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EPOC > SEC Filings for EPOC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for EPOCRATES INC

Form 10-Q for EPOCRATES INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2011, or fiscal year 2011, included in our Annual Report on Form 10-K for fiscal year 2011, or 2011 Annual Report on Form 10-K. References to "Epocrates," "we," "our" and "us" are to Epocrates, Inc. unless otherwise specified or the context otherwise requires.

This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Terminology such as "believe," "may," "might," "objective," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "potential" or the negative of these terms or other similar expressions is intended to identify forward-looking statements.

We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in "Part II - Item 1A. Risk Factors" below, and those discussed in the sections titled "Special Note Regarding Forward-Looking Statements" and "Risk Factors" included in our 2011 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, or SEC, on March 19, 2012. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Business Overview

Epocrates is a leading physician platform for essential clinical content, practice tools and health industry engagement at the point of care. The Epocrates network consists of more than one million healthcare professionals, including 50% of U.S. physicians, who routinely use its solutions and services. Epocrates' portfolio includes top-ranked medical applications, such as the industry's #1 medical application among U.S. physicians, which provides convenient, point-of-care access to information such as dosing, drug interactions, pricing and insurance coverage for thousands of brand, generic and over-the-counter drugs. The features available through our unique physician platform are often referenced multiple times per day and help healthcare professionals make more informed prescribing decisions, improve workflow and enhance patient safety. We offer our products on major U.S. mobile platforms including Apple, Android and BlackBerry.

We generate revenue by providing clients in the healthcare industry (e.g., pharmaceutical companies, managed care companies and market research firms) with interactive services to engage with our network of members and through the sale of subscriptions to our premium drug and clinical reference tools to healthcare professionals. Our client base is located almost entirely within the U.S. For the three and nine months ended September 30, 2012 and 2011, no single client accounted for more than 10% of total revenues. There was one client that accounted for more than 10% of accounts receivable, net as of September 30, 2012. One client accounted for 15% of accounts receivable, net as of December 31, 2011.

Recent Developments

As previously reported, the Audit Committee of the Board of Directors of Epocrates, as authorized by the Board of Directors, approved the discontinuation of Epocrates' Electronic Health Record, or EHR, business in early 2012. In connection with this


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decision, we recorded an impairment charge of approximately $8.5 million in the fourth fiscal quarter of 2011, which represents the write-down of the carrying value of the goodwill, intangible and other long-lived assets related to the EHR product to their estimated fair value of zero. This charge was recorded in Impairment of Long-lived Assets and Goodwill in our consolidated statements of operations for the year ended December 31, 2011.

Upon the Audit Committee's approval, we met the requirements for reporting the EHR segment as discontinued operations for the three months ended March 31, 2012, and the results of this segment are now recorded in gain (loss) from discontinued operations, net of tax on our condensed consolidated statements of comprehensive (loss) income. Prior period results have been revised to conform to the current period presentation.

In June 2012, we sold certain assets related to the EHR iPad application to a third party pursuant to a purchase agreement that was not material to our condensed consolidated financial statements. The consideration received from the sale of the EHR iPad application together with all other miscellaneous wind-down costs resulted in a net gain of approximately $0.4 million for the three months ended September 30, 2012, and a net loss of approximately $1.7 million for the nine months ended September 30, 2012. Refer to "Note 6 - Acquisitions and Dispositions" for further details.

The Company understated $50 thousand of operating expenses in the three months ended March 31, 2012 and overstated $32 thousand of operating expenses in the three months ended June 30, 2012. The Company recorded correcting adjustments of these same amounts during the three months ended June 30, 2012 and September 30, 2012, respectively. Management does not believe the misstatements or correcting adjustments described above are material to any previously issued interim or annual financial statements or to the expected full year results for 2012.

Highlights

For the three months ended September 30, 2012, we recorded total revenues of $26.0 million, a decrease of $0.6 million, or 2%, from the three months ended September 30, 2011. For the nine months ended September 30, 2012, we recorded total revenues of $80.4 million, a decrease of $3.3 million, or 4%, from the nine months ended September 30, 2011. For the nine months ended September 30, 2012, the decrease was primarily due to an unusually high number of unused pharmaceutical license code expirations for which we recognized revenue in the nine months ended September 30, 2011 as well as lower iTunes App Store sales for the nine months ended September 30, 2012.

Net loss was $0.6 million for the three months ended September 30, 2012, versus net income of $0.7 million for the three months ended September 30, 2011. Net loss was $2.4 million for the nine months ended September 30, 2012, versus net income of $3.0 million for the nine months ended September 30, 2011. Results for these periods include $0.2 million for the three months ended September 30, 2012, and $1.5 million for the nine months ended September 30, 2012, of proceeds from the sale of the EHR component technology.

Net loss per share was $0.02 for the three months ended September 30, 2012, compared to net income per diluted share of $0.03 for the three months ended September 30, 2011. Net loss per share was $0.10 for the nine months ended September 30, 2012, compared to net income per diluted share of $0.11 for the nine months ended September 30, 2011.

Loss from continuing operations was $1.0 million for the three months ended September 30, 2012, versus income from continuing operations of $0.7 million for the three months ended September 30, 2011. For the three months ended September 30, 2012, the net loss was primarily due to increased operating expenses as well as decreased revenues and increased cost of revenues. Loss from continuing operations was $0.7 million for the nine months ended September 30, 2012 versus income from continuing operations of $5.1 million for the nine months ended September 30, 2011. Income from continuing operations for the nine months ended September 30, 2011 includes a $6.4 million gain on settlement as a result of an agreement entered into with the sellers of MedCafe, Inc. during June 2011. Excluding the gain on settlement and change in fair value of contingent consideration, results for both the nine months ended September 30, 2012 and 2011 would have been comparable.

Loss per share from continuing operations was $0.04 for the three months ended September 30, 2012, compared to income from continuing operations of $0.03 per diluted share for the three months ended September 30, 2011. Loss from continuing operations per share was $0.03 for the nine months ended September 30, 2012, compared to income from continuing operations of $0.21 per diluted share for the nine months ended September 30, 2011.

Earnings before interest, taxes, non-cash and other items ("adjusted EBITDA"), as defined in the GAAP to non-GAAP reconciliation provided in "Non-GAAP Financial Measures," was $2.0 million for the three months ended September 30, 2012, compared to adjusted EBITDA of $3.9 million for the three months ended September 30, 2011, or a 50% decrease


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from the prior year. For the nine months ended September 30, 2012, adjusted EBITDA was $9.0 million compared to $15.6 million for the nine months ended September 30, 2011, or a 42% decrease from the prior year. The decrease in adjusted EBITDA for the three and nine months ended September 30, 2012, was primarily attributable to increased operating expenses as well as decreased revenues coupled with an increase in cost of revenues compared to the three and nine months ended September 30, 2011.

Total cash, cash equivalents and short-term investments declined by 7% to $79.1 million at September 30, 2012, compared to $85.2 million at December 31, 2011.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S., or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. Our critical accounting policies are those that affect our historical financial statements materially and involve difficult, subjective or complex judgments by management.

There have been no significant changes in our critical accounting policies during the quarter ended September 30, 2012, compared to those previously disclosed in "Critical Accounting Policies and Estimates" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our 2011 Annual Report on Form 10-K.

Results of Operations

The following table summarizes our results of operations for the three and nine
months ended September 30, 2012, compared to the three and nine months ended
September 30, 2011 (in thousands):
                                          Three Months Ended             Nine Months Ended
                                            September 30,                  September 30,
                                         2012            2011           2012           2011
Total revenues, net                  $    26,025     $   26,595     $   80,380     $   83,632
Total cost of revenues                    10,803         10,283         32,039         29,441
Gross profit                              15,222         16,312         48,341         54,191
Operating expenses:
Sales and marketing                        6,871          6,050         19,664         19,650
Research and development                   5,369          5,312         15,497         15,386
General and administrative                 4,113          4,259         14,333         16,424
Facilities exit costs                          -              -              -            618
Gain on settlement and change in
fair value of contingent
consideration                                  -              -              -         (5,933 )
Total operating expenses                  16,353         15,621         49,494         46,145
(Loss) income from operations             (1,131 )          691         (1,153 )        8,046
Interest income                               11             15             22             66
Other income (expense), net                    -              3             (1 )          182
(Loss) income before income taxes         (1,120 )          709         (1,132 )        8,294
Benefit from (provision for) income
taxes                                        104             (4 )          392         (3,154 )
(Loss) income from continuing
operations                                (1,016 )          705           (740 )        5,140
Gain (loss) from discontinued
operations, net of tax                       408            (19 )       (1,705 )       (2,186 )
Net (loss) income                    $      (608 )   $      686     $   (2,445 )   $    2,954

In 2011, we had two reportable segments: (1) Subscriptions and Interactive Services and (2) EHR. On February 24, 2012, the Audit Committee of our Board of Directors, as authorized by the Board of Directors, approved the discontinuation of Epocrates' EHR product. In the first quarter of 2012, we qualified for discontinued operations presentation under GAAP, and at such time, the EHR operating segment results were reported in loss from discontinued operations on our condensed consolidated statements of comprehensive (loss) income. Prior period results have been revised in order to conform to the current period presentation.


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Revenues

We generate revenue by providing clients in the healthcare industry with
interactive services to engage with our network of members and through the sale
of subscriptions to our premium drug and clinical reference tools to healthcare
professionals. Revenues from Subscriptions and Interactive Services were as
follows (in thousands):

                          Three Months Ended         Nine Months Ended
                            September 30,              September 30,
                           2012         2011         2012         2011
Subscriptions          $     5,045    $  5,143    $   14,472    $ 17,446
Interactive Services        20,980      21,452        65,908      66,186
                       $    26,025    $ 26,595    $   80,380    $ 83,632

Subscriptions. Subscriptions revenue decreased $0.1 million for the three months ended September 30, 2012, and decreased $3.0 million for the nine months ended September 30, 2012. The decrease in subscriptions revenue for the three months ended September 30, 2012 is primarily attributable to a decrease in iTunes App Store sales. The decrease in subscriptions revenue for the nine months ended September 30, 2012 is primarily attributable to an unusually high number of unused license code expirations for which we recognized revenue of $1.8 million in the first nine months of 2011. The decline in subscriptions revenue was additionally impacted by a decrease of approximately $0.6 million in the nine months ended September 30, 2012 in iTunes App Store sales, as we decreased our offering of Modality applications from the prior year. We expect the percentage of members who pay for a subscription to remain unchanged or even decrease over time. As a result, we expect subscription revenue from our premium products to decrease in total and as a percentage of revenue in the future.

Interactive Services. Interactive services revenue decreased $0.5 million for the three months ended September 30, 2012, and decreased $0.3 million for the nine months ended September 30, 2012. The $0.5 million decrease in interactive services revenue for the three months ended September 30, 2012 was primarily due to a $1.5 million decline in pharmaceutical revenues, which was partially offset by a $1.0 million increase in market research services. The $0.3 million decrease in interactive services revenue for the nine months ended September 30, 2012 was the result of a $0.3 million decrease in formulary hosting services, as a $2.1 million increase in market research services was entirely offset by a $2.1 million decline in pharmaceutical revenues.

Cost of revenues

Cost of revenues consists of the costs related to providing services to clients which include salaries and related personnel expenses, stock-based compensation, service support costs, payments to participants for market research surveys we conduct for our clients, third-party royalties and allocated overhead. Third-party royalties consist of fees paid to branded content owners for the use of their intellectual property in our premium drug and reference products. Allocated overhead represents expenses such as rent, occupancy charges and information technology costs that we allocate to all departments based on headcount. We also allocate depreciation and amortization expense to cost of revenues.

The following is a breakdown of cost of revenues related to subscriptions and interactive services for the three and nine months ended September 30, 2012 and 2011 (in thousands):

                          Three Months Ended         Nine Months Ended
                            September 30,              September 30,
                           2012         2011         2012         2011
Subscriptions          $     1,782    $  1,597    $    5,480    $  5,440
Interactive Services         9,021       8,686        26,559      24,001
                       $    10,803    $ 10,283    $   32,039    $ 29,441

Subscriptions. Cost of revenues for subscriptions increased by $0.2 million for the three months ended September 30, 2012, and increased less than $0.1 million for the nine months ended September 30, 2012 versus the comparable period in 2011. As a percentage of subscriptions revenue, cost of subscriptions revenues was 35% for the three months ended September 30, 2012, versus 31% for the three months ended September 30, 2011. As a percentage of subscriptions revenue, cost of subscriptions revenues was 38% for the nine months ended September 30, 2012, versus 31% for the nine months ended September 30, 2011. The increase in cost of subscriptions revenues as a percentage of subscriptions revenues for the three and nine months ended


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September 30, 2012 is due to the decline in subscriptions revenues from the same periods in the prior year.

Interactive Services. Cost of revenues for interactive services increased approximately $0.3 million for the three months ended September 30, 2012, compared to the same period in 2011, primarily due to increases of $0.8 million in honoraria expenses as a result of higher market research activity and $0.2 million in co-location employee-related expenses due to hiring new employees, partially offset by a decrease of $0.7 million for pharmaceutical and third-party content costs.

Cost of interactive services revenues increased approximately $2.6 million for the nine months ended September 30, 2012, compared to the same period in 2011, primarily due to increases of $1.5 million in honoraria expenses as a result of higher market research activity and $0.9 million in increased co-location employee-related expenses as a result of hiring new employees.

Cost of interactive services revenues as a percentage of interactive services revenues was 43% for the three months ended September 30, 2012, and 40% for the three months ended September 30, 2011. Cost of interactive services revenues as a percentage of interactive services revenues was 40% for the nine months ended September 30, 2012, and 36% for the nine months ended September 30, 2011.

Sales and marketing expense

Sales and marketing expense primarily consists of salaries and related personnel expenses, sales commissions, stock-based compensation, trade show expenses, promotional expenses, public relations expenses and allocated overhead.

Sales and marketing expense increased approximately $0.8 million for the three months ended September 30, 2012, versus the same period in 2011. The increase in the three months ended September 30, 2012, compared to the same period in the prior year, was due to an increase of $0.5 million in employee compensation and a $0.2 million increase in stock compensation as a result of several positions being filled during the period, and a $0.2 million increase in marketing related expenses. This was partially offset by a $0.2 million decrease in sales commissions as a result of a revised commission plan for 2012. Sales and marketing expense was $19.7 million for both the nine months ended September 30, 2012 and 2011.

Sales and marketing expense as a percentage of total revenues increased from 23% for the three months ended September 30, 2011, to 26% for the three months ended September 30, 2012, as a result of lower revenues in the three months ended September 30, 2012. Sales and marketing expense as a percentage of total revenues increased from 23% for the nine months ended September 30, 2011, to 24% for the nine months ended September 30, 2012.

Research and development expense

Research and development expense primarily consists of salaries and related personnel expenses, stock-based compensation, allocated overhead, consultant fees and expenses related to the design, development, testing and enhancements of our services.

Research and development expense increased approximately $0.1 million, or 1%, for the three months ended September 30, 2012, compared to the three months ended September 30, 2011. As a percentage of total revenues, research and development expense was 21% for the three months ended September 30, 2012, and 20% for the three months ended September 30, 2011.

Research and development expense increased approximately $0.1 million, or 1%, for the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011. As a percentage of total revenues, research and development expense was 19% for the nine months ended September 30, 2012, and was 18% for the nine months ended September 30, 2011.

General and administrative expense

General and administrative expense primarily consists of salaries and related personnel expenses, stock-based compensation, consulting, audit fees, legal fees, allocated overhead and other general corporate expenses.

General and administrative expense decreased $0.1 million, or 3%, for the three months ended September 30, 2012, compared to the three months ended September 30, 2011. General and administrative expense as a percentage of total revenues was 16% for both the three months ended September 30, 2012 and 2011.

General and administrative expense decreased $2.1 million, or 13%, for the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011. This decrease was primarily due to decreases of $1.4 million in stock-based compensation expense and $1.0 million in legal fees. The $1.4 million decrease in stock-based compensation expense was primarily due the departure of certain members of senior management during the nine months ended September 30, 2012 as well as additional


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stock-based compensation expense of $0.7 million in the nine months ended September 30, 2011 that was recorded in connection with the modification of the terms of the stock options held by certain directors who resigned from the Board of Directors during the first quarter of 2011. We incurred significant legal and other professional fees during the nine months ended September 30, 2011, to support our compliance with the subpoena received in connection with the SEC investigation. General and administrative expense as a percentage of total revenues was 18% for the nine months ended September 30, 2012, and was 20% for the nine months ended September 30, 2011.

Facilities exit costs

We recorded a charge of approximately $0.6 million in the nine months ended September 30, 2011, relating to facilities exit costs. We vacated our East Windsor, New Jersey office in the first quarter of 2011 and relocated our New Jersey operations to Ewing, New Jersey. We had signed a non-cancellable lease for the East Windsor location, which does not expire until the end of fiscal 2012, and therefore, we will be liable to make monthly lease rentals under the contract. The liability recorded at fair value is based on the present value of the remaining lease rentals and is reduced for the estimated sub-lease rentals that could be reasonably obtained for the property.

Gain on settlement and change in fair value of contingent consideration

For the nine months ended September 30, 2011, gain on settlement and change in fair value of contingent consideration reflects a $6.4 million gain on settlement as a result of an agreement entered into with the sellers of MedCafe, Inc. during June 2011, offset by an increase in contingent consideration expense of $0.5 million related to revaluing the contingent consideration liability to its fair value as of March 31, 2011.

Benefit from (provision for) income taxes

For the three months ended September 30, 2012, the Company recorded an income tax benefit of approximately $0.2 million, of which $0.1 million was allocated to continuing operations, with the balance of $0.1 million allocated to discontinued operations. For the three months ended September 30, 2011, the Company recorded an income tax benefit of $0.4 million, which was comprised of a minimal tax provision allocated to continuing operations and a tax benefit of $0.4 million allocated to discontinued operations. The income tax benefit during the three months ended September 30, 2012 represented the federal and state statutory rates adjusted for non-deductible stock compensation expense partially offset by a return-to-provision adjustment. The income tax provision during the three months ended September 30, 2011 reflects the federal and state statutory tax rates adjusted for non-deductible stock compensation expense partially offset by research and development credits.

For the nine months ended September 30, 2012, the Company recorded an income tax . . .

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