<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
<TABLE>
<S> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>
Commission file number 000-19480
MEDAPHIS CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 58-1651222
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2700 CUMBERLAND PARKWAY, SUITE 300 30339
ATLANTA, GEORGIA (Zip code)
(Address of principal executive offices)
</TABLE>
(770) 444-5300
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares of stock outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT APRIL 30, 1997
----- -----------------------------
<C> <C>
Common Stock
$0.01 PAR VALUE 72,429,480 SHARES
Non-voting Common Stock
$0.01 PAR VALUE 0 SHARES
</TABLE>
================================================================================
<PAGE> 2
MEDAPHIS CORPORATION
FORM 10-Q
MARCH 31, 1997
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Part I: Financial Information
Consolidated Statements of Operations for the three months
ended March 31, 1997 and 1996.......................... A-3
Consolidated Balance Sheets as of March 31, 1997 and
December 31, 1996...................................... A-4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1997 and 1996.......................... A-5
Notes to Consolidated Financial Statements................ A-6
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... A-15
Part II: Other Information
Legal Proceedings......................................... A-20
Other Information......................................... A-22
Exhibits and Reports on Form 8-K.......................... A-23
Index to Exhibits......................................... A-26
</TABLE>
---------------------
THIS FORM 10-Q AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
MEDAPHIS CORPORATION OR ITS REPRESENTATIVES CONTAIN STATEMENTS WHICH MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT
OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF MEDAPHIS CORPORATION AND MEMBERS OF ITS MANAGEMENT
TEAM AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-Q, AND ARE
HEREBY INCORPORATED HEREIN BY REFERENCE. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS, THE
OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER
TIME.
A-2
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
1997 1996
-------- -------------
(AS RESTATED,
SEE NOTE 8)
<S> <C> <C>
Revenue..................................................... $147,546 $162,249
Salaries and wages.......................................... 93,578 91,730
Other operating expenses.................................... 40,242 39,335
Depreciation................................................ 6,985 5,940
Amortization................................................ 4,690 5,109
Interest expense, net....................................... 6,115 2,105
Restructuring and other charges............................. -- (58)
-------- --------
Total expenses.................................... 151,610 144,161
Income (loss) before income taxes........................... (4,064) 18,088
Income tax (benefit) expense................................ (2,225) 7,429
-------- --------
Net income (loss)................................. (1,839) 10,659
Pro forma income tax adjustments............................ -- 354
-------- --------
Pro forma net income (loss)....................... $ (1,839) $ 11,013
======== ========
Pro forma net income (loss) per common share................ $ (0.03) $ 0.15
======== ========
Weighted average shares outstanding......................... 72,235 75,704
======== ========
</TABLE>
See notes to consolidated financial statements.
A-3
<PAGE> 4
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash...................................................... $ 10,174 $ 7,631
Restricted cash........................................... 19,952 19,568
Accounts receivable, billed............................... 101,728 99,823
Accounts receivable, unbilled............................. 89,163 94,057
Deferred tax asset........................................ 36,177 36,177
Other..................................................... 13,809 12,129
-------- ---------
Total current assets.............................. 271,003 269,385
Property and equipment...................................... 92,798 97,850
Deferred tax asset.......................................... 44,608 42,379
Intangible assets........................................... 383,159 389,033
Other....................................................... 19,105 16,977
-------- ---------
$810,673 $ 815,624
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 14,698 $ 11,765
Accrued compensation...................................... 34,086 30,332
Accrued expenses.......................................... 85,715 95,680
Current portion of long-term debt......................... 106,955 55,975
-------- ---------
Total current liabilities......................... 241,454 193,752
Long-term debt.............................................. 162,720 215,752
Other obligations........................................... 12,331 13,830
-------- ---------
Total liabilities................................. 416,505 423,334
-------- ---------
Stockholders' Equity:
Common stock, voting, $0.01 par value, 200,000 authorized
in 1997 and 1996; issued and outstanding 72,417 in 1997
and 71,705 in 1996..................................... 724 717
Common stock, non voting, $0.01 par value, 600 authorized
in 1997 and 1996; none issued.......................... -- --
Paid-in capital........................................... 526,154 522,491
Accumulated deficit....................................... (132,710) (130,749)
-------- ---------
394,168 392,459
Less treasury stock, at cost -- 16 shares in 1996......... -- 169
-------- ---------
Total stockholders' equity........................ 394,168 392,290
-------- ---------
$810,673 $ 815,624
======== =========
</TABLE>
See notes to consolidated financial statements.
A-4
<PAGE> 5
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1997 1996
-------- --------------
(AS RESTATED,
SEE NOTE 8)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ (1,839) $ 10,659
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization.......................... 11,675 11,049
(Gain) loss on sale of property and equipment.......... (102) 210
Deferred income taxes.................................. (2,225) 7,429
Changes in assets and liabilities, excluding effects of
acquisitions:
Increase in accounts receivable, billed.............. (1,905) (16,195)
Decrease (increase) in accounts receivable,
unbilled............................................ 4,893 (6,615)
Increase (decrease) in accounts payable.............. 2,933 (8,634)
Increase in accrued compensation..................... 3,754 9,016
Decrease in accrued expenses......................... (10,261) (10,492)
Other, net........................................... (1,046) (599)
-------- --------
Net cash provided by (used for) operating
activities...................................... 5,877 (4,172)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired........................ (769) (5,722)
Purchases of property and equipment....................... (3,400) (19,467)
Proceeds from sale of property and equipment.............. 3,644 13
Software development costs................................ (1,398) (13,419)
-------- --------
Net cash used for investing activities............ (1,923) (38,595)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................... 3,618 7,660
Proceeds from borrowings.................................. 10,000 43,566
Principal payments of long-term debt...................... (12,020) (13,782)
Other..................................................... (3,009) 3,819
-------- --------
Net cash (used for) provided by financing
activities...................................... (1,411) 41,263
-------- --------
CASH:
Net change................................................ 2,543 (1,504)
Balance at beginning of period............................ 7,631 18,979
-------- --------
Balance at end of period.................................. $ 10,174 $ 17,475
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest............................................... $ 4,615 $ 3,551
Income taxes........................................... 612 629
Non-cash investing and financing activities:
Liabilities assumed in acquisitions.................... -- 2,027
Additions to capital lease obligations................. -- 9,190
Common stock issued upon conversion of subordinated
debentures............................................ -- 63,375
</TABLE>
See notes to consolidated financial statements.
A-5
<PAGE> 6
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Medaphis Corporation ("Medaphis" or the "Company") are presented in accordance
with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. For further
information, the reader of this Form 10-Q may wish to refer to the audited
consolidated financial statements of the Company for the fiscal year ended
December 31, 1996 included in the Company's Annual Report on Form 10-K filed
March 31, 1997 ("10-K").
The unaudited condensed financial information has been prepared in
accordance with the Company's customary accounting policies and practices. In
the opinion of management, all adjustments, consisting of normal recurring
adjustments considered necessary for a fair presentation of results for the
interim period, have been included.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Actual results could differ from those estimates.
As in the past, the Company's consolidated financial statements have been
prepared on a going concern basis which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of
business. On March 31, 1997, the Company's independent auditors noted in a
modifying fourth paragraph to their unqualified independent report on the
Company's financial statements included in the 10-K that, because the Company's
plans to divest of certain assets to generate funds to meet scheduled 1997
amortization requirements did not then include binding contracts to dispose of
these assets, and because no other contractual arrangements were in place to
refinance or raise additional funds to otherwise satisfy such required debt
reduction, substantial doubt was raised about the Company's ability to continue
as a going concern. As discussed in Note 7, the Company's cash flow from
operations will not be sufficient to satisfy required reductions in the
Company's outstanding borrowings; however, as discussed in the next paragraph,
the Company has adopted plans to divest certain assets which management believes
will generate the necessary cash flows to satisfy these required debt
reductions. The Company's consolidated financial statements do not include any
adjustments relating to the recoverability and classification of liabilities
that may be necessary should the Company, contrary to plans and expectations, be
unable to continue as a going concern.
As previously discussed in the Company's 10-K, the Company and its lenders
have always contemplated that the contractual amortization of loan commitments
under the Second Amended and Restated Loan Facility (the "Second Amended
Facility") would be accomplished through asset divestitures since operating cash
flow was never intended to be utilized for this purpose and would be
insufficient to meet these obligations. Also as previously announced and
pursuant to the Company's 1997 business plan, the Company is pursuing the sale
of Healthcare Recoveries, Inc. ("HRI") and the assessment of alternatives for
its client/server integration businesses (the "BSG Group"). On April 22, 1997,
the Company announced that its two-pronged divestiture strategy for HRI, either
through a private sale or an initial public offering (in which it is being
advised by Bear, Stearns & Co. Inc.) continued to be on track. The Company also
reported that one or more private sale preliminary indications of interest for
the purchase of HRI have been received that are in excess of the funds required
to satisfy 1997 amortization obligations under the Second Amended Facility. The
Company has also filed the HRI registration statement with the SEC which is
completing its review process. The preliminary prospectus (subject to
completion) was distributed by the Company during the week of April 28, 1997.
The Company remains confident that it will be able to meet its amortization
obligations under the Second Amended Facility through the continued execution of
the Company's 1997 business plan and related asset divestiture program.
A-6
<PAGE> 7
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 2 -- LEGAL MATTERS
The United States Attorney's Office for the Central District of California
is conducting an investigation (the "Federal Investigation") of Medaphis'
billing and collection practices in its offices located in Calabasas and
Cypress, California (the "Designated Offices"). Medaphis first became aware of
the Federal Investigation when it received search warrants and grand jury
subpoenas on June 13, 1995. Although the precise scope of the Federal
Investigation is not known to the Company at this time, Medaphis believes that
the U.S. Attorney's Office is investigating allegations of billing fraud and
that the inquiry is focused upon Medaphis' billing and collection practices in
the Designated Offices. Numerous federal and state civil and criminal laws
govern medical billing and collection activities. In general, these laws provide
for various fines, penalties, multiple damages, assessments and sanctions for
violations, including possible exclusion from Medicare, Medicaid and certain
other federal and state healthcare programs. Although the Designated Offices
represent less than 2% of Medaphis' annual revenue, there can be no assurance
that the Federal Investigation will be resolved promptly, that additional
subpoenas or search warrants will not be received by Medaphis or that the
Federal Investigation will not have a material adverse effect upon the Company.
The Company recorded charges of $12 million in the third quarter of 1995 and $2
million in the fourth quarter of 1996, solely for the administrative fees, costs
and expenses it anticipates incurring in connection with the Federal
Investigation and the putative class action lawsuits described below which were
filed following the Company's announcement of the Federal Investigation. The
charges are intended to cover only the anticipated expenses of the Federal
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of common stock in April 1995 were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits allege violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of common stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the
named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contains any claims based on the Securities Act of 1933, as
amended, and the Company's underwriters and outside directors are no longer
named as defendants. On June 26, 1996, the court denied the plaintiffs' motion
to certify a plaintiffs' class. The plaintiffs and the defendants have reached
an agreement in principle to settle this action on a class-wide basis for $4.75
million, subject to court approval and other customary conditions (the "1995
Class Action Settlement"). The 1995 Class Action Settlement would also include
the related putative class action lawsuit currently pending in the Superior
Court of Cobb County, Georgia, described more fully below. The Company expects
to receive approximately $3.7 million from insurance to fund a portion of the
1995 Class Action Settlement and accrued approximately $1.2 million in the
quarter ending December 31, 1996 to fund the anticipated balance of the 1995
Class Action Settlement and to pay certain fees incident thereto.
On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James
S. Douglass were named as defendants in a putative shareholder class action
lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit
alleges violations of Georgia securities laws based on the same public
statements and filings generally described above. The lawsuit is brought on
behalf of a putative class of purchasers of Medaphis common stock during the
period from March 29, 1995 through June 15, 1995. The plaintiffs seek
compensatory damages and costs. As noted above, it is currently contemplated
that this action will be settled as part of the 1995 Class Action Settlement.
A-7
<PAGE> 8
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients. In March 1997, the Company was informed by the
Civil Division of the Department of Justice that it is investigating allegations
concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary.
The Company has received a request from the Department of Justice for records,
and may receive additional requests. The Company intends to cooperate in
producing records. There can be no assurance that this matter will be resolved
promptly or that the investigation will not have a material adverse effect upon
Medaphis.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its current and former
officers, one of whom was also a director, were named as defendants in nineteen
putative shareholder class action lawsuits filed in the United States District
Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs
in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996
Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges
violations of the federal securities laws in connection with Medaphis' filings
under the federal securities acts and public disclosures. The 1996 Consolidated
Complaint is brought on behalf of a class of all persons who purchased or
otherwise acquired Medaphis common stock between January 6, 1996 and October 21,
1996. The 1996 Consolidated Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis common stock pursuant to the
merger between Medaphis and Health Data Sciences Corporation ("HDS"). On
December 30, 1996, the defendants filed a motion to dismiss most of the 1996
Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated
Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss
the Consolidated Second Amended Complaint in its entirety.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs. On January 28, 1997, Medaphis and certain individual defendants filed a
motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an
amended complaint adding as defendants additional current and former directors
and officers of Medaphis. On April 23, 1997, Medaphis and certain of the
defendants filed a motion to dismiss the amended complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things more fully described in the complaint, making material
misstatements and omissions in public and private disclosures in connection with
the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive
damages, rescission, injunctive relief and costs. On January 10, 1997, the
defendants filed a demurrer to the complaint. The demurrer was denied on
February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for
a preliminary injunction. As a result of the Company's restatement of its fiscal
1995 financial statements, the Company may not be able to sustain a defense to
strict liability on certain claims under the 1933 Act, but the Company believes
that it has substantial defenses to the alleged damages relating to the 1933 Act
claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
A-8
<PAGE> 9
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and Brown). On April 18,
1997, the Medaphis defendants and BSG defendants filed motions to dismiss the
complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. On the date of the demand, Mr. Papermaster was an executive officer and a
director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997,
although he remains an executive officer of BSG. The indemnification demand
claims damages of $35 million (the maximum damages payable by Medaphis under the
indemnification agreement) for the alleged breach by the Company of its
representations and warranties made in the merger agreement between Medaphis and
BSG.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity
Trust, and the Paulanne H. Thacker Retained Annuity Trust filed a complaint
against the Company and Randolph G. Brown in the United States District Court
for the Southern District of New York arising out of Medaphis' acquisition of
Medical Management Sciences, Inc. ("MMS") in December of 1995. The complaint is
brought on behalf of all former shareholders of MMS who exchanged their MMS
holdings for unregistered shares of Medaphis common stock. In general, the
complaint alleges both common law fraud and violations of the federal securities
laws in connection with the merger. In addition, the complaint alleges breaches
of contract relating to the merger agreement and a registration rights
agreement, as well as tortious interference with economic advantage. The
plaintiffs seek rescission of the merger agreement and the return of all MMS
shares, as well as damages in excess of $100 million. Additionally, plaintiffs
seek to void various noncompete covenants and contract provisions between
Medaphis and plaintiffs.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it is conducting a non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ending September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996.
The Company intends to cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against, and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company, that the lawsuits, the written demands and the
pending governmental investigations will not have a disruptive effect upon the
operations of the business, that the written demands, the defense of the
lawsuits and the pending investigations will not consume the time and attention
of the senior management of the Company or that the resolution of the lawsuits,
the written demands and the pending governmental investigations will not have a
material adverse effect upon the Company.
A-9
<PAGE> 10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 3 -- ACQUISITIONS AND OTHER MATTERS
In 1996, the Company acquired Intelligent Visual Computing Inc. ("IVC"),
Rapid Systems Solutions, Inc. ("Rapid Systems"), BSG and HDS in acquisitions
accounted for as poolings-of-interests. A reconciliation of revenue, pro forma
net income and pro forma net income per common share of the Company, as
originally reported (which includes IVC), with the Company after restating for
the mergers with Rapid Systems, BSG and HDS, including the pro forma provision
for "S" corporation income taxes, is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
------------------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C>
Revenue:
Medaphis, as originally reported.......................... $136,582
Restatement adjustments................................... (2,878)
--------
Medaphis, as restated..................................... 133,704
Rapid Systems............................................. 5,248
BSG, as restated.......................................... 19,539
HDS....................................................... 3,758
--------
Combined.................................................. $162,249
========
Pro forma net income (loss):
Medaphis, as originally reported.......................... $ 13,198
Restatement adjustments................................... (4,566)
--------
Medaphis, as restated..................................... 8,632
Rapid Systems............................................. (852)
BSG, as restated.......................................... 2,497
HDS....................................................... 382
Pro forma provision for Rapid Systems..................... 354
--------
Combined.................................................. $ 11,013
========
Pro forma net income per common share:
Medaphis, as originally reported.......................... $ 0.23
========
Medaphis, as restated..................................... $ 0.15
========
Combined.................................................. $ 0.15
========
</TABLE>
In February 1996, the Company, through its wholly owned indirect
subsidiary, Imonics GMBH, entered into a joint venture (the "Joint Venture").
The Joint Venture was formed in order to provide customer-service related work
flow applications throughout Europe. Each partner holds a 50% interest in the
Joint Venture. During the quarter ended March 31, 1996, the Joint Venture signed
an agreement with a German telecommunications entity to provide systems
integration and work flow engineering systems and services over a multi-year
contract. Included in revenue in the accompanying Consolidated Statement of
Operations, for the quarter ended March 31, 1996, is approximately $12.5 million
relating to the Company's share of net earnings of the Joint Venture.
A-10
<PAGE> 11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 4 -- RESTRUCTURING AND OTHER CHARGES
Components of restructuring and other charges are as follows:
<TABLE>
<CAPTION>
MARCH 31,
1996
--------------
(IN THOUSANDS)
<S> <C>
Restructuring charges....................................... $ 2,099
Pooling charges............................................. (2,157)
-------
$ (58)
=======
</TABLE>
Restructuring Charges. During the first quarter of 1996, the Company
incurred approximately $2.1 million of costs which were related to the Company's
reengineering and consolidation project which had not previously been accrued.
Pooling Charges. In connection with the IVC merger, the Company incurred
estimated transaction fees, costs and expenses of $200,000. In addition,
management revised its estimate of certain transaction fees, costs and expenses
associated with the mergers recorded using the pooling-of-interests method of
accounting consummated in 1995 and reversed estimated charges which had been
reflected in the Company's operating results in the periods the mergers were
consummated.
<TABLE>
<CAPTION>
MARCH 31,
1996
--------------
(IN THOUSANDS)
<S> <C>
IVC......................................................... $ 200
Automation Atwork Companies................................. (408)
Healthcare Recoveries, Inc. ("HRI")......................... (765)
Consort Technologies, Inc................................... (526)
Medical Management Sciences, Inc............................ (658)
-------
$(2,157)
=======
</TABLE>
A description of the type and amount of exit costs incurred in the quarter
ended March 31, 1997 are as follows:
<TABLE>
<CAPTION>
RESERVE INCURRED RESERVE
BALANCE THROUGH BALANCE
12/31/96 3/31/97 3/31/97
-------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Lease termination costs..................................... $ 7,514 $(1,188) $6,326
Severance................................................... 2,748 (799) 1,949
Other....................................................... 1,222 (816) 406
------- ------- ------
$11,484 $(2,803) $8,681
======= ======= ======
</TABLE>
NOTE 5 -- INCOME TAXES
In 1996, Medaphis acquired IVC, Rapid Systems and BSG in merger
transactions which were accounted for as poolings-of-interests. Prior to such
mergers, IVC, Rapid Systems and a company acquired by BSG prior to the BSG
merger had elected "S" corporation status for income tax purposes. As a result
of such mergers (or, in the case of the company acquired by BSG, its acquisition
by BSG), such entities terminated their "S" corporation elections. Pro forma net
income and pro forma net income per common share are presented as if the
entities had been "C" corporations during the three months ended March 31, 1996.
A-11
<PAGE> 12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 6 -- LINES OF BUSINESS
The Company operates in three major lines of business: Services (providing
healthcare transaction processing services to physicians, hospitals and payors),
BSG Group (client/server information technology services), and HIT (healthcare
information technology and hardware sales). Total revenue includes only sales to
unaffiliated customers as reported in the Company's consolidated statements of
operations. Operating profit represents total revenue less operating expenses
excluding interest and restructuring and other charges. Corporate items include
general corporate expenses. Corporate assets consist primarily of cash and cash
equivalents, deferred income taxes, deferred financing costs, fixed assets and
miscellaneous prepaids and receivables. Information concerning operations in
these lines of business is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1997 1996
-------- -------------
(IN THOUSANDS)
(AS RESTATED,
SEE NOTE 8)
<S> <C> <C>
Revenue:
Services.................................................. $104,083 $105,634
BSG Group................................................. 23,810 41,263
HIT....................................................... 19,690 16,212
Corporate and eliminations................................ (37) (860)
-------- --------
$147,546 $162,249
======== ========
Operating profit (loss):
Services.................................................. $ 7,402 $ 7,218
BSG Group................................................. 274 14,241
HIT....................................................... 2,818 3,597
Corporate................................................. (8,443) (4,921)
-------- --------
$ 2,051 $ 20,135
======== ========
Interest expense, net....................................... 6,115 2,105
-------- --------
Restructuring and other charges:
Services.................................................. -- 676
BSG Group................................................. -- 200
HIT....................................................... -- (934)
Corporate................................................. -- --
-------- --------
-- (58)
-------- --------
Income (loss) before income taxes........................... $ (4,064) $ 18,088
======== ========
Depreciation and amortization:
Services.................................................. $ 8,592 $ 7,486
BSG Group................................................. 1,045 1,744
HIT....................................................... 1,710 1,486
Corporate................................................. 328 333
-------- --------
$ 11,675 $ 11,049
======== ========
</TABLE>
A-12
<PAGE> 13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1997 1996
-------- -------------
<S> <C> <C>
Capital expenditures:
Services.................................................. $ 2,109 14,574
BSG Group................................................. 609 3,337
HIT....................................................... 665 966
Corporate................................................. 17 590
-------- --------
$ 3,400 $ 19,467
======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
--------------------------
MARCH 31, DECEMBER 31,
1997 1996
--------- -------------
<S> <C> <C>
Identifiable assets:
Services.................................................. $577,488 $594,738
BSG Group................................................. 44,313 51,972
HIT....................................................... 95,843 84,298
Corporate................................................. 93,029 84,616
-------- --------
$810,673 $815,624
======== ========
</TABLE>
NOTE 7 -- LONG-TERM DEBT
On February 4, 1997, the Company entered into the Second Amended and
Restated Credit Agreement (the "Second Amended Facility"). This agreement
replaced the Company's previous senior credit facility and increased the
revolving line of credit to $285 million. The Second Amended Facility is
composed of a $275 million revolving line of credit and a $10 million cash
management swing loan line with lenders from a six-bank syndicate. The Second
Amended Facility effectively refinanced the loans outstanding under the previous
senior credit facility and can be used to finance working capital and other
general corporate needs. The Second Amended Facility provides for "base rate"
loans which bear interest equal to prime plus 1% as long as certain financial
covenants are met. The loan commitments under the Second Amended Facility will
reduce to $200 million and $150 million on July 31, 1997 (unless extended by the
lenders until September 30, 1997) and January 31, 1998, respectively. The
Company does not and did not expect to generate sufficient cash flow from
operations to satisfy the required reductions in debt. Management of the Company
has adopted plans to divest HRI and is seeking alternatives for the BSG Group,
which management believes will generate sufficient net proceeds to meet the
reduction in the loan commitments required by the Second Amended Facility. The
Company has retained an investment banking firm to advise it on the divestiture
of HRI as well as to assist in the evaluation of alternatives for the BSG Group.
While management is confident the Company will be able to meet its debt service
obligations, there can be no assurance that the Company will be successful in
its efforts to divest HRI or the BSG Group. If the Company is unable to dispose
of HRI or the BSG Group or through other means generate sufficient net proceeds
to satisfy the required reductions in the loan commitments, the Company's
lenders can cause the borrowings under the Second Amended Facility to become
immediately due and payable. The Second Amended Facility also contains
restrictions on the Company's ability to declare or pay cash dividends on its
common stock.
As part of the consideration paid to the six-bank syndicate for the Second
Amended Facility, the Company issued the lenders warrants with vesting for 1% of
the common stock of the Company on each of January 1, 1998 and April 1, 1998.
The warrants terminate if the Company has no outstanding borrowings on
A-13
<PAGE> 14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
the line of credit on December 31, 1997. The Company has not allocated any value
to these warrants because management believes the Company will realize
sufficient net proceeds from the divestiture of HRI and the potential
alternatives for the BSG Group or the refinancing of any remaining borrowings
under the Second Amended Facility to enable the Company to repay all borrowings
under the Second Amended Facility by December 31, 1997.
NOTE 8 -- RESTATEMENT OF THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTERLY
PERIOD ENDED MARCH 31, 1996
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors (the "Audit Committee") in March 1997 prior
to completion of the audit process for the Company's 1996 fiscal year,
information was developed that certain revenues and expenses may have been
recorded incorrectly between certain quarters during 1996. At the conclusion of
the review, the Company determined that there were certain accounting errors and
irregularities and that its interim financial statements for each fiscal quarter
of 1996 required restatement. These errors and irregularities consisted
primarily of the following: (1) incorrect quarterly recording of revenues and
the related costs and expenses for certain contracts; (2) incorrect quarterly
recording of certain liabilities for employee bonuses and related expenses; (3)
certain costs and expenses of certain acquired companies, which were later
determined not to be properly recordable, were recognized by those companies in
periods prior to their acquisitions, resulting in an overstatement of the
Company's earnings subsequent to those acquisitions; and (4) incorrect
depreciation of certain assets related to the Company's comprehensive
reengineering and consolidation project.
The Company has determined that all appropriate adjustments have been made
to its interim financial statements and that its consolidated financial
statements, taken as a whole, present fairly in all material respects the
Company's financial position, results of operations and cash flows for its
fiscal quarter ended March 31, 1996 in conformity with generally accepted
accounting principles.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
----------------------
AS
PREVIOUSLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Revenue..................................................... $163,627 $162,249
Salaries and wages.......................................... 90,565 91,730
Other Operating expenses.................................... 39,354 39,335
Depreciation................................................ 4,951 5,940
Amortization................................................ 4,909 5,109
Income before income taxes.................................. 21,593 18,088
Net income.................................................. 12,725 10,659
Pro forma net income........................................ 13,079 11,013
Pro forma net income per common share....................... $ 0.17 $ 0.15
</TABLE>
NOTE 9 -- NEW ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No.
128"). SFAS No. 128 provides for new accounting principles used in the
calculation of earnings per share ("EPS") and shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
This new pronouncement would not materially effect the EPS calculation for the
three month periods ended March 31, 1997 and 1996.
A-14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Medaphis Corporation, a corporation organized in 1985 under the laws of the
State of Delaware ("Medaphis" or the "Company"), provides business management
services and information products primarily to healthcare providers. Medaphis'
healthcare services are designed to assist its clients with the business
management functions associated with the delivery of healthcare services,
thereby permitting physicians and hospitals to focus on providing quality
medical services to their patients. Medaphis' healthcare information systems
include patient-centered clinical information management systems and
enterprise-wide patient and employee scheduling systems. These systems are
designed to improve efficiency and quality of care within hospitals and emerging
integrated healthcare delivery systems. Medaphis currently provides business
management systems and services to approximately 20,500 physicians and over
2,600 hospitals in all 50 states, subrogation and recovery services to
healthcare plans covering in excess of 32 million people throughout the United
States and systems integration and services in the United States and abroad.
In February 1997, Medaphis announced the implementation during the 1997
fiscal year of a business plan focused on Medaphis' core business and comprised
of the following five components: (1) exiting non-core businesses, such as the
planned sale of Healthcare Recoveries, Inc. ("HRI") that is discussed below; (2)
achieving improved predictability of results through enhanced management
accountability and controls; (3) reducing costs and increasing efficiencies; (4)
emphasizing customer service; and (5) implementing cross-selling initiatives.
Medaphis' business is impacted by trends in the U.S. healthcare industry.
As healthcare expenditures have grown as a percentage of the U.S. gross national
product, public and private healthcare cost containment measures have applied
pressure to the margins of healthcare providers. Historically, some healthcare
payors have willingly paid the prices established by providers while other
healthcare payors, notably the government and managed care companies, have paid
far less than established prices (in many cases less than the average cost of
providing the services). As a consequence, prices charged to healthcare payors
willing to pay established prices have increased in order to recover the cost of
services purchased by the government and others but not paid by them (i.e.,
"cost shifting"). The increasing complexity in the reimbursement system and
assumption of greater payment responsibility by individuals have caused
healthcare providers to experience increased receivables and bad debt levels and
higher business office costs. Healthcare providers historically have addressed
these pressures on profitability by increasing their prices, by relying on
demographic changes to support increases in the volume and intensity of medical
procedures, and by cost shifting. Notwithstanding providers' responses to
revenue pressures, management believes that the revenue growth rate experienced
by the Company's clients continues to be adversely affected by increased managed
care and other industry factors impacting healthcare providers in the United
States. At the same time, the process of submitting healthcare claims for
reimbursement to third-party payors in accordance with applicable industry and
regulatory standards continues to grow in complexity and to become more costly.
Management believes that these trends have placed pressure on the rate of
the revenue growth and profit margins of the Company's physician accounts
receivable and practice management operations. Due to these revenue and margin
pressures, Medaphis Physicians Services Corporation ("MPSC"), the Company's
largest subsidiary providing accounts receivable and practice management
services to physicians, did not significantly contribute to the Company's
operating profit for 1996 and this trend is not expected to improve until
further progress is made with, among other things, ongoing initiatives designed
to reduce redundant costs, improve efficiencies and enhance operational
effectiveness in MPSC's operations.
A-15
<PAGE> 16
RESULTS OF OPERATIONS
The following table shows the percentage of certain items reflected in the
Company's statements of operations to revenue.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1997 1996
----- -------------
(AS RESTATED)
<S> <C> <C>
Revenue..................................................... 100.0% 100.0%
Salaries and wages.......................................... 63.4 56.5
Other operating expenses.................................... 27.3 24.2
Depreciation................................................ 4.7 3.7
Amortization................................................ 3.2 3.1
Interest expense, net....................................... 4.1 1.3
Restructuring and other charges............................. 0.0 0.0
----- -----
Income (loss) before income taxes........................... (2.7) 11.2
Income taxes................................................ (1.5) 4.6
----- -----
Net income (loss)........................................... (1.2) 6.6
Pro forma adjustments....................................... -- 0.2
----- -----
Pro forma net income (loss)................................. (1.2)% 6.8%
===== =====
</TABLE>
Revenue. Revenue classified by the Company's different operating segments
is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
1997 1996
-------- -------------
(AS RESTATED)
(IN THOUSANDS)
<S> <C> <C>
Revenue:
Services............................................. $104,083 $105,634
BSG Group............................................ 23,810 41,263
HIT.................................................. 19,690 16,212
Corporate and eliminations................................ (37) (860)
-------- --------
$147,546 $162,249
======== ========
</TABLE>
As part of the 1997 operating plan, management's primary emphasis is on
improving the services provided to its existing clients and not on growing its
revenue base.
The slight decrease in Services' revenue in the first quarter of 1997 from
the same period of 1996 is attributable to the above-mentioned revenue pressure
on the physician accounts receivable and practice management operations and the
emphasis of improving customer service.
The 42.3% decrease in the BSG Group's revenue is primarily a result of the
Company's decision to shut down its wholly-owned operating subsidiary, Imonics
Corporation ("Imonics"). Imonics generated approximately $16.5 million during
the three month period ended March 31, 1996.
HIT's revenue increased 21.5% during the three months ended March 31, 1997
as compared with the same period for the prior year. This increase is primarily
a result of an increase in the number of healthcare information system licenses
sold by Healthcare Data Sciences Corporation.
Salaries and Wages. Salaries and wages increased to 63.4% of revenue in
the first quarter of 1997 from 56.5% in the first quarter of 1996. The increase
in salaries and wages, as a percentage of revenue, is due to a slowdown in the
growth of the Company's revenue. The Company has not reduced its employment
levels to coincide with the decrease in revenue because the 1997 operating plan
has placed a renewed emphasis on client service.
A-16
<PAGE> 17
Other Operating Expenses. Other operating expenses increased to 27.3% of
revenue in the first quarter of 1997 compared to 24.2% in the first quarter of
1996. The increase in other operating expenses as a percentage of revenue for
1997, as compared with 1996, is due to the previously mentioned slowdown in the
growth of the Company's revenue. Other operating expenses are primarily
comprised of postage, facility and equipment rental, telecommunications, travel,
outside consulting and legal services and office supplies.
Depreciation. Depreciation expense was $7.0 million in the first quarter
of 1997 as compared with $5.9 million in the first quarter of 1996. This
increase reflects the Company's investment in property and equipment to support
its business.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $4.7 million in the first quarter of 1997 as compared with $5.1 million in
the first quarter of 1996. The decrease is primarily due to the write-off of
Imonics' purchased goodwill.
Interest. Net interest expense was $6.1 million in the first quarter of
1997 as compared with $2.1 million in the first quarter of 1996. The increase is
primarily due to increased borrowing under the Company's Second Amended
Facility. Management anticipates that future interest expense will be impacted
by interest rate fluctuations and changes in the amount of borrowings under the
Second Amended and Restated Credit Agreement (the "Second Amended Facility").
Restructuring and Other Charges. Components of restructuring and other
charges are as follows:
<TABLE>
<CAPTION>
MARCH 31,
1996
---------------
(IN THOUSANDS)
<S> <C>
Restructuring charges.................................. $ 2,099
Pooling charges........................................ (2,157)
-------
$ (58)
=======
</TABLE>
Restructuring Charges. During the first quarter of 1996, the Company
incurred approximately $2.1 million of costs which were related to the Company's
reengineering and consolidation project which had not previously been accrued.
Pooling Charges. In connection with the Intelligent Visual Computing, Inc.
("IVC") merger, the Company incurred estimated transaction fees, costs and
expenses of $200,000. In addition, management revised its estimate of certain
transaction fees, costs and expenses associated with the mergers recorded using
the pooling-of-interests method of accounting consummated in 1995 and reversed
estimated charges which had been reflected in the Company's operating results in
the periods the mergers were consummated.
<TABLE>
<CAPTION>
1996
--------------
(IN THOUSANDS)
<S> <C>
IVC......................................................... $ 200
Automation Atwork Companies................................. (408)
HRI......................................................... (765)
Consort Technologies, Inc................................... (526)
Medical Management Sciences, Inc............................ (658)
-------
$(2,157)
=======
</TABLE>
Income (Loss) Before Income Taxes. The Company's loss before income taxes
was (2.8)% of revenue in the first quarter of 1997 as compared with income of
11.1% of revenue in the first quarter of 1996. The decrease is primarily the
result of the aforementioned revenue decreases.
Income Taxes. Effective income tax rates for the periods presented vary
from statutory rates primarily as a result of nondeductible goodwill associated
with merger transactions consummated by the Company in previous years. Pro forma
adjustments for income taxes have been provided for companies accounted for
under
A-17
<PAGE> 18
the pooling-of-interest method of accounting which elected to be treated as "S"
corporations under the Internal Revenue Code of 1986, as amended, prior to
merging with the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $29.5 million at March 31, 1997,
including $10.2 million of cash.
The Company's operating activities generated cash of $5.9 million during
the three months ended March 31, 1997 as compared with the use of cash of $4.2
million during the three months ended March 31, 1996. The increase in the
Company's operating cash flows resulted primarily from the collection of
outstanding receivables and management's cash control initiatives.
On February 4, 1997, the Company entered into the Second Amended Facility
which replaced the Company's previous revolving credit agreement and increased
the revolving line of credit from $250 million to $285 million. At March 31,
1997, the Company had $244 million in borrowings outstanding under the Second
Amended Facility which bore interest at 9.5%. The Second Amended Facility
expires on June 30, 1998 and may be extended or otherwise amended pursuant to
the agreement. Borrowings under the Second Amended Facility are secured by
substantially all of the Company's assets and are guaranteed by substantially
all of the Company's subsidiaries. The Second Amended Facility effectively
refinanced the loans outstanding under the Company's previous senior credit
facility and can be used to finance working capital and other general corporate
needs with restrictions on new acquisitions, certain litigation settlement
payments and capital expenditures for the fiscal quarter ending March 31, 1996.
The Second Amended Facility provides for "base rate" loans which bear interest
equal to prime plus 1% as long as certain financial covenants are met. The loan
commitments under the Second Amended Facility will reduce to $200 million and
$150 million on July 31, 1996 (unless extended by the lenders to September 30,
1997) and January 31, 1998, respectively. In late 1996 and in 1997, the Company
has taken actions to reduce capital expenditures and to monitor uses of cash.
The Company believes that it will be able to fund its operating cash
requirements through operating cash flows and borrowings under the Second
Amended Facility through July 31, 1997, when the Company will be required to
reduce the outstanding amount of borrowings under the Second Amended Facility to
a maximum of $200 million. In developing its 1997 business plan, the Company did
not expect to generate sufficient cash flow from operations to meet the required
debt reduction and, therefore, management has adopted plans to divest HRI and is
seeking alternatives for the BSG Group, which it believes will generate
sufficient net proceeds to meet the July 31, 1997 reduction in the loan
commitments required by the Second Amended Facility. The Company has retained
investment banking counsel to advise it on the divestiture of HRI as well as to
assist in the evaluation of alternatives for the BSG Group. On March 14, 1997,
the Company filed a registration statement with the Commission relating to the
planned initial public offering of 100% of the common stock of HRI. This initial
public offering is subject to review by the Commission and the marketability of
HRI. There can be no assurance that the Company will be successful in its
efforts to sell HRI and/or the BSG Group. If the Company is unable to generate
sufficient net proceeds through the sale of HRI and/or the BSG Group or obtain
alternative debt financing by July 31, 1997 (unless extended by the lenders
until September 30, 1997), the Company's lenders can cause the borrowing under
the Second Amended Facility to become immediately due and payable.
As part of the consideration paid to the six-bank syndicate for the Second
Amended Facility, the Company issued the lenders warrants with vesting
arrangements for 1% of the Common Stock of the Company on each of January 1,
1998 and April 1, 1998. These warrants terminate if the Company has no
outstanding borrowings on the line of credit on December 31, 1997. The Company
has not allocated any value to these warrants because management believes the
Company will generate sufficient cash flows from asset sales or the refinancing
of any remaining borrowings under the Second Amended Facility to repay all the
borrowings under the Second Amended Facility by December 31, 1997.
OTHER MATTERS
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors (the "Audit Committee") in March 1997 prior
to completion of the audit process for the
A-18
<PAGE> 19
Company's 1996 fiscal year, information was developed that certain revenues and
expenses may have been recorded incorrectly between certain quarters during
1996. At the conclusion of the review, the Company determined that there were
certain accounting errors and irregularities and that its interim financial
statements for each fiscal quarter of 1996 required restatement. These errors
and irregularities consisted primarily of the following: (1) incorrect quarterly
recording of revenues and the related costs and expenses for certain contracts;
(2) incorrect quarterly recording of certain liabilities for employee bonuses
and related expenses; (3) certain costs and expenses of certain acquired
companies, which were later determined not to be properly recordable, were
recognized by those companies in periods prior to their acquisitions, resulting
in an overstatement of the Company's earnings subsequent to those acquisitions;
and (4) incorrect depreciation of certain assets related to the Company's
comprehensive reengineering and consolidation project.
The Company has determined that all appropriate adjustments have been made
to its interim financial statements and that its consolidated financial
statements, taken as a whole, present fairly in all material respects the
Company's financial position, results of operations and cash flows for its
fiscal quarter ended March 31, 1996 in conformity with generally accepted
accounting principles.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
----------------------------
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Revenue..................................................... $163,627 $162,249
Salaries and wages.......................................... 90,565 91,730
Other Operating expenses.................................... 39,354 39,335
Depreciation................................................ 4,951 5,940
Amortization................................................ 4,909 5,109
Income before income taxes.................................. 21,593 18,088
Net income.................................................. 12,725 10,659
Pro forma net income........................................ 13,079 11,013
Pro forma net income per common share....................... $ 0.17 $ 0.15
</TABLE>
A-19
<PAGE> 20
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The United States Attorney's Office for the Central District of California
is conducting an investigation (the "Federal Investigation") of Medaphis'
billing and collection practices in its offices located in Calabasas and
Cypress, California (the "Designated Offices"). Medaphis first became aware of
the Federal Investigation when it received search warrants and grand jury
subpoenas on June 13, 1995. Although the precise scope of the Federal
Investigation is not known to the Company at this time, Medaphis believes that
the U.S. Attorney's Office is investigating allegations of billing fraud and
that the inquiry is focused upon Medaphis' billing and collection practices in
the Designated Offices. Numerous federal and state civil and criminal laws
govern medical billing and collection activities. In general, these laws provide
for various fines, penalties, multiple damages, assessments and sanctions for
violations, including possible exclusion from Medicare, Medicaid and certain
other federal and state healthcare programs. Although the Designated Offices
represent less than 2% of Medaphis' annual revenue, there can be no assurance
that the Federal Investigation will be resolved promptly, that additional
subpoenas or search warrants will not be received by Medaphis or that the
Federal Investigation will not have a material adverse effect upon the Company.
The Company recorded charges of $12 million in the third quarter of 1995 and $2
million in the fourth quarter of 1996, solely for the administrative fees, costs
and expenses it anticipates incurring in connection with the Federal
Investigation and the putative class action lawsuits described below which were
filed following the Company's announcement of the Federal Investigation. The
charges are intended to cover only the anticipated expenses of the Federal
Investigation and the related lawsuits and do not include any provision for
fines, penalties, damages, assessments, judgments or sanctions that may arise
out of such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of common stock in April 1995 were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits allege violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of common stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the
named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contains any claims based on the Securities Act of 1933, as
amended, and the Company's underwriters and outside directors are no longer
named as defendants. On June 26, 1996, the court denied the plaintiffs' motion
to certify a plaintiffs' class. The plaintiffs and the defendants have reached
an agreement in principle to settle this action on a class-wide basis for $4.75
million, subject to court approval and other customary conditions (the "1995
Class Action Settlement"). The 1995 Class Action Settlement would also include
the related putative class action lawsuit currently pending in the Superior
Court of Cobb County, Georgia, described more fully below. The Company expects
to receive approximately $3.7 million from insurance to fund a portion of the
1995 Class Action Settlement and accrued approximately $1.2 million in the
quarter ending December 31, 1996 to fund the anticipated balance of the 1995
Class Action Settlement and to pay certain fees incident thereto.
On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James
S. Douglass were named as defendants in a putative shareholder class action
lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit
alleges violations of Georgia securities laws based on the same public
statements and filings generally described above. The lawsuit is brought on
behalf of a putative class of purchasers of Medaphis common stock during the
period from March 29, 1995 through June 15, 1995. The plaintiffs seek
compensatory damages and costs. As noted above, it is currently contemplated
that this action will be settled as part of the 1995 Class Action Settlement.
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests)
A-20
<PAGE> 21
concerning particular billing and collection practices related to certain
subsidiaries of the Company and its many clients. In March 1997, the Company was
informed by the Civil Division of the Department of Justice that it is
investigating allegations concerning the Company's Gottlieb's Financial
Services, Inc. ("GFS") subsidiary. The Company has received a request from the
Department of Justice for records, and may receive additional requests. The
Company intends to cooperate in producing records. There can be no assurance
that this matter will be resolved promptly or that the investigation will not
have a material adverse effect upon Medaphis.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its current and former
officers, one of whom was also a director, were named as defendants in nineteen
putative shareholder class action lawsuits filed in the United States District
Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs
in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996
Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges
violations of the federal securities laws in connection with Medaphis' filings
under the federal securities acts and public disclosures. The 1996 Consolidated
Complaint is brought on behalf of a class of all persons who purchased or
otherwise acquired Medaphis common stock between January 6, 1996 and October 21,
1996. The 1996 Consolidated Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis common stock pursuant to the
merger between Medaphis and Health Data Sciences Corporation ("HDS"). On
December 30, 1996, the defendants filed a motion to dismiss most of the 1996
Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated
Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss
the Consolidated Second Amended Complaint in its entirety.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs. On January 28, 1997, Medaphis and certain individual defendants filed a
motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an
amended complaint adding as defendants additional current and former directors
and officers of Medaphis. On April 23, 1997, Medaphis and certain of the
defendants filed a motion to dismiss the amended complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things more fully described in the complaint, making material
misstatements and omissions in public and private disclosures in connection with
the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive
damages, rescission, injunctive relief and costs. On January 10, 1997, the
defendants filed a demurrer to the complaint. The demurrer was denied on
February 5, 1997. On March 18, 1997, the court denied the plaintiff's motion for
a preliminary injunction. As a result of the Company's restatement of its fiscal
1995 financial statements, the Company may not be able to sustain a defense to
strict liability on certain claims under the 1933 Act, but the Company believes
that it has substantial defenses to the alleged damages relating to the 1933 Act
claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG Corporation ("BSG") common stock were
converted to Medaphis stock options in connection with Medaphis' acquisition of
BSG. The plaintiffs allege failure to perform diligence, breaches of fiduciary
duties of candor, loyalty and fair dealing and negligence against the BSG
defendants (Papermaster, Pickering, Lundeen, Smith, Noorda and Grosh) and fraud
and deceit against the Medaphis defendants (Medaphis and
A-21
<PAGE> 22
Brown). On April 18, 1997, the Medaphis defendants and BSG defendants filed
motions to dismiss the complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. On the date of the demand, Mr. Papermaster was an executive officer and a
director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997,
although he remains an executive officer of BSG. The indemnification demand
claims damages of $35 million (the maximum damages payable by Medaphis under the
indemnification agreement) for the alleged breach by the Company of its
representations and warranties made in the merger agreement between Medaphis and
BSG.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity
Trust, and the Paulanne H. Thacker Retained Annuity Trust filed a complaint
against the Company and Randolph G. Brown in the United States District Court
for the Southern District of New York arising out of Medaphis' acquisition of
Medical Management Sciences, Inc. ("MMS") in December of 1995. The complaint is
brought on behalf of all former shareholders of MMS who exchanged their MMS
holdings for unregistered shares of Medaphis common stock. In general, the
complaint alleges both common law fraud and violations of the federal securities
laws in connection with the merger. In addition, the complaint alleges breaches
of contract relating to the merger agreement and a registration rights
agreement, as well as tortious interference with economic advantage. The
plaintiffs seek rescission of the merger agreement and the return of all MMS
shares, as well as damages in excess of $100 million. Additionally, plaintiffs
seek to void various noncompete covenants and contract provisions between
Medaphis and plaintiffs.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") has notified the Company that it is conducting a non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ending September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996.
The Company intends to cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against, and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company, that the lawsuits, the written demands and the
pending governmental investigations will not have a disruptive effect upon the
operations of the business, that the written demands, the defense of the
lawsuits and the pending investigations will not consume the time and attention
of the senior management of the Company or that the resolution of the lawsuits,
the written demands and the pending governmental investigations will not have a
material adverse effect upon the Company.
ITEM 5. OTHER INFORMATION
On April 25, 1997, the Compensation Committee of the Board of Directors of
the Company approved an adjustment of the exercise price for certain outstanding
employee stock options which have an exercise price of $5.50 and above. No
adjustments were made to any options held by directors or former employees of
the Company. The revised exercise price of $5.375 was established by reference
to the closing price of the Company's common stock on April 25, 1997. In
approving the adjustment, the Compensation Committee relied upon the views of
its outside advisors with respect to the legal, accounting and compensation
issues associated with the action and took into consideration, among other
things, the following factors: (i) the Company had historically paid salaries
which were at or below market levels and had made up for lower salaries through
stock option grants to employees; (ii) the Company historically had used stock
options as its principal long-term incentive program; (iii) the highly skilled
employees of the Company possessed marketable skills; and (iv) senior management
of the Company believed that there was potential for increased attrition among
its key employees and that adjustment of the exercise price of the outstanding
options would significantly help to mitigate such risk.
A-22
<PAGE> 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 of
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 of
Registrant's Quarterly Report on Form 10-Q for the Quarterly
Period Ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-8, File
No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.2 of Registrant's 1992 Form 10-K,
File No. 000-19480)
4.1 -- Form of Warrant issued to one or more lenders pursuant to
Registrant's Second Amended and Restated Credit Agreement,
dated as of February 4, 1997 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K filed on February
18, 1997)
10.1 -- Sixth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Employees of Acquired Companies
(incorporated by reference to Exhibit 10.21 of the Annual
Report on Form 10-K for the year ended December 31, 1996,
File No. 000-19480)
10.2 -- First Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.24 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.3 -- Employment Agreement by and between Registrant and Daniel S.
Connors, Jr., dated February 25, 1997 (incorporated by
reference to Exhibit 10.50 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.4 -- Employment Agreement by and between Registrant and Carl
James Schaper, dated February 25, 1997 (incorporated by
reference to Exhibit 10.51 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.5 -- Employment Agreement by and between Registrant and Jerome H.
Baglien, dated January 3, 1997 (incorporated by reference to
Exhibit 10.52 of the Annual Report on Form 10-K for the year
ended December 31, 1996, File No. 000-19480)
10.6 -- Second Amended and Restated Credit Agreement, dated as of
February 4, 1997, among the Registrant, the lenders listed
therein and the Agent (incorporated by reference to Exhibit
99.2 to Current Report on Form 8-K filed on February 18,
1997)
10.7 -- Form of Second Amendment to the Amended and Restated
Medaphis Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.31 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking
Statements
</TABLE>
A-23
<PAGE> 24
(B) REPORTS ON FORM 8-K
The following reports on Form 8-K have been filed by the Company during the
quarter ended March 31, 1997:
<TABLE>
<CAPTION>
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILE DATE
- ------------- ---------- ----------------- -----------------
<S> <C> <C> <C>
7th Modification of bank agreement.... No December 31, 1996 January 3, 1997
1996 Year end press release, second
amended and restated credit
agreement........................... Yes(1) December 31, 1996 February 18, 1997
</TABLE>
- ---------------
(1) Consolidated statement of operations for the three months and year ended
December 31, 1996, condensed consolidated balance sheets as of December 31,
1996 and 1995 and supplemented consolidated segment data for the quarterly
periods ended March 31, June 30, September 30 and December 31, 1996 and
1995.
A-24
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDAPHIS CORPORATION
By: /s/ JEROME H. BAGLIEN
-----------------------------------
Jerome H. Baglien
Senior Vice President, Chief Financial Officer
and Assistant Secretary
Date: May 6, 1997
A-25
<PAGE> 26
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF EXHIBITS PAGE
- ------- ----------------------- ------------
<C> <C> <S> <C>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 of
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 of
Registrant's Quarterly Report on Form 10-Q for the Quarterly
Period Ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-8, File
No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.2 of Registrant's 1992 Form 10-K,
File No. 000-19480)
4.1 -- Form of Warrant issued to one or more lenders pursuant to
Registrant's Second Amended and Restated Credit Agreement,
dated as of February 4, 1997 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K filed on February
18, 1997)
10.1 -- Sixth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Employees of Acquired Companies
(incorporated by reference to Exhibit 10.21 of the Annual
Report on Form 10-K for the year ended December 31, 1996,
File No. 000-19480)
10.2 -- First Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.24 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.3 -- Employment Agreement by and between Registrant and Daniel S.
Connors, Jr., dated February 25, 1997 (incorporated by
reference to Exhibit 10.50 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.4 -- Employment Agreement by and between Registrant and Carl
James Schaper, dated February 25, 1997 (incorporated by
reference to Exhibit 10.51 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
10.5 -- Employment Agreement by and between Registrant and Jerome H.
Baglien, dated January 3, 1997 (incorporated by reference to
Exhibit 10.52 of the Annual Report on Form 10-K for the year
ended December 31, 1996, File No. 000-19480)
10.6 -- Second Amended and Restated Credit Agreement, dated as of
February 4, 1997, among the Registrant, the lenders listed
therein and the Agent (incorporated by reference to Exhibit
99.2 to Current Report on Form 8-K filed on February 18,
1997)
10.7 -- Form of Second Amendment to the Amended and Restated
Medaphis Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.31 of the Annual Report on Form 10-K
for the year ended December 31, 1996, File No. 000-19480)
</TABLE>
A-26
<PAGE> 27
<TABLE>
<C> <C> <S> <C>
11 -- Statement regarding Computation of Earnings Per Share
27 -- Financial Data Schedule (for SEC use only)
99.1 -- Safe Harbor Compliance Statement for Forward-Looking Statements
</TABLE>
A-27
<PAGE> 1
EXHIBIT 11
MEDAPHIS CORPORATION
COMPUTATION OF PRIMARY AND FULLY DILUTED PRO FORMA EARNINGS PER SHARE
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
DESCRIPTION 1997 1996
- ----------- ------- -------
<S> <C> <C>
Weighted average shares outstanding during the period....... 72,235 70,434
Shares issuable upon assumed exercise of stock options, less
amounts assumed repurchased under the treasury stock
method.................................................... -- 5,270
------- -------
Total weighted average common stock and common stock
equivalents outstanding during the period................. 72,235 75,704
======= =======
Pro forma net income (loss)................................. $(1,839) $11,013
======= =======
Pro forma net income (loss) per common share................ $ (0.03) $ 0.15
======= =======
</TABLE>
A-28
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 10,174
<SECURITIES> 0
<RECEIVABLES> 190,891
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 271,003
<PP&E> 92,798
<DEPRECIATION> 0
<TOTAL-ASSETS> 810,673
<CURRENT-LIABILITIES> 241,454
<BONDS> 0
0
0
<COMMON> 724
<OTHER-SE> 393,444
<TOTAL-LIABILITY-AND-EQUITY> 810,673
<SALES> 147,546
<TOTAL-REVENUES> 147,546
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 145,495
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,115
<INCOME-PRETAX> (4,064)
<INCOME-TAX> (2,225)
<INCOME-CONTINUING> (1,839)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,839)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
<PAGE> 1
EXHIBIT 99.1
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR COMPLIANCE STATEMENT
FOR FORWARD-LOOKING STATEMENTS
In passing the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"), 15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996), Congress
encouraged public companies to make "forward-looking statements" by creating a
safe harbor to protect companies from securities law liability in connection
with forward-looking statements. Medaphis Corporation ("Medaphis" or the
"Company") intends to qualify both its written and oral forward-looking
statements for protection under the Reform Act and any other similar safe harbor
provisions.
"Forward-looking statements" are defined by the Reform Act. Generally,
forward-looking statements include expressed expectations of future events and
the assumptions on which the expressed expectations are based. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties which could cause actual
events or results to differ materially from those projected. Due to those
uncertainties and risks, the investment community is urged not to place undue
reliance on written or oral forward-looking statements of Medaphis. The Company
undertakes no obligation to update or revise this Safe Harbor Compliance
Statement for Forward-Looking Statements (the "Safe Harbor Statement") to
reflect future developments. In addition, Medaphis undertakes no obligation to
update or revise forward-looking statements to reflect changed assumptions, the
occurrence of unanticipated events or changes to future operating results over
time.
Medaphis provides the following risk factor disclosure in connection with
its continuing effort to qualify its written and oral forward-looking statements
for the safe harbor protection of the Reform Act and any other similar safe
harbor provisions. Important factors currently known to management that could
cause actual results to differ materially from those in forward-looking
statements include the following:
FUTURE OPERATING RESULTS. While Medaphis has in the past expanded its
operations through acquisitions and internal growth, the 1997 business plan of
the Company does not provide for further acquisitions and, in any event, any
such acquisitions would require the unanimous consent of the Company's existing
lenders. While the Company has and continues to implement management initiatives
designed to enhance and improve its business and operations, there can be no
assurance that Medaphis will be able to achieve or sustain profitability or
revenue growth on an annual or quarterly basis in the future, that fluctuations
in quarter-to-quarter or year-to-year operating results will not occur or that
any such quarter-to-quarter or year-to-year fluctuations will not be material.
Future operating results of Medaphis will be dependent upon, among other things,
(i) successful integration of certain recently acquired businesses, (ii)
successfully exiting non-core businesses, (iii) improvement in operations of the
Company's physician billing business, (iv) successful implementation of various
management initiatives designed to reduce costs and increase efficiencies within
the Company's core business and (v) successful growth in sales of the Company's
business management services and information products.
The Company has recently consummated a number of significant acquisitions,
many of which the Company is in the process of integrating into its operations.
In addition, the Company recently announced its intention to focus on its core
business of delivering business management services and information products to
healthcare providers and to divest non-strategic businesses, including
Healthcare Recoveries, Inc. ("HRI"). The Company also recently announced that it
was assessing alternatives for its client/server integration businesses (the
"BSG Group), including, but not limited to, seeking a buyer, a spin-off
transaction or other capital-raising alternatives. There can be no assurance
that the Company will be able to successfully integrate any of the recently
acquired companies, that Medaphis will be able to continue to operate recently
acquired companies in a profitable manner or that any of the recently acquired
companies will not have a material adverse effect upon Medaphis' results of
operations, particularly while such acquisitions are being integrated into the
Company. Similarly, there can be no assurance that the Company will be able to
successfully exit
<PAGE> 2
non-core businesses in a timely fashion or at all, that the Company will be able
to divest HRI on favorable terms, that the Company will be able to find a buyer
or develop suitable alternatives for the BSG Group or that any such divestiture
and/or assessment will not have a material adverse effect upon the results of
operations of the Company. Additionally, there can be no assurance that any such
divestiture or assessment will not have an adverse effect upon the results of
operations of HRI or the BSG Group or the reputation and standing of each of
these businesses in their respective markets or their ability to attract and
retain key employees.
During the six months ended December 31, 1996, the Company undertook to
reorganize its Imonics operating unit, integrate the Imonics operations into BSG
Corporation ("BSG") and to discontinue the custom software development business
previously pursued by the Imonics unit. This process involved, among other
things, recording large restructuring and other charges during the relevant
period, significant downsizing of Imonics' employee workforce, renegotiation of
Imonics' significant client contracts and other restructuring, reorganization
and exit activities. There can be no assurance that such restructuring and
reorganization activities will not have an adverse effect upon the reputation
and standing of Medaphis, BSG and/or Rapid Systems Solutions, Inc. in the
information management and client/server information technology marketplaces or
that such matters will not have an adverse effect upon the results of operations
of Medaphis in future periods or adversely effect BSG's ability to attract and
retain key employees.
The Company's expansion strategy in the past has involved both acquisitions
and internal growth. The Company recently announced that it intends to focus on
its core business of delivering business management services and information
products to healthcare providers and to divest non-strategic businesses.
Moreover, the Company does not currently anticipate pursuing any significant
acquisitions. There can be no assurance that such shift in focus will not have
an adverse effect upon the Company's revenue and operations.
The Company is experiencing margin pressure in the billing and accounts
receivable management services operations of Medaphis Physician Services
Corporation, a wholly owned subsidiary of the Company ("MPSC"). MPSC has not
significantly contributed to the Company's overall results of operations for the
past eighteen months. Management does not expect this trend to improve
significantly until further progress is made with, among other things, ongoing
initiatives designed to reduce redundant costs, improve efficiencies and enhance
operational effectiveness in MPSC's operations. One of the major components of
the Company's 1997 operating plan is to reduce costs and increase efficiencies
in the core business. During 1996 and going forward, the Company has and will
continue to implement various initiatives within the Company's Services Division
(which includes MPSC) designed to reduce costs and improve operational
efficiency. These initiatives have included, among other things, downsizing of
management ranks and improvements in operational processes through the
implementation of best practices. Although the preliminary indications from such
management initiatives have been positive, there can be no assurance that the
Company will be able to successfully implement such initiatives throughout
MPSC's operations, that such management initiatives ultimately will be
successful, that MPSC's margins will improve or that MPSC will contribute
meaningfully to the Company's overall results of operations in future periods.
The Company's future operations are dependent upon, among other things,
continued growth in sales of its healthcare information technology ("HIT")
products, including, but not limited to, sales of its clinical information
management system in both domestic and international markets. The markets for
these products are characterized by rapidly changing technology, evolving
industry standards and frequent new products and product enhancements. The
Company's success in its HIT business will depend upon its continued ability (i)
to enhance its existing products, (ii) to effect conversions of existing
products into foreign languages, (iii) to introduce new products on a timely and
cost effective basis to meet evolving customer requirements, (iv) to achieve
market acceptance for new product offerings and (v) to respond to emerging
industry standards and other technological changes. During the six months ended
December 31, 1996, the Company experienced slower than expected sales of certain
of its enterprise-wide and departmental scheduling products. There can be no
assurance that sales of such scheduling products will improve, that Medaphis
will be able to effectively enhance existing products, create new products or
respond to technological changes or new industry standards. Moreover, there can
be no assurance that competitors of Medaphis will not develop competitive
<PAGE> 3
products, or that any such competitive products will not have an adverse effect
upon Medaphis' operating results.
The Company recently announced its operating plan for 1997. As noted above,
the operating plan involves refocusing the Company on its core business of
providing business management services and information products to healthcare
providers. The major components of the plan include (i) exiting non-core
businesses, (ii) achieving improved predictability of business results through
enhanced management accountability and controls, (iii) reducing costs and
increasing efficiencies in the core business, (iv) achieving excellence in
customer service, and (v) implementing cross-selling initiatives. Although
management believes that the 1997 operating plan reflects the key action items
which will contribute to Medaphis' efforts to improve and enhance the operations
of the Company, there can be no assurance that the operating plan will result in
meaningful improvements to the Company's operating results in future periods or
that the plan will ultimately be successful.
ABANDONED REENGINEERING PROGRAM; EXISTING SYSTEMS AND TECHNOLOGY. The
Company recently announced that it had abandoned its reengineering program. This
decision was reached at the conclusion of a comprehensive assessment of the
program begun during 1996. The conclusions of the assessment were that it was
not cost effective to continue the development and deployment of the software
and technology upon which the reengineering program was based and that the
reengineering software and technology had no alternative useful application in
the Company's operations. In lieu of further developing and deploying the
reengineering software and technology, the Company intends to further refine,
enhance and develop certain of the Company's existing software and billing
systems and to migrate over time the Company's billing and accounts receivable
management services operations to the Company's most proven software systems and
technology, so as to reduce the number of systems and technology that must be
maintained and supported. Moreover, management intends to continue to implement
"best practices" and other established process improvements in its operations
going forward. There can be no assurance that the Company will be able to
successfully refine, enhance and develop its software and billing systems going
forward, that the costs associated with maintaining, enhancing and developing
such software and systems will not increase significantly in future periods,
that the Company will be able to successfully migrate the Company's billing and
accounts receivable management services operations to the Company's most proven
software systems and technology or that the Company's existing software and
technology will not become obsolete as a result of ongoing technological
developments in the marketplace.
CASH FLOW FROM OPERATIONS; SENIOR CREDIT FACILITY. During the year ended
December 31, 1996, the Company used approximately $7.9 million in cash for
operating activities. At March 31, 1997, approximately $244 million in
borrowings were outstanding under the Company's second amended facility. The
previous senior credit facility was amended and restated on February 4, 1997
(the "Second Amended Facility") to, among other things, increase the loan
commitments from $250 million to $285 million and extend the maturity through
June 30, 1998. The Second Amended Facility is secured by substantially all of
the Company's assets and is guaranteed by substantially all of the Company's
subsidiaries. The loan commitments under the Second Amended Facility will reduce
to $200 million on July 31, 1997 (unless extended to September 30, 1997) and
$150 million on January 31, 1998. Certain of the other material terms of the
Second Amended Facility include adjustment of the interest rates, fees and
charges and other compensation to be paid to the lenders by the Company,
including the vesting of certain warrant arrangements for 1% of the common stock
of the Company on each of January 1, 1998 and April 1, 1998; modification of the
financial reporting requirement to the lenders; restrictions on new acquisitions
and certain litigation settlement payments; and establishment of a maximum
permitted capital expenditures covenant for the fiscal quarter ending March 31,
1997 and additional financial covenants for fiscal quarters ending on and after
June 30, 1997. This summary of certain terms of the Second Amended Facility and
the warrants are subject to the terms of the agreements which have been
incorporated by reference as exhibits to the Company's Annual Report on Form
10-K filed March 31, 1997.
While management presently anticipates that the liquidity provided in the
Second Amended Facility (together with anticipated results from operations based
on the 1997 business plan) will be sufficient to fund the Company's anticipated
operating and capital expenditure requirements during 1997, there can be no
<PAGE> 4
assurance that there will not be material deviations in actual operations from
the 1997 business plan which would make it necessary for the Company to seek
either further modifications to the Amended Facility or other sources of
liquidity. Similarly, while the Company presently anticipates that the timing
and proceeds from the previously announced non-core business divestiture program
will be sufficient to meet the Company's principal amortization and other
obligations under the Second Amended Facility, there can be no assurance that
the timing or amount of the proceeds to be generated from business divestitures
for debt service purposes will not require further modifications of the Second
Amended Facility, some of which modifications would require the consent of all
of the lenders thereto. Finally, while the Second Amended Facility incorporates
an extension of maturity through June 30, 1998, the Company will be required to
renegotiate the Second Amended Facility prior to maturity and complete its
non-core business divestiture program in order to provide adequate liquidity for
the Company's 1998 business plan. There can be no assurance that the Company's
lenders will agree to further modifications of the Second Amended Facility or
that the Company will complete the non-core business divestiture program as
required. The Company may also be required to consider other alternative
financing arrangements and/or equity transactions, which could prove costly
and/or involve further dilution to the Company's stockholders. There can be no
assurance that any such alternative financing arrangements and/or equity
transactions will be available to the Company on acceptable terms or at all.
PENDING FEDERAL INVESTIGATION; PUTATIVE CLASS ACTION LAWSUITS. The United
States Attorney's Office for the Central District of California is conducting an
investigation (the "Federal Investigation") of Medaphis' billing and collection
practices in its offices located in Calabasas and Cypress, California (the
"Designated Offices"). Medaphis first became aware of the Federal Investigation
when it received search warrants and grand jury subpoenas on June 13, 1995.
Although the precise scope of the Federal Investigation is not known to the
Company at this time, Medaphis believes that the U.S. Attorney's Office is
investigating allegations of billing fraud and that the inquiry is focused upon
Medaphis' billing and collection practices in the Designated Offices. Numerous
federal and state civil and criminal laws govern medical billing and collection
activities. In general, these laws provide for various fines, penalties,
multiple damages, assessments and sanctions for violations, including possible
exclusion from Medicare, Medicaid and certain other federal and state healthcare
programs. Although the Designated Offices represent less than 2% of Medaphis'
annual revenue, there can be no assurance that the Federal Investigation will be
resolved promptly, that additional subpoenas or search warrants will not be
received by Medaphis or that the Federal Investigation will not have a material
adverse effect upon the Company. The Company recorded charges of $12 million in
the third quarter of 1995 and $2 million in the fourth quarter of 1996, solely
for the administrative fees, costs and expenses it anticipates incurring in
connection with the Federal Investigation and the putative class action lawsuits
described below which were filed following the Company's announcement of the
Federal Investigation. The charges are intended to cover only the anticipated
expenses of the Federal Investigation and the related lawsuits and do not
include any provision for fines, penalties, damages, assessments, judgments or
sanctions that may arise out of such matters.
Following the announcement of the Federal Investigation, Medaphis, various
of its current and former officers and directors and the lead underwriters
associated with Medaphis' public offering of common stock in April 1995 were
named as defendants in putative shareholder class action lawsuits filed in the
United States District Court for the Northern District of Georgia. In general,
these lawsuits allege violations of the federal securities laws in connection
with Medaphis' public statements and filings under the federal securities acts,
including the registration statement filed in connection with Medaphis' public
offering of common stock in April 1995. On October 13, 1995, the named
plaintiffs in these lawsuits filed a consolidated class action complaint (the
"Consolidated Complaint"). On January 3, 1996, the court denied defendants'
motion to dismiss the Consolidated Complaint. On April 11, 1996, certain of the
named plaintiffs to the Consolidated Complaint voluntarily dismissed with
prejudice all of their claims. As a result of these dismissals, the Consolidated
Complaint no longer contains any claims based on the Securities Act of 1933, as
amended, and the Company's underwriters and outside directors are no longer
named as defendants. On June 26, 1996, the court denied the plaintiffs' motion
to certify a plaintiffs' class. The plaintiffs and the defendants have reached
an agreement in principle to settle this action on a class-wide basis for $4.75
million, subject to court approval and other customary conditions (the "1995
Class Action Settlement"). The 1995 Class Action Settlement would also include
the related putative class action lawsuit currently pending in the Superior
Court of Cobb
<PAGE> 5
County, Georgia, described more fully below. The Company expects to receive
approximately $3.7 million from insurance to fund a portion of the 1995 Class
Action Settlement and accrued approximately $1.2 million in the quarter ending
December 31, 1996 to fund the anticipated balance of the 1995 Class Action
Settlement and to pay certain fees incident thereto.
On November 5, 1996, Medaphis, Randolph G. Brown, Michael R. Cote and James
S. Douglass were named as defendants in a putative shareholder class action
lawsuit filed in Superior Court of Cobb County, State of Georgia. This lawsuit
alleges violations of Georgia securities laws based on the same public
statements and filings generally described above. The lawsuit is brought on
behalf of a putative class of purchasers of Medaphis common stock during the
period from March 29, 1995 through June 15, 1995. The plaintiffs seek
compensatory damages and costs. As noted above, it is currently contemplated
that this action will be settled as part of the 1995 Class Action Settlement.
The Company and its clients from time to time have received, and the
Company anticipates that they will receive in the future, official inquiries
(including subpoenas, search warrants, as well as informal requests) concerning
particular billing and collection practices related to certain subsidiaries of
the Company and its many clients. In March 1997, the Company was informed by the
Civil Division of the Department of Justice that it is investigating allegations
concerning the Company's Gottlieb's Financial Services, Inc. ("GFS") subsidiary.
The Company has received a request from the Department of Justice for records,
and may receive additional requests. The Company intends to cooperate in
producing records. There can be no assurance that this matter will be resolved
promptly or that the investigation will not have a material adverse effect upon
Medaphis.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its current and former
officers, one of whom was also a director, were named as defendants in nineteen
putative shareholder class action lawsuits filed in the United States District
Court for the Northern District of Georgia. On November 22, 1996, the plaintiffs
in these lawsuits filed a Consolidated Amended Class Action Complaint (the "1996
Consolidated Complaint"). In general, the 1996 Consolidated Complaint alleges
violations of the federal securities laws in connection with Medaphis' filings
under the federal securities acts and public disclosures. The 1996 Consolidated
Complaint is brought on behalf of a class of all persons who purchased or
otherwise acquired Medaphis common stock between January 6, 1996 and October 21,
1996. The 1996 Consolidated Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis common stock pursuant to the
merger between Medaphis and Health Data Sciences Corporation ("HDS"). On
December 30, 1996, the defendants filed a motion to dismiss most of the 1996
Consolidated Complaint. On February 3, 1997, the plaintiffs filed a Consolidated
Second Amended Complaint. On February 14, 1997, the defendants moved to dismiss
the Consolidated Second Amended Complaint in its entirety.
On November 1, 1996, Thomas W. Brown, Administrator, Thomas W. Brown Profit
Sharing Plan filed a shareholder derivative lawsuit in the United States
District Court for the Northern District of Georgia alleging that certain of
Medaphis' current and former directors breached their fiduciary duties, were
grossly negligent, and breached various contractual obligations to Medaphis by
allegedly failing to implement and maintain an adequate system of internal
accounting controls, allowing Medaphis to commit securities law violations and
damaging Medaphis' reputation. The plaintiff seeks compensatory damages and
costs. On January 28, 1997, Medaphis and certain individual defendants filed a
motion to dismiss the complaint. On February 11, 1997, the plaintiff filed an
amended complaint adding as defendants additional current and former directors
and officers of Medaphis. On April 23, 1997, Medaphis and certain of the
defendants filed a motion to dismiss the amended complaint.
On November 7, 1996, Health Systems International, Inc. filed suit in the
Superior Court for the State of California, County of Los Angeles against
Medaphis, Randolph G. Brown and "Does 1-50," who are alleged to be unnamed
Medaphis directors, officers and employees. Generally, this lawsuit alleges that
the defendants violated federal and California securities laws and common law
by, among other things more fully described in the complaint, making material
misstatements and omissions in public and private disclosures in connection with
the acquisition of HDS. Plaintiff seeks rescissory, compensatory and punitive
damages, rescission,
<PAGE> 6
injunctive relief and costs. On January 10, 1997, the defendants filed a
demurrer to the complaint. The demurrer was denied on February 5, 1997. On March
18, 1997, the court denied the plaintiff's motion for a preliminary injunction.
As a result of the Company's restatement of its fiscal 1995 financial
statements, the Company may not be able to sustain a defense to strict liability
on certain claims under the 1933 Act, but the Company believes that it has
substantial defenses to the alleged damages relating to the 1933 Act claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberg against Steven G. Papermaster, Robert E. Pickering, Jr., David S.
Lundeen, Norman Smith, Raymond J. Noorda, Gregory A. Grosh, Medaphis and
Randolph G. Brown on November 12, 1996 in the Superior Court, Law Division,
Essex County, State of New Jersey. The alleged class consists of persons and
entities whose options to purchase BSG common stock were converted to Medaphis
stock options in connection with Medaphis' acquisition of BSG. The plaintiffs
allege failure to perform diligence, breaches of fiduciary duties of candor,
loyalty and fair dealing and negligence against the BSG defendants (Papermaster,
Pickering, Lundeen, Smith, Noorda and Grosh) and fraud and deceit against the
Medaphis defendants (Medaphis and Brown). On April 18, 1997, the Medaphis
defendants and BSG defendants filed motions to dismiss the complaint.
On February 28, 1997, Steven G. Papermaster, Raymond J. Noorda and two
entities they control made a demand for indemnification under an indemnification
agreement executed by Medaphis in connection with its acquisition of BSG in May
1996. On the date of the demand, Mr. Papermaster was an executive officer and a
director of Medaphis. Mr. Papermaster resigned such positions on March 21, 1997,
although he remains an executive officer of BSG. The indemnification demand
claims damages of $35 million (the maximum damages payable by Medaphis under the
indemnification agreement) for the alleged breach by the Company of its
representations and warranties made in the merger agreement between Medaphis and
BSG.
On April 21, 1997, James F. Thacker, Alyson T. Stinson, Carol T. Shumaker,
Lori T. Caudill, William J. Dezonia, the James F. Thacker Retained Annuity
Trust, and the Paulanne H. Thacker Retained Annuity Trust filed a complaint
against the Company and Randolph G. Brown in the United States District Court
for the Southern District of New York arising out of Medaphis' acquisition of
Medical Management Sciences, Inc. ("MMS") in December of 1995. The complaint is
brought on behalf of all former shareholders of MMS who exchanged their MMS
holdings for unregistered shares of Medaphis common stock. In general, the
complaint alleges both common law fraud and violations of the federal securities
laws in connection with the merger. In addition, the complaint alleges breaches
of contract relating to the merger agreement and a registration rights
agreement, as well as tortious interference with economic advantage. The
plaintiffs seek rescission of the merger agreement and the return of all MMS
shares, as well as damages in excess of $100 million. Additionally, plaintiffs
seek to void various noncompete covenants and contract provisions between
Medpahis and plaintiffs.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it is conducting a non-public
investigation into, among other things, certain trading and other issues related
to Medaphis' August 14, 1996 and October 22, 1996 announcements of the Company's
loss for the quarter ending September 30, 1996 and its restated consolidated
financial statements for the three months and year ended December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996.
The Company intends to cooperate fully with the Commission in its investigation.
Although the Company believes that it has meritorious defenses to the
claims of liability or for damages in the actions against, and written demands
placed upon the Company, there can be no assurance that additional lawsuits will
not be filed against the Company, that the lawsuits, the written demands and the
pending governmental investigations will not have a disruptive effect upon the
operations of the business, that the written demands, the defense of the
lawsuits and the pending investigations will not consume the time and attention
of the senior management of the Company or that the resolution of the lawsuits,
the written demands and the pending governmental investigations will not have a
material adverse effect upon the Company.
<PAGE> 7
HEALTHCARE FRAUD INITIATIVES; HEALTHCARE REFORM MEASURES
The federal government in recent years has placed increased scrutiny on the
billing and collection practices of healthcare providers and related entities.
This scrutiny has been directed at, among other things, fraudulent billing
practices. The Department of Health and Human Services in recent years has
increased the resources of its Office of the Inspector General ("OIG")
specifically to pursue both false claims and fraud and abuse violations of the
Medicare program. This heightened examination has resulted in a number of high
profile investigations, lawsuits and settlements.
In 1996, Congress enacted the Health Insurance Portability and Accounting
Act of 1996, Pub. L. No. 104-191, 1996 U.S.C.C.A.N. (110 Stat. 1936) (the
"Health Insurance Act"), which includes an expansion of certain fraud and abuse
provisions, such as expanding the application of Medicare and Medicaid fraud
penalties to other federal healthcare programs, and creating additional criminal
offenses relating to "healthcare benefit programs," which are defined to include
both public and private payor programs. The Health Insurance Act also provides
for forfeitures and asset freezing orders in connection with such healthcare
offenses. Civil monetary penalties and program exclusion authority available to
the OIG also have been expanded. The Health Insurance Act contains provisions
for instituting greater coordination of federal, state and local enforcement
agency resources and actions through the OIG. There also have been several
recent healthcare reform proposals which have included an expansion of the
anti-kickback laws to include referrals of any patients regardless of payor
source.
In addition to the provisions of the Health Insurance Act, submission of
claims for services or procedures that are not provided as claimed may lead to
civil monetary penalties, criminal fines, imprisonment and/or exclusion from
participation in Medicare, Medicaid and other federally funded healthcare
programs. Specifically, the Federal False Claims Act allows a private person to
bring suit alleging false or fraudulent Medicare or Medicaid claims or other
violations of the statute and for such person to share in any amounts paid to
the government in damages and civil penalties. Successful plaintiffs can receive
up to 25-30% of the total recovery from the defendant. Such qui tam actions or
"whistleblower lawsuits" have increased significantly in recent years and have
increased the risk that a company engaged in the healthcare industry such as
Medaphis and many of its customers may become the subject of a federal or state
investigation or may ultimately be required to defend a false claims action, may
be subjected to government investigation and possible criminal fines, may be
sued by private payors, and may be excluded from Medicare, Medicaid and/or other
federally funded healthcare programs as a result of such an action. The
government on its own may also institute a Civil False Claims Act case, either
in conjunction with a criminal prosecution or as a stand alone civil case.
Whether instituted by a qui tam plaintiff or by the government, the government
can recover triple its damages together with civil penalties of $5,000-$10,000
per false claim. Under applicable case law, a party successfully sued under the
False Claims Act may be jointly and severally liable for the damages and
penalties. Some state laws also provide for false claims actions, including
actions initiated by a qui tam plaintiff. There can be no assurance that
Medaphis will not be the subject of false claims or qui tam proceedings relating
to its billing and collection activities or that Medaphis will not be the
subject of further government scrutiny or investigations relating to its billing
and accounts receivable management services operations. See "Pending Federal
Investigation; Putative Class Action Lawsuits." Any such proceeding or
investigation could have a material adverse effect upon the Company.
In the 1995 and 1996 sessions of the United States Congress, the focus of
healthcare legislation was on budgetary and related funding mechanism issues. A
number of reports, including the 1995 Annual Report of the Board of Trustees of
the Federal Hospital Insurance Program (Medicare), have projected that the
Medicare "trust fund" is likely to become insolvent by the year 2002 if the
current growth rate of approximately 10% per annum in Medicare expenditures
continue. Similarly, federal and state expenditures under the Medicaid program
are projected to increase significantly during the same seven-year period. In
response to these projected expenditure increases, and as part of an effort to
balance the federal budget, both the Congress and the Clinton Administration
have made proposals to reduce the rate of increase in projected Medicare and
Medicaid expenditures and to change funding mechanisms and other aspects of both
programs. In late 1995, Congress passed legislation that would substantially
reduce projected expenditure increases substantially and would make significant
changes in the Medicare and the Medicaid programs. The Clinton
<PAGE> 8
Administration has proposed alternate measures to reduce, to a lesser extent,
projected increases in Medicare and Medicaid expenditures. Neither proposal
became law prior to Congress' 1996 adjournment. Medaphis anticipates that both
the Clinton Administration and the Republican majorities in Congress will
introduce legislation in 1997 designed to reduce projected increases in Medicare
and Medicaid expenditures and to make other changes in the Medicare and Medicaid
programs. Medaphis anticipates that such proposed legislation would, if adopted,
change aspects of the present methods of paying physicians under such programs
and provide incentives for Medicare and Medicaid beneficiaries to enroll in
health maintenance organizations and other managed care plans. Medaphis cannot
predict the effect of any such legislation, if adopted, on its operations.
A number of states in which Medaphis has operations either have adopted or
are considering the adoption of healthcare reform proposals at the state level.
Medaphis cannot predict the effect of proposed state healthcare reform laws on
its operations. Additionally, certain reforms are occurring in the healthcare
market which may continue regardless of whether comprehensive federal or state
healthcare reform legislation is adopted and implemented. These market reforms
include certain employer initiatives such as creating purchasing cooperatives
and contracting for healthcare services for employees through managed care
companies (including health maintenance organizations), and certain provider
initiatives such as risk-sharing among healthcare providers and managed care
companies through capitated contracts and integration among hospitals and
physicians into comprehensive delivery systems. Consolidation of management and
billing services by integrated delivery systems may result in a decrease in
demand for Medaphis' billing and collection services for particular physician
practices, but this decrease may be offset by an increase in demand for
Medaphis' consulting and comprehensive business management services (including
billing and collection services) for the new provider systems.
CLIENT/SERVER INFORMATION TECHNOLOGY PROJECTS. Medaphis' client/server
information technology business involves, among other things, projects designed
to reengineer significant client operations through the strategic use of
imaging, client/server and other advanced technologies. Failure to meet
expectations with respect to a major project could damage the Company's
reputation and standing in the client/server information technology marketplace,
affect its ability to attract new client/server information technology business,
result in the payment of damages to the client and jeopardize the Company's
ability to collect for services already performed on the project.
VOLATILITY OF STOCK PRICE. Medaphis believes factors such as announcements
with respect to the Federal Investigation, the Company's liquidity and financial
resources, divestiture of businesses, the ongoing governmental investigations,
putative class action lawsuits, other lawsuits or demands, healthcare reform
measures and quarter-to-quarter and year-to-year variations in financial results
could cause the market price of Medaphis common stock to fluctuate
substantially. Any adverse announcement with respect to such matters or any
shortfall in revenue or earnings from levels expected by securities analysts
could have an immediate and material adverse effect on the trading price of
Medaphis common stock in any given period. As a result, the market for Medaphis
common stock may experience material adverse price and volume fluctuations and
an investment in the Company's common stock is not suitable for any investor who
is unwilling to assume the risk associated with any such price and volume
fluctuations.
COMPETITION. Medaphis faces intense competition in each of the areas in
which it does business. In providing business management systems and services to
physicians and hospitals, Medaphis competes with certain national information
management systems and transaction processing organizations, certain regional
companies which provide such systems or services and certain physician groups
and hospitals which provide their own business management services. In providing
subrogation and recovery services, Medaphis competes primarily with the internal
recovery operations of potential customers and with certain regional subrogation
recovery vendors. In terms of providing client/server information technology
services, Medaphis competes with national, regional and local companies
specializing in information technology and systems integration consulting
services, national and regional application development companies and the
software development and systems integration units of national computer
equipment manufacturers, large information systems facilities management and
outsourcing organizations, national "Big Six" accounting firms and the
information systems groups of large general management consulting firms. Certain
of Medaphis' competitors have longer
<PAGE> 9
operating histories and greater financial, technical and marketing resources
than Medaphis. There can be no assurance that competition from current or
potential competitors will not have a material adverse effect upon Medaphis.
This Safe Harbor Statement supersedes the Safe Harbor Statement filed as
Exhibit 99.6 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996.
