or the context otherwise requires, references in this Quarterly Report to “we,” “us,” “our,” “Emdeon” and the “Company” refer to Emdeon Inc. and its subsidiaries.

 

Forward-Looking Statements

 

This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on those statements because they are subject to numerous uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Forward-looking statements include information concerning our possible or assumed future results of operations, including descriptions of our business strategy. These statements often include words such as “may,” “will,” “should,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or similar expressions. These statements are based upon assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read this Quarterly Report, you should understand that these statements are not guarantees of performance or results. They involve known and unknown risks, uncertainties and assumptions. Although we believe that these forward-looking statements are based upon reasonable assumptions, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those in the forward-looking statements. For further information about these and other factors that could affect our future results, please see the risk factors contained in the section titled “Risk Factors” Part II, Item 1A of this Quarterly Report and in our Form 10-K.

 

Our forward looking statements made herein speak only as of the date on which made. We expressly disclaim any intent, obligation or undertaking to update or revise any forward-looking statements made herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report.

 

Overview

 

We are a leading provider of revenue and payment cycle management solutions, connecting payers, providers and patients in the U.S. healthcare system. Our product and service offerings integrate and automate key business and administrative functions of our payer and provider customers throughout the patient encounter, including pre-care patient eligibility and benefits verification, clinical exchange capabilities, claims management and adjudication, payment integrity, payment distribution, payment posting and denial management, patient billing and payment processing. Our customers are able to improve efficiency, reduce costs, increase cash flow and more efficiently manage the complex revenue and payment cycle process by using our comprehensive suite of products and services.

 

We deliver our solutions and operate our business in three business segments: (i) payer services, which provides solutions to commercial insurance companies, third party administrators and governmental payers; (ii) provider services, which provides services to hospitals, physicians, dentists and other healthcare providers, such as labs and home healthcare providers; and (iii) pharmacy services, which provides services to pharmacies, pharmacy benefit

management companies and other payers. Through our payer services segment, we provide payment cycle solutions, both directly and through our network of companies with which we have contracted, including healthcare information system vendors, such as physician practice management system, hospital information system, payer administration system and electronic medical record vendors (“channel partners”), to market and sell some of our products and services that simplify the administration of healthcare related to insurance eligibility and benefit verification, claims filing, payment integrity and claims and payment distribution. Additionally, we provide management consulting services through our payer services segment. Through our provider services segment, we provide revenue cycle management solutions, patient billing and payment services and clinical exchange capabilities, both directly and through our channel partners, that simplify providers’ revenue cycle, reduce related costs and improve cash flow. Through our pharmacy services segment, we provide electronic prescribing services and other electronic solutions to pharmacies, pharmacy benefit management companies and government agencies related to prescription benefit claim filing, adjudication and management.

 

There are a number of company-specific initiatives and industry trends that may affect our transaction volumes, revenues, cost of operations and margins. As part of our strategy, we encourage our customers to migrate from paper-based claim, patient statement, payment and other transaction processing to electronic, automated processing in order to improve efficiency. Our business is aligned with our customers to support this transition, and as they migrate from paper-based transaction processing to electronic processing, even though our revenues for an applicable customer generally will decline, our margins and profitability will typically increase. For example, because the cost of postage is included in our revenues for patient statement and payment distribution services (which is then also deducted as a cost of operations), when our customers transition to electronic processing, our revenues and costs of operations are expected to decrease as we will no longer incur or be required to charge for postage. As another example, as our payer customers migrate to exclusive eligibility and benefits verification and/or claims management services agreements with us, which we refer to as Managed Gateway Agreements (“MGAs”), our electronic transaction volume usually increases while the rebates we pay and the per transaction rate we charge under these agreements is typically reduced.

 

Part of our strategy also includes the development and introduction of new products and services. Our new and updated products and services are likely to require us to incur development and engineering expenditures at levels similar to, and possibly greater than, recent years’ expenditures in order to successfully develop and achieve market acceptance of such products and services. We also may acquire, or enter into agreements with third parties to assist us in providing, new products and services. For example, we offer, or plan to offer, our electronic payment solutions through banks or vendors who contract with banks and other financial service firms. The costs of these initiatives or the failure to achieve broad penetration in target markets with respect to new or updated products and services may negatively affect our results of operations and margins.

 

In addition to our internal development efforts, we actively evaluate opportunities to improve and expand our solutions through strategic acquisitions. Our acquisition strategy focuses on identifying acquisitions that improve and streamline the healthcare revenue and payment cycle. We believe our broad customer footprint allows us to deploy acquired products and services into our installed base, which, in turn, can help to accelerate growth of our acquired businesses. We also believe our management team’s ability to identify acquisition opportunities that are complementary and synergistic to our business and to integrate them into our existing operations with minimal disruption, will continue to play an important role in the expansion of our business and in our growth. Our success in acquiring and integrating acquired businesses into our existing operations, the associated costs of such acquisitions, including integration costs, and the operating characteristics of the acquired businesses also may impact our results of operations and margins.

 

We also expect to continue to be affected by general economic, regulatory and demographic factors affecting the health care industry. For several years, there has been pricing pressure in our industry, which has led (and is expected to continue to lead) to reduced prices for the same services. We have sought in the past and will continue to seek to mitigate pricing pressure by (i) providing additional value-added products and services, (ii) increasing the

volume of services we provide and (iii) managing our costs. In addition, significant changes in regulatory schemes, such as the updated Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) Version 5010 standard electronic transaction code set requirements for ICD-10, American Recovery and Reinvestment Act of 2009 (“ARRA”), Patient Protection and Affordable Care Act (as amended by the Health Care and Education Reconciliation Act of 2010) (the “PPACA”) and other federal healthcare policy initiatives could impact our customers’ healthcare activities. Demographic trends affecting the healthcare industry, such as population growth and aging or higher unemployment rates as a result of the recent economic downturn, also could affect the frequency and nature of our customers’ healthcare transactional activity. The impact of such changes could impact our revenues, cost of operations and infrastructure expenses and thereby affect our results of operations and the way we operate our business. For example, an increase in the U.S. population, if such increase is accompanied by an increase in the U.S. population that has health benefits, or the aging of the U.S. population, which requires an overall increased need for healthcare services, may result in an increase in our transaction volumes which, in turn, may increase our revenues and costs of operations. Alternatively, a general economic downturn which reduces the number of discretionary health procedures by patients or a persistent high unemployment rate, if such unemployment rate is accompanied by a decrease in the U.S. population that has health benefits, may result in a decrease in our transaction volumes, which, in turn, may decrease our revenues and cost of operations.

 

In March 2010, the President signed PPACA into law. PPACA will change how healthcare services are covered, delivered and reimbursed through expanded coverage of uninsured individuals, reduced Medicare program spending and insurance market reforms. By January 2014, PPACA requires states to expand Medicaid coverage significantly, requires states to establish health insurance exchanges to facilitate the purchase of health insurance by individuals and small employers and provides subsidies to states to create non-Medicaid plans for certain low-income residents. Effective in 2014, PPACA imposes penalties on individuals who do not obtain health insurance and employers that do not provide health insurance to their employees. PPACA also sets forth several health insurance market reforms, including increased dependent coverage, prohibitions on excluding individuals based on pre-existing conditions and mandated minimum medical loss ratios for health plans. In addition, PPACA provides for significant new taxes, including an industry user tax paid by health insurance companies beginning in 2014, as well as an excise tax on health insurers and employers offering high cost health coverage plans. PPACA also imposes significant Medicare Advantage funding cuts and material reductions to Medicare and Medicaid program spending. PPACA provides for additional resources to combat healthcare fraud, waste and abuse and also requires the Department of Health & Human Services (“HHS”) to adopt standards for electronic transactions in addition to those required under HIPAA and to establish operating rules to promote uniformity in the implementation of each standardized electronic transaction.

 

In addition to federal reform, several states are considering, or may consider, legislative proposals that could affect our business or our customers. Because of the many variables involved, including PPACA’s complexity, lack of implementing regulations or interpretive guidance, gradual implementation, and possible amendment or repeal, we are unable to predict all of the ways in which PPACA could impact us. See “Risk Factors” Part II, Item 1A of this Quarterly Report. While many of the provisions of PPACA will not be directly applicable to us, PPACA will affect the business of our payer, provider and pharmacy customers and will also affect the Medicaid programs of the states with which we have contracts. Because it is too early to fully understand the impacts of the legislation on our business or on the business of our customers, we are currently unable to predict with any reasonable certainty or otherwise quantify the likely impact of PPACA on our business model, financial condition or result of operations.

 

Organizational Structure

 

The Company is a Delaware corporation. A brief history of our organizational structure is as follows:

 

 

 

Recent Developments

 

In January 2010, we acquired Future Vision Investment Group L.L.C. and the assets of two related companies (collectively, “FVTech”), a provider of outsourced services specializing in electronic data conversion and information management solutions, for consideration of $20.0 million in cash at closing, and additional contingent payments of $0.0 to $40.0 million in cash based upon the financial performance of the acquired business for the two and three year periods following the closing. This acquisition will allow us to electronically process virtually all patient and third party healthcare payments regardless of the format in which the payments are submitted.

 

In March 2010, we acquired Healthcare Technology Management Services (“HTMS”), a management consulting company focused primarily on the healthcare payer market. Under the terms of the purchase agreement, the purchase price consisted of $8.5 million (before the payment of HTMS obligations by us at closing of approximately $0.7 million), 152,532 shares of our Class A common stock and contingent payments of $0.0 to $14.0 million in cash based upon the financial performance of the acquired business for the calendar years 2010, 2011 and 2012. This acquisition will allow us to assist payers in evaluating their existing information technology strategies, systems and technologies in order to help our customers implement effective solutions.

 

In April 2010, we exercised our option (with a specified effective date of May 1, 2010) to acquire certain additional rights to specified uses of its data from HLTH. The Company expects to record an additional amortizable intangible asset with an estimated life of approximately eight years and an obligation of approximately $6.3 million based on the present value of the scheduled annual payments through 2018.

 

Our Revenues and Expenses

 

We generate virtually all of our revenue by providing products and services that automate and simplify business and administrative functions for payers and providers, generally on either a per transaction, per document, per communication or per member per month basis; or, in some cases, on a monthly flat-fee basis. For certain services, we may charge an implementation fee in conjunction with related setup and connection to our network and other systems. We also receive software license fees and software and hardware maintenance fees, primarily from payers who license our systems for converting paper claims into electronic ones, and occasionally, sell additional software

and hardware products to such payers. Additionally, we receive management consulting services fees on an hourly, and in some instances, project basis through our payer services segment.

 

Cost of operations consists primarily of costs related to products and services we provide to customers and costs associated with the operation and maintenance of our networks. These costs include (i) postage and materials costs related to our patient statement and payment distribution services, (ii) rebates paid to our channel partners and (iii) data communications costs, all of which generally vary with our revenues. Cost of operations also includes (i) personnel costs associated with production, network operations, customer support and other personnel, (ii) facilities expenses and (iii) equipment maintenance, which vary less directly with our revenue due to the fixed or semi-fixed nature of these expenses.

 

The largest component of our cost of operations is currently postage which is primarily incurred in our patient statements and payment services businesses and which is also a component of our revenue in those businesses. Our postage costs increase as our patient statement and payment distribution volumes increase and also when the U.S. Postal Service increases postal rates. U.S. postage rate increases, while generally billed as pass-through costs to our customers, affect our cost of operations as a percentage of revenue. In recent years, we have offset the impact of postage rate increases through cost reductions from efficiency measures, including data communication expense reductions and production efficiencies. Though we plan to continue our efficiency measures, we may not be able to offset the impact of postage rate increases in the future and, as a result, cost of operations as a percentage of revenue may rise if postage rate increases continue. Although the U.S. Postal Service increased postal rates annually from 2006 to 2009, such annual increases may not occur as regularly in the future. For example, in November 2009, the U.S. Postal Service announced that there would be no postal rate increase for 2010.

 

Rebates are paid to channel partners for electronic and other volumes delivered through our network to certain payers and can be impacted by the number of MGAs we execute with payers, the associated rate structure with our payer customers, the success of our direct sales efforts for provider revenue cycle management products and services and the extent to which direct connections to payers are developed by channel partners.

 

Our data communication expense consists of telecommunication and transaction processing charges. Over the last several years, we have been able to reduce our data communication expense due to efficiency measures and contract pricing changes. Due to the significance of these past reductions in recent years, further reductions may have a lesser impact in future periods.

 

Our material costs relate primarily to our patient statement and payment distribution volumes, and consist primarily of paper and printing costs.

 

Development and engineering expense consists primarily of personnel costs related to the development, management and maintenance of our current and future products and services. We plan to invest more in this area in the future as we develop new products and enhance existing products.

 

Sales, marketing, general and administrative expense (excluding corporate expense described in the next paragraph) consists primarily of personnel costs associated with our sales, account management and marketing functions and management and administrative services related to the operations of our business segments.

 

Our corporate expense relates to personnel costs associated with management, administrative, finance, human resources, legal, marketing, public relations and other corporate service functions as well as professional services, costs incurred in connection with acquisitions, certain facilities costs, advertising and promotion, insurance and other expenses related to our overall business operations. Since the IPO, we have incurred costs and we expect to incur additional costs related to operating as a public company, including additional directors’ and officers’ liability insurance, outside director compensation, additional personnel costs and Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and other compliance costs.

Our development and engineering expense, sales, marketing, general and administrative expense and our corporate expense, while related to our current operations, are also affected and influenced by our future plans (including the development of new products and services), business strategies and enhancement and maintenance of our infrastructure.

 

Significant Items Affecting Comparability

 

Certain significant items or events should be considered to better understand differences in our results of operations from period to period. We believe that the following items or events have had a significant impact on our results of operations for the periods discussed below or may have a significant impact on our results of operations in future periods:

 

Acquisitions and Divestitures

 

We actively evaluate opportunities to improve and expand our business through targeted acquisitions that are consistent with our strategy. On occasion, we also may dispose of certain components of our business that no longer fit within our overall strategy. Because of our acquisition and divestiture activity, our results of operations may not be directly comparable among periods. The following summarizes our acquisition and divestiture transactions from January 1, 2009 through March 31, 2010 and the affected segments:

 

 

 

Income Taxes

 

Our statutory federal and state income tax rate generally ranges from 38% to 40%. Several factors, however, can affect the Company’s effective tax rate for particular periods. Among these factors are the following items:

 

 

Stock-Based and Equity-Based Compensation Expense