UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

 

Form 10-Q

 

 

 

 

Commission file number: 0-24975

 

 

EMDEON CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

(201) 703-3400

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

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

 

As of November 3, 2006, there were 284,628,031 shares of

Emdeon Common Stock outstanding (including unvested shares of restricted Emdeon Common Stock).

 

 

 

EMDEON CORPORATION

 

QUARTERLY REPORT ON FORM 10-Q
For the period ended September 30, 2006

 

TABLE OF CONTENTS

 

 

WebMD^®, WebMD Health^®, CME Circle^®, dakota imaging^tm, Emdeon^tm, Emdeon Business Services^tm, eMedicine^®, Envoy^®, ExpressBill^®, Healthpayers USA^®, MedicineNet^®, Medifax^®, Medifax-EDI^®, Medpulse^®, Medscape^®, MEDPOR^®, Medsite^®, POREX^®, Publishers’ Circle^®, RxList^®, Select Quality Care^®, Summex^®, theheart.org^®, The Little Blue Book^tm and ViPS^® are trademarks of Emdeon Corporation or its subsidiaries.

 

This Quarterly Report on Form 10-Q contains both historical and forward-looking statements. All statements other than statements of historical fact are, or may be, forward-looking statements. For example, statements concerning projections, predictions, expectations, estimates or forecasts and statements that describe our objectives, future performance, plans or goals are, or may be, forward-looking statements. These forward-looking statements reflect management’s current expectations concerning future results and events and can generally be identified by the use of expressions such as “may,” “will,” “should,” “could,” “would,” “likely,” “predict,” “potential,” “continue,” “future,” “estimate,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “foresee,” and other similar words or phrases, as well as statements in the future tense.

 

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be different from any future results, performance and achievements expressed or implied by these statements. The following important risks and uncertainties could affect our future results, causing those results to differ materially from those expressed in our forward-looking statements:

 

 

These factors are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could have material adverse effects on our future results.

 

The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. Except as required by law or regulation, we do not undertake any obligation to update any forward-looking statements to reflect subsequent events or circumstances.

PART I

FINANCIAL INFORMATION

 

EMDEON CORPORATION

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data, unaudited)

 

 

See accompanying notes.

EMDEON CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)

 

 

See accompanying notes.

EMDEON CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)

 

 

See accompanying notes.

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data, unaudited)

 

 

Background

 

Emdeon Corporation (“Emdeon” or the “Company”) is a Delaware corporation that was incorporated in December 1995 and commenced operations in January 1996 as Healtheon Corporation. Emdeon’s Common Stock began trading on the Nasdaq National Market under the symbol “HLTH” on February 11, 1999 and now trades on the Nasdaq Global Select Market. The Company changed its name to Healtheon/WebMD Corporation in November 1999 and to WebMD Corporation in September 2000. In October 2005, WebMD Corporation changed its name to Emdeon Corporation in connection with the initial public offering of equity securities of WebMD Health Corp. (“WHC”), a subsidiary that the Company formed to act as a holding company for the business of the Company’s WebMD segment (described below) and to issue shares in that initial public offering. Because the WebMD name had been more closely associated with the Company’s public and private online portals than with its other businesses, the Company’s Board of Directors determined that WHC would, following its initial public offering, have the sole right to use the WebMD name and related trademarks.

 

WHC’s Class A Common Stock began trading on the Nasdaq National Market under the symbol “WBMD” on September 29, 2005 and now trades on the Nasdaq Global Select Market. As of September 30, 2006, the Company owned 48,100,000 shares of WHC Class B Common Stock, which represents 85.6% of all outstanding WHC’s Class A and Class B Common Stock. WHC Class A Common Stock has one vote per share, while WHC Class B Common Stock has five votes per share. As a result, the WHC Class B Common Stock owned by the Company represented, as of September 30, 2006, 96.6% of the combined voting power of WHC’s outstanding Common Stock.

 

Basis of Presentation

 

The accompanying consolidated financial statements include the consolidated accounts of Emdeon and its subsidiaries and have been prepared in United States dollars, and in accordance with U.S. generally accepted accounting principles (“GAAP”). The consolidated accounts include 100% of the assets and liabilities of the majority owned WHC and the ownership interests of minority stockholders of WHC are recorded as Minority interest in WebMD Health Corp. in the accompanying consolidated balance sheets.

 

On September 14, 2006, the Company completed the sale of its Emdeon Practice Services segment (“EPS”). Accordingly, the historical results of EPS, including the gain related to the sale, have been reclassified as discontinued operations in the accompanying unaudited consolidated financial statements. See Note 2 for a further description of this transaction.

 

On September 26, 2006, the Company entered into a definitive agreement for the sale of a 52% interest in its Emdeon Business Services segment, excluding the ViPS business unit (“EBS”). Accordingly, the underlying assets and liabilities of EBS as of September 30, 2006 have been reclassified as assets held for sale and liabilities held for sale in the accompanying consolidated balance sheets. See Note 3 for a further description of this transaction.

 

Interim Financial Statements

 

The unaudited consolidated financial statements of the Company have been prepared by management and reflect all adjustments (consisting of only normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for any subsequent period or for the entire year ending December 31, 2006. Certain information and footnote

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under the Securities and Exchange Commission’s (the “SEC”) rules and regulations.

 

The unaudited consolidated financial statements and notes included herein should be read in conjunction with the Company’s audited consolidated financial statements and notes for the year ended December 31, 2005, which are included in the Company’s Annual Report on Form 10-K filed with the SEC.

 

Accounting Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company bases its estimates on historical experience, current business factors, and various other assumptions that the Company believes are necessary to consider in order to form a basis for making judgments about the carrying values of assets and liabilities, the recorded amounts of revenue and expenses, and disclosure of contingent assets and liabilities. The Company is subject to uncertainties such as the impact of future events, economic, environmental and political factors, and changes in the Company’s business environment; therefore, actual results could differ from these estimates. Accordingly, the accounting estimates used in the preparation of the Company’s financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. Changes in estimates are made when circumstances warrant. Such changes in estimates and refinements in estimation methodologies are reflected in reported results of operations; if material, the effects of changes in estimates are disclosed in the notes to the consolidated financial statements. Significant estimates and assumptions by management affect: the allowance for doubtful accounts, the carrying value of inventory, the carrying value of prepaid advertising services, the carrying value of long-lived assets (including goodwill and intangible assets), the amortization and depreciation period of long-lived assets (excluding goodwill), the carrying value, capitalization and amortization of software development costs, the carrying value of short-term and long-term investments, the provision for income taxes and related deferred tax accounts, certain accrued expenses, revenue recognition, contingencies, litigation and the value attributed to employee stock options and other stock-based awards.

 

Minority Interest

 

Minority interest represents the minority stockholders’ proportionate share of equity and net income or net loss of the Company’s consolidated WebMD segment. Additionally, minority interest includes the stock-based compensation expense related to stock options and other stock awards based on WHC Class A Common Stock that have been expensed since the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123, “(Revised 2004): Share-Based Payment” on January 1, 2006, and to a much lesser extent, the expense associated with these awards that were expensed in connection with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) prior to January 1, 2006. As of September 30, 2006 and December 31, 2005, the minority stockholders’ proportionate share of the equity in WHC of $60,413 and $43,229, respectively, are reflected as Minority interest in WebMD Health Corp. in the accompanying consolidated balance sheets. The minority stockholders’ proportionate share of net income or loss for the three and nine months ended September 30, 2006 was income of $140 and a loss of $653, respectively, and income of $38 for the three and nine months ended September 30, 2005.

 

Net Income Per Common Share

 

Basic income per common share and diluted income per common share are presented in conformity with SFAS No. 128, “Earnings Per Share” (“SFAS 128”). In accordance with SFAS 128, basic income per common share has been computed using the weighted-average number of shares of common stock outstanding during the period, increased to give effect to the participating rights of the convertible redeemable exchangeable

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

preferred stock. Diluted income per common share has been computed using the weighted-average number of shares of common stock outstanding during the period, increased to give effect to potentially dilutive securities. Additionally, for purposes of calculating diluted income per common share of the Company, the numerator has been adjusted to consider the effect of potentially dilutive securities of WHC, which can dilute the portion of WHC’s net income otherwise retained by the Company. The impact of WHC’s potentially dilutive securities on the calculation of diluted income per common share was not material. The following table presents the calculation of basic and diluted income per common share (shares in thousands):

 

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company has excluded convertible notes, as well as certain outstanding warrants and stock options, from the calculation of diluted income per common share because such securities were anti-dilutive during the periods presented. The following table presents the total number of shares that could potentially dilute basic income per common share in the future that were not included in the computation of diluted income per common share during the periods presented (shares in thousands):

 

 

Revenue

 

Products and Services

 

The Company’s revenue consists of product and service revenue. Service revenue is comprised of revenue earned through the Company’s automated business and administrative functions for healthcare payers and providers, and consulting services to governmental agencies and commercial enterprises, and content sponsorship, advertising and licensing of the Company’s private and public online portals. The Company’s product revenue is primarily comprised of porous plastic products and components used in healthcare, industrial and consumer applications which are sold through its Porex segment. Additionally, product revenues include other miscellaneous products, such as, medical forms and supplies, medical reference publications and directories, as well as other miscellaneous software products.

 

Sales, Use and Value Added Tax

 

The Company excludes sales, use and value added tax from revenue in the consolidated statements of operations.

 

Advisory Expense

 

Advisory expense includes professional fees, primarily consisting of legal, accounting and financial advisory services, related to the pending sale transaction involving EBS.

 

Assets and Liabilities Held for Sale

 

When specific actions to dispose of assets and liabilities progress to the point that the plan of sale criteria included in Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” have been met, impairments to the extent they exist, are recognized and the underlying assets and liabilities are reflected as Assets Held for Sale and Liabilities Held for Sale, respectively, in the accompanying consolidated balance sheets. There was no impairment charge recorded in relation to the pending sale of the Company’s Emdeon Business Services segment.

 

Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standard Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

November 15, 2007. The Company is currently evaluating the impact, if any, that this new standard will have on the Company’s results of operations, financial position or cash flows.

 

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognizing, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact, if any, that this new standard will have on the Company’s results of operations, financial position or cash flows.

 

Reclassifications

 

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

 

 

In February 2006, the Company announced that, in connection with inquiries received from several third parties expressing an interest in acquiring EPS and EBS, the Company’s Board of Directors authorized commencing a process to evaluate strategic alternatives relating to EPS and EBS. For information regarding a pending sale transaction involving EBS, see Note 3.

 

On August 8, 2006 the Company entered into a Stock Purchase Agreement for the sale of EPS to Sage Software, Inc. (“Sage Software”), an indirect wholly owned subsidiary of The Sage Group plc. On September 14, 2006, the Company completed the sale of Emdeon Practice Services, Inc., which together with its subsidiaries comprised EPS (the “EPS Sale”). Accordingly, the historical financial information of EPS has been reclassified as discontinued operations in the accompanying unaudited consolidated financial statements. The Company received net cash proceeds of $529,466, which does not include $35,000 being held in escrow as security for the Company’s indemnification obligations under the Stock Purchase Agreement. One-third and two-thirds of the amount in escrow are scheduled to be released twelve and eighteen months from the closing date, and are included in other current assets and other assets, respectively, in the accompanying consolidated balance sheet as of September 30, 2006. The Company incurred approximately $7,700 of professional fees and other expenses associated with the EPS Sale, of which approximately $2,500 was unpaid as of September 30, 2006 and is therefore included in accrued expenses in the accompanying consolidated balance sheet as of September 30, 2006. In connection with the EPS Sale, the Company recognized a gain of $352,269, which is included in income from discontinued operations, net of tax of $34,714, in the accompanying consolidated statements of operations during the three and nine months ended September 30, 2006. While the determination of the gain on disposal is substantially complete, the purchase price is subject to customary post-closing adjustments, including an adjustment for working capital, which has not been finalized. Also included in income from discontinued operations for the three months ended September 30,

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2006 is $5,779 representing the income from operations of EPS, net of tax, through the date of sale on September 14, 2006. Summarized operating results for EPS through September 14, 2006 were as follows:

 

 

The assets and liabilities of EPS are reflected as discontinued operations as of December 31, 2005 and were comprised of the following:

 

 

In consideration of EITF 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”), the Company will continue to generate cash flows from EPS after the disposal date of September 14, 2006. The continuing cash inflows will relate to revenue recognized by EBS, which provides print-and-mail services, including postage, and electronic data interchange services to EPS’s customer base under an agreement between EBS and EPS that continues through 2013. Also through this agreement, EBS will have continuing cash outflows to EPS, to be included in cost of operations, related to its obligations to pay sales commissions related to the submission of claims. The Company believes that these continuing cash flows will not be significant in accordance with EITF 03-13. The revenue and cost of operations associated with these activities that were previously eliminated in consolidation were as follows:

 

 

The Company and Sage Software will make an IRC Section 338(h)(10) election and will treat the EPS Sale as a sale of assets for tax purposes. The Company will utilize a portion of its federal net operating loss

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(“NOL”) carryforwards to offset the gain on this transaction. Under the Company’s Tax Sharing Agreement with WHC, the Company has agreed to reimburse WHC, at the current federal statutory tax rate of 35%, for any NOL carryforwards attributable to WHC that are utilized by the Company in this transaction. The Company estimates that the amount of WHC’s NOL carryforwards to be utilized in this transaction will be approximately $240,000 to $260,000 resulting in a cash reimbursement to WHC of $84,000 to $91,000. The estimates of the amount of WHC’s NOL carryforwards to be utilized and of the related reimbursement are based on various assumptions and will not be finalized until the Company completes the calculation of its 2006 federal income taxes.

 

In connection with the EPS Sale, the Company entered into a transition services agreement whereby it will provide EPS with certain administrative services, including payroll, accounting, purchasing and procurement, tax and human resource services, as well as information technology (“IT”) support. The IT support services are scheduled to continue to September 2008, while the majority of the other services are scheduled to be completed by July 2007. Sage Software may at any time terminate any individual service prior to the scheduled end date, although they will continue to remain liable for any costs incurred by the Company due to early termination. The transition services fee charged to EPS for the period from September 15, 2006 to September 30, 2006 was $341 and is included in the Company’s Corporate segment.

 

 

On September 26, 2006, the Company entered into a definitive agreement for the sale of a 52% interest in EBS to an affiliate of General Atlantic LLC (“GA”) (the “Pending EBS Transaction”). At the closing of this transaction, the Company will receive approximately $1,200,000 in cash, subject to customary post-closing adjustments including an adjustment based on the amount of working capital at closing. The acquisition will be financed with approximately $925,000 in bank debt and an investment of approximately $320,000 by GA. The Pending EBS Transaction will be structured so that the Company and GA each own interests in a limited liability company (“Master LLC”), which will own the entities comprising EBS through a wholly owned limited liability company (“EBS LLC”). The bank debt will be an obligation of EBS LLC and will be guaranteed by Master LLC, but will not be an obligation of or guaranteed by the Company. After the closing of the Pending EBS Transaction, the Company’s 48% ownership interest in Master LLC will be reflected as an investment in the Company’s consolidated financial statements and will be accounted for under the equity method. The Company has classified the assets and liabilities of EBS as assets and liabilities held for sale in the accompanying consolidated balance sheet as of September 30, 2006.

 

The assets and liabilities of EBS as of September 30, 2006 and December 31, 2005 were comprised of the following:

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company expects to recognize a taxable gain on the Pending EBS Transaction and expects to utilize approximately $400,000 to $450,000 of its NOL carryforwards to eliminate a significant portion of the tax liability that would otherwise result from this transaction. Approximately $130,000 to $150,000 of the NOL carryforwards utilized will be NOL carryforwards attributable to WHC. Under Emdeon’s Tax Sharing Agreement with WHC, Emdeon has agreed to reimburse WHC at the current federal statutory tax rate of 35% for any NOL carryforwards attributable to WHC that are utilized by Emdeon in this transaction. The Company currently estimates that the amount of the resulting cash reimbursement to WHC will be approximately $45,000 to $52,000. The estimates of the amounts of the utilization of the NOL carryforwards attributable to WHC and to Emdeon and of the related reimbursement are based on various assumptions and will not be finalized until the Company completes the calculation of its consolidated 2006 federal income taxes.

 

 

On January 1, 2006, the Company adopted SFAS No. 123, “(Revised 2004): Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. The Company elected to use the modified prospective transition method and as a result, prior period results were not restated. Under the modified prospective transition method, awards that were granted or modified on or after January 1, 2006 are measured and accounted for in accordance with SFAS 123R. Unvested stock options and restricted stock awards that were granted prior to January 1, 2006 will continue to be accounted for in accordance with SFAS 123, using the same grant date fair value and same expense attribution method used under SFAS 123, except that all awards are recognized in the results of operations over the remaining vesting periods. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized for all stock-based compensation beginning January 1, 2006.

 

Prior to January 1, 2006, the Company accounted for stock-based employee compensation using the intrinsic value method under the recognition and measurement principles of APB 25, and related interpretations. In accordance with APB 25, the Company did not recognize stock-based compensation cost with respect to stock options granted with an exercise price equal to the market value of the underlying common stock on the date of grant. As a result, the recognition of stock-based compensation expense was generally limited to the expense related to restricted stock awards and stock option modifications, as well as the amortization of

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

deferred compensation related to certain acquisitions in 2000. Additionally, all restricted stock awards and stock options granted prior to January 1, 2006 had graded vesting, and the Company valued these awards and recognized actual and pro-forma expense, with respect to restricted stock awards and stock options, as if each vesting portion of the award was a separate award. This resulted in an accelerated attribution of compensation expense over the vesting period. As permitted under SFAS 123R, the Company began using a straight-line attribution method beginning January 1, 2006 for all stock options and restricted stock awards granted on or after January 1, 2006, but will continue to apply the accelerated attribution method for the remaining unvested portion of any awards granted prior to January 1, 2006.

 

The Company has various stock-based compensation plans (collectively, the “Plans”) under which directors, officers and other eligible employees receive awards of options to purchase Emdeon Common Stock and restricted shares of Emdeon Common Stock. Additionally, the Company’s majority owned public subsidiary has a similar stock-based compensation plan that provides for stock options and restricted stock awards based on WHC Class A Common Stock. The Company also maintains an Employee Stock Purchase Plan which provides employees with the ability to buy shares of Emdeon Common Stock at a discount. The following sections of this note summarize the activity for each of these plans.

 

Emdeon Plans

 

The Company had an aggregate of 8,142,996 shares of Emdeon Common Stock available for future grants under the Plans at September 30, 2006. In addition to the Plans, the Company has granted options to certain directors, officers and key employees pursuant to an individual stock option agreement. At September 30, 2006, there were options to purchase 5,762,700 shares of Emdeon Common Stock outstanding to these individuals. The terms of these grants are similar to the terms of the stock options granted under the Plans and accordingly, the stock option activity of these individuals is included in all references to the Plans. The Company issues new shares when stock options are exercised under the Plans.

 

Stock Options

 

Generally, options under the Plans vest and become exercisable ratably over a three to five year period based on their individual grant dates subject to continued employment on the applicable vesting dates. The majority of options granted under the Plans expire within ten years from the date of grant. Options are granted at prices not less than the fair market value of Emdeon’s Common Stock on the date of grant. The following table summarizes activity for the Plans for the nine months ended September 30, 2006:

 

 

 

 

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model and using the assumptions also noted in the following table. Expected volatility is based on

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

implied volatility from traded options of Emdeon’s Common Stock combined with historical volatility of Emdeon’s Common Stock. Prior to January 1, 2006, only historical volatility was considered. The expected term represents the period of time that options are expected to be outstanding following their grant date, and was determined using historical exercise data. The risk-free rate is based on the U.S. Treasury yield curve for periods equal to the expected term of the options on the grant date.

 

 

Restricted Stock Awards

 

Emdeon Restricted Stock consists of shares of Emdeon Common Stock which have been awarded to employees. The grants are restricted such that they are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer by the employee until they vest. Generally, Emdeon Restricted Stock awards vest ratably over a three to five year period from their individual award dates subject to continued employment on the applicable vesting dates. The following table summarizes the activity of non-vested Emdeon Restricted Stock for the nine months ended September 30, 2006:

 

 

Proceeds received from the exercise of options to purchase Emdeon Common Stock were $32,317 and $62,060 for the three and nine months ended September 30, 2006, respectively, and $10,326 and $40,940 for the three and nine months ended September 30, 2005, respectively. The intrinsic value related to the exercise of these stock options, as well as the fair value of shares of Emdeon Restricted Stock that vested was $25,460 and $44,320 for the three and nine months ended September 30, 2006, respectively, and $9,794 and $44,383 for the three and nine months ended September 30, 2005, respectively. The intrinsic value of these stock options and shares of Emdeon Restricted Stock awards is deductible for tax purposes. However, these tax benefits were not realized as the Company has NOL carryforwards.

 

WebMD Plan

 

During September 2005, WHC adopted the 2005 Long-Term Incentive Plan (the “WHC Plan”). The maximum number of shares of WHC Class A Common Stock that may be subject to options or restricted stock awards under the WHC Plan is 7,130,574, subject to adjustment in accordance with the terms of the WHC Plan. WHC had an aggregate of 1,374,722 shares of Class A Common Stock available for grant under the WHC Plan at September 30, 2006.

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock Options

 

Generally, options under the WHC Plan vest and become exercisable ratably over a four year period based on their individual grant dates subject to continued employment on the applicable vesting dates. The options granted under the WHC Plan expire within ten years from the date of grant. Options are granted at prices not less than the fair market value of WHC’s Class A Common Stock on the date of grant. The following table summarizes activity for the WHC Plan for the nine months ended September 30, 2006:

 

 

 

 

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model and using the assumptions noted in the following table. Expected volatility is based on implied volatility from traded options of stock of comparable companies combined with historical stock price volatility of comparable companies. The expected term represents the period of time that options are expected to be outstanding following their grant date, and was determined using historical exercise data of WHC employees who were previously granted Emdeon stock options. The risk-free rate is based on the U.S. Treasury yield curve for periods equal to the expected term of the options on the grant date.

 

 

Restricted Stock Awards

 

WHC Restricted Stock consists of shares of WHC Class A Common Stock which have been awarded to employees. The grants are restricted such that they are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer by the employee until they vest. Generally, WHC Restricted Stock awards vest ratably over a four year period from their individual award dates subject to continued employment

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

on the applicable vesting dates. The following table summarizes the activity of non-vested WHC Restricted Stock for the nine months ended September 30, 2006:

 

 

Proceeds received from the exercise of options to purchase WHC Class A Common Stock were $649 for the three and nine months ended September 30, 2006. The intrinsic value related to the exercise of these stock options, as well as the fair value of shares of WHC Restricted Stock that vested was $3,899 for the three and nine months ended September 30, 2006. The intrinsic value of these stock options and shares of WHC Restricted Stock awards is deductible for tax purposes. However, these tax benefits were not realized as the Company has NOL carryforwards.

 

Other

 

In addition, at the time of the WHC initial public offering and subsequently on the first anniversary, WHC issued shares of WHC Class A Common Stock to each non-employee director with a value equal to their annual board and committee retainers. The Company recorded $85 and $255 of stock-based compensation expense during the three and nine months ended September 30, 2006, respectively, in connection with these issuances.

 

Employee Stock Purchase Plan

 

The Company’s 1998 Employee Stock Purchase Plan, as amended from time to time (the “ESPP”), allows eligible employees the opportunity to purchase shares of Emdeon Common Stock through payroll deductions, up to 15% of a participant’s annual compensation with a maximum of 5,000 shares available per participant during each purchase period. The purchase price of the stock is 85% of the fair market value on the last day of each purchase period. As of September 30, 2006, a total of 7,443,058 shares of Emdeon Common Stock were reserved for issuance under the ESPP. The ESPP provides for annual increases equal to the lesser of 1,500,000 shares, 0.5% of the outstanding common shares, or a lesser amount determined by the Board of Directors. There were 167,142 and 184,074 shares issued under the ESPP during the nine months ended September 30, 2006 and 2005, respectively. No shares were issued during the three months ended September 30, 2006 and 2005.

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Summary of Stock-Based Compensation Expense

 

The following table summarizes the components and classification of stock-based compensation expense:

 

 

No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for substantially all net deferred tax assets. As of September 30, 2006, approximately $28,708 and $35,373 of unrecognized stock-based compensation expense related to unvested awards (net of estimated forfeitures) is expected to be recognized over a weighted-average period of approximately 1.39 years and 2.01 years, related to the Plans and the WHC Plan, respectively.

 

The following table summarizes pro forma net income and net income per common share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (including non-cash stock-based compensation expense related to discontinued operations) for the three and nine months ended September 30, 2005:

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

2006 Acquisitions

 

On September 11, 2006, the Company acquired, through WHC, the interactive medical education, promotion and physician recruitment businesses of Medsite, Inc. (“Medsite”). Medsite provides e-detailing services for pharmaceutical, medical device and healthcare companies, including program development, targeted recruitment and online distribution and delivery. In addition, Medsite provides educational programs to physicians. The total purchase consideration for Medsite was approximately $31,467, comprised of $30,682 in cash, net of cash acquired, and $785 of estimated acquisition costs. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the preliminary allocation of the purchase price and intangible asset valuation, goodwill of $31,758 and intangible assets subject to amortization of $10,000 were recorded. The goodwill and intangible assets recorded will be deductible for tax purposes. The intangible assets are comprised of $5,500 relating to customer relationships with estimated useful lives of three years, $3,500 relating to acquired technology with an estimated life of three years and $1,000 relating to a trade name with an estimated useful life of seven years. The results of operations of Medsite have been included in the financial statements of the Company from September 11, 2006, the closing date of the acquisition, and are included in the WebMD segment.

 

On July 18, 2006, the Company acquired Interactive Payer Network, Inc. (“IPN”), a privately held provider of healthcare electronic data interchange services. The total purchase consideration for IPN was approximately $3,907, comprised of $3,799 in cash, net of cash acquired, and $108 of estimated acquisition costs. In addition, the Company has agreed to pay up to an additional $3,000 in cash over a two-year period beginning in August 2007 if certain financial milestones are achieved. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the preliminary allocation of the purchase price, goodwill of $3,692 was recorded. The goodwill recorded will be deductible for tax purposes. The results of operations of IPN have been included in the financial statements of the Company from July 18, 2006, the closing date of the acquisition, and are included in the Emdeon Business Services segment.

 

On June 13, 2006, the Company acquired, through WHC, Summex Corporation (“Summex”), a provider of health and wellness programs that include online and offline health risk assessments, lifestyle education and personalized telephonic health coaching. The total purchase consideration for Summex was approximately $30,191, comprised of $29,691 in cash, net of cash acquired, and $500 of estimated acquisition costs. In addition, the Company has agreed to pay up to an additional $10,000 in cash over a two-year period if certain financial milestones are achieved. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the preliminary allocation of

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the purchase price and intangible asset valuation, goodwill of $21,786 and intangible assets subject to amortization of $8,500 were recorded. The goodwill and intangible assets recorded will not be deductible for tax purposes. The intangible assets are comprised of $4,000 relating to customer relationships with estimated useful lives of three years and $4,500 relating to acquired technology with an estimated useful life of five years. The results of operations of Summex have been included in the financial statements of the Company from June 13, 2006, the closing date of the acquisition, and are included in the WebMD segment.

 

On January 17, 2006, the Company acquired, through WHC, eMedicine.com, Inc. (“eMedicine”), a privately held online publisher of medical reference information for physicians and other healthcare professionals. The total purchase consideration for eMedicine was approximately $25,382, comprised of $24,682 in cash, net of cash acquired, and $700 of estimated acquisition costs. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the preliminary allocation of the purchase price and intangible asset valuation, goodwill of $18,402 and an intangible asset subject to amortization of $9,000 were recorded. The goodwill and intangible asset recorded will not be deductible for tax purposes. The intangible asset recorded was content with an estimated useful life of three years. The results of operations of eMedicine have been included in the financial statements of the Company from January 17, 2006, the closing date of the acquisition, and are included in the WebMD segment.

 

2005 Acquisitions

 

On December 2, 2005, the Company acquired, through WHC, the assets of and assumed certain liabilities of Conceptis Technologies, Inc. (“Conceptis”), a privately held Montreal-based provider of online and offline medical education and promotion aimed at physicians and other healthcare professionals. The total purchase consideration for Conceptis was approximately $19,859, comprised of $19,256 in cash and $603 of estimated acquisition costs. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the preliminary allocation of the purchase price and intangible asset valuation, goodwill of $14,717 and intangible assets subject to amortization of $6,140 were recorded. The goodwill and intangible assets recorded will be deductible for tax purposes. The intangible assets recorded were $1,900 relating to content with an estimated useful life of two years, $3,300 relating to acquired technology with an estimated useful life of three years and $940 relating to a trade name with an estimated useful life of ten years. The results of operations of Conceptis have been included in the financial statements of the Company from December 2, 2005, the closing date of the acquisition, and are included in the WebMD segment.

 

On March 14, 2005, the Company acquired HealthShare Technology, Inc. (“HealthShare”), a privately held company that provides online tools that compare cost and quality measures of hospitals for use by consumers, providers and health plans. The total purchase consideration for HealthShare was approximately $29,985, comprised of $29,533 in cash, net of cash acquired, and $452 of acquisition costs. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed on the basis of their respective fair values. In connection with the allocation of the purchase price, goodwill of $24,611 and intangible assets subject to amortization of $8,500 were recorded. The goodwill and intangible assets recorded will not be deductible for tax purposes. The intangible assets are comprised of $7,500 relating to customer relationships with estimated useful lives of five years and $1,000 relating to acquired technology with an estimated useful life of three years. The results of operations of HealthShare have been included in the financial statements of the Company from March 14, 2005, the closing date of the acquisition, and are included in the WebMD segment.

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Balance Sheet Data

 

The following table summarizes the tangible and intangible assets acquired, the liabilities assumed and the consideration paid for each acquisition:

 

 

Pro Forma Information

 

The following unaudited pro forma financial information for the nine months ended September 30, 2006 and 2005 gives effect to the acquisitions of Medsite, IPN, Summex, eMedicine, Conceptis and HealthShare, including the amortization of intangible assets, as if the acquisitions had all occurred on January 1, 2005. The information is provided for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred if the transactions had been consummated on the date indicated, nor is it necessarily indicative of future operating results of the consolidated companies, and should not be construed as representative of these results for any future period.

 

 

 

Segment information has been prepared in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). The accounting policies of the segments are the same as the accounting policies for the consolidated Company. Inter-segment revenue primarily represents printing services provided by the Company’s Emdeon Business Services segment and certain services provided by the Company’s WebMD segment to the Company’s other operating segments. The performance of the Company’s business is monitored based on earnings before interest, taxes, non-cash and other items. Non-cash and other items include: legal expenses which reflect costs and expenses related to the investigation by the

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

United States Attorney for the District of South Carolina and the SEC (“Legal expense”); professional fees, primarily consisting of legal, accounting and financial advisory services, related to the Pending EBS Transaction (“Advisory expense”); a charge related to the redemption of $300,000 31/4% Convertible Subordinated Notes; minority interest in the Company’s consolidated WebMD segment; non-cash advertising expense related to advertising acquired in exchange for the Company’s equity securities; costs and expenses related to the settlement of the McKesson HBOC litigation; and non-cash stock-based compensation expense, which relates to stock options issued and assumed in connection with acquisitions and restricted stock issued to employees and, beginning January 1, 2006, includes the incremental non-cash stock-based compensation expense associated with the adoption of SFAS 123R.

 

The Company has aligned its business into four operating segments and one corporate segment. In connection with the Pending EBS Transaction and the revised manner in which management views the operations, the Company classified the ViPS segment, formerly a business unit of the Emdeon Business Services segment, as a separate operating segment. The following is a description of each of the Company’s operating and corporate segments:

 

Emdeon Business Services provides solutions that automate key business and administrative functions for healthcare payers and providers, including: electronic patient eligibility and benefit verification; electronic and paper claims processing; electronic and paper paid-claims communication services; and patient billing, payment and communications services. In addition, Emdeon Business Services provides clinical communications services that improve the delivery of healthcare by enabling physicians to manage laboratory orders and results, hospital reports and electronic prescriptions.

 

WebMD provides health information services to consumers, physicians, healthcare professionals, employers and health plans through public and private online portals and health-focused publications. WebMD’s public network of health portals enables consumers and physicians to readily access health information relevant to their specific areas of interest or specialty. WebMD’s public portals sell advertising and sponsorship programs, including online continuing medical education (“CME”) services, to companies interested in reaching consumers and physicians online, including pharmaceutical, biotechnology, medical device and consumer products companies. WebMD’s private portals are licensed to employers and health plans for use by their employees and members and provide access to personalized health and benefit information and decision support services. WebMD provides related services for the use of such employees and members, including lifestyle education and personalized telephonic health coaching. WebMD also provides physician recruitment services for use by pharmaceutical, medical device and healthcare companies. In addition, WebMD provides offline CME, in-person medical education services and publishes medical reference textbooks, healthcare provider directories and WebMD the Magazine, a consumer magazine distributed to physician office waiting rooms.

 

ViPS (formerly a business unit of EBS) provides decision support solutions, data warehousing solutions and consulting services to governmental, Blue Cross Blue Shield and commercial healthcare payers and performs software maintenance and consulting services for governmental agencies involved in healthcare.

 

Porex develops, manufactures and distributes proprietary porous plastic products and components used in healthcare, industrial and consumer applications, as well as in finished products used in the medical device and surgical markets.

 

Corporate includes services shared across all operating segments, such as executive personnel, accounting, tax, treasury, legal, human resources, risk management and certain information technology functions. Corporate service costs include compensation related costs, insurance and audit fees, leased property, facilities cost, legal and other professional fees, software maintenance and telecommunication costs. Additionally, in connection with the EPS Sale, the Company entered into a transition services agreement whereby the Company will provide EPS with certain administrative services, including payroll, accounting, purchasing and

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

procurement, tax, and human resource services, as well as IT support. These services will be provided through the Corporate segment, and the related transition services fee the Company charges to EPS will also be included in the Corporate segment, offsetting the cost of providing these services. The transition services fee charged to EPS for the period from September 15, 2006 to September 30, 2006 was $341.

 

Reclassification of Segment Information.  In connection with the EPS Sale and related reclassification of that operating segment to discontinued operations, the Company has reclassified certain expenses related to activities that were previously managed, and therefore reported, within the Corporate and EBS segments, to the discontinued EPS segment, as these expenses will not be incurred by the continuing operations of the Company. In accordance with SFAS 144, these expenses were reclassified for the current and comparable prior year periods. The expenses which were reclassified to the discontinued EPS segment aggregated $260 and $924 for the three and nine months ended September 30, 2006, respectively, and $550 and $1,262 for the three and nine months ended September 30, 2005, respectively.

 

Summarized financial information for each of the Company’s four operating segments and corporate segment and reconciliation to net income are presented below:

 

EMDEON CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)