<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
<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 SEPTEMBER 30, 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>
<C> <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>
SHARES OUTSTANDING
TITLE OF CLASS AT NOVEMBER 7, 1997
- -------------- -------------------
<S> <C>
Common Stock $0.01 Par Value................................ 73,208,235 Shares
Non-voting Common Stock $0.01 Par Value..................... 0 Shares
</TABLE>
================================================================================
<PAGE> 2
MEDAPHIS CORPORATION
FORM 10-Q/A
SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I: FINANCIAL INFORMATION
Consolidated Statements of Operations for the three and
nine months ended September 30, 1997 and 1996, as
restated............................................... 3
Consolidated Balance Sheets as of September 30, 1997 and
December 31, 1996, as restated......................... 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1997 and 1996, as restated......... 5
Notes to Consolidated Financial Statements................ 6
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 21
PART II: OTHER INFORMATION
Legal Proceedings......................................... 31
Exhibits and Reports on Form 8-K.......................... 35
</TABLE>
THIS FORM 10-Q/A 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. FIFTEEN 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/A, 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.
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 NINE MONTHS ENDED
---------------------------------- ---------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
--------------- ---------------- --------------- ---------------
(AS RESTATED, (AS RESTATED, (AS RESTATED, (AS RESTATED,
SEE NOTE 6) SEE NOTE 6) SEE NOTE 6) SEE NOTE 6)
<S> <C> <C> <C> <C>
Revenue.................................. $124,649 $132,121 $423,162 $455,138
Salaries and wages....................... 95,544 106,473 281,508 293,425
Other operating expenses................. 37,818 39,370 115,841 118,594
Depreciation............................. 7,505 7,201 21,540 19,981
Amortization............................. 5,798 6,234 18,001 19,299
Interest expense, net.................... 7,246 3,284 19,417 8,019
Litigation settlement.................... 52,500 -- 52,500 --
Restructuring and other charges.......... 13,837 24,534 16,661 41,729
-------- -------- -------- --------
Total expenses................. 220,248 187,096 525,468 501,047
Loss before income taxes and
extraordinary item..................... (95,599) (54,975) (102,306) (45,909)
Income tax benefit....................... (14,390) (20,966) (16,773) (11,039)
-------- -------- -------- --------
Loss before extraordinary item........... (81,209) (34,009) (85,533) (34,870)
Extraordinary income on sale of HRI, net
of tax................................. -- -- 76,391 --
-------- -------- -------- --------
Net loss....................... (81,209) (34,009) (9,142) (34,870)
Pro forma income tax adjustments......... -- 625 -- 979
-------- -------- -------- --------
Pro forma net loss............. $(81,209) $(33,384) $ (9,142) $(33,891)
======== ======== ======== ========
Pro forma net loss per common share:
Pro forma net loss before extraordinary
item................................ $ (1.11) $ (0.47) $ (1.18) $ (0.48)
Extraordinary income on sale of HRI.... -- -- 1.05 --
-------- -------- -------- --------
Pro forma net loss..................... $ (1.11) $ (0.47) $ (0.13) $ (0.48)
======== ======== ======== ========
Weighted average shares outstanding...... 72,942 71,665 72,542 71,123
======== ======== ======== ========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- -------------
(AS RESTATED, (AS RESTATED,
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C>
ASSETS
Current Assets:
Cash...................................................... $ 6,710 $ 7,631
Restricted cash........................................... 4,884 19,568
Accounts receivable, billed............................... 103,800 99,823
Accounts receivable, unbilled............................. 73,352 79,911
Deferred tax asset........................................ -- 36,177
Other..................................................... 10,936 12,129
--------- ---------
Total current assets.............................. 199,682 255,239
Property and equipment...................................... 80,756 97,850
Deferred tax asset.......................................... 69,029 43,044
Intangible assets........................................... 520,298 539,151
Other....................................................... 4,972 1,570
--------- ---------
$ 874,737 $ 936,854
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 16,019 $ 11,765
Accrued compensation...................................... 36,377 30,332
Accrued expenses.......................................... 73,994 100,675
Current portion of long-term debt......................... 15,209 55,975
Deferred tax liability.................................... 9,312 --
--------- ---------
Total current liabilities......................... 150,911 198,747
Long-term debt.............................................. 151,975 215,752
Accrued litigation settlement............................... 52,500 --
Other obligations........................................... 11,737 13,830
--------- ---------
Total liabilities................................. 367,123 428,329
--------- ---------
Stockholders' Equity:
Preferred stock, no par value, 20,000 authorized in 1997;
none issued............................................ -- --
Common stock, voting, $0.01 par value, 200,000 authorized
in 1997 and 1996; issued and outstanding 73,143 in 1997
and 71,705 in 1996..................................... 731 717
Common stock, non-voting, $0.01 par value, 600 authorized
in 1997 and 1996; none issued.......................... -- --
Paid-in capital........................................... 674,843 666,673
Accumulated deficit....................................... (167,960) (158,696)
--------- ---------
507,614 508,694
Less treasury stock, at cost -- 16 shares in 1996......... -- (169)
--------- ---------
Total stockholders' equity........................ 507,614 508,525
--------- ---------
$ 874,737 $ 936,854
========= =========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
1997 1996
-------------- --------------
(AS RESTATED, (AS RESTATED,
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (9,142) $(34,870)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization.......................... 39,541 39,280
Gain on sale of HRI.................................... (76,391) --
Impairment loss of property and equipment.............. 8,661 10,713
Deferred income taxes.................................. (15,905) (11,039)
Changes in assets and liabilities, excluding effects of
acquisitions and divestitures:
Decrease in restricted cash.......................... 799 1,030
Increase in accounts receivable, billed.............. (6,217) (11,570)
Decrease (increase) in accounts receivable,
unbilled............................................ 7,829 (6,756)
Increase (decrease) in accounts payable.............. 5,015 (13,177)
Increase in accrued compensation..................... 8,193 6,784
(Decrease) increase in accrued expenses.............. (15,244) 6,775
Increase in accrued litigation settlement............ 52,500 --
Other, net........................................... (4,456) 5,303
--------- --------
Net cash used for operating activities............ (4,817) (7,527)
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired........................ (5,897) (13,569)
Purchases of property and equipment....................... (15,198) (44,801)
Proceeds from sale of HRI, net............................ 126,375 --
Proceeds from sale of property and equipment.............. 3,644 19
Software development costs................................ (4,452) (33,937)
--------- --------
Net cash provided by (used for) investing
activities...................................... 104,472 (92,288)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options............... 6,808 6,853
Proceeds from borrowings.................................. 98,992 110,615
Principal payments of long-term debt...................... (203,368) (33,429)
Other..................................................... (3,008) 3,813
--------- --------
Net cash (used for) provided by financing
activities...................................... (100,576) 87,852
--------- --------
CASH:
Net change................................................ (921) (11,963)
Balance at beginning of period............................ 7,631 18,979
--------- --------
Balance at end of period.................................. $ 6,710 $ 7,016
========= ========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest............................................... $ 12,503 $ 10,921
Income taxes........................................... 10,347 6,797
Non-cash investing and financing activities:
Liabilities assumed in acquisitions.................... -- 2,737
Additions to capital lease obligations................. -- 14,043
Common stock issued upon conversion of subordinated
debentures............................................ -- 63,375
Issuance of stock warrants............................. 4,969 --
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 10Q/A may wish to refer to the audited
consolidated financial statements of the Company for the fiscal years ended
December 31, 1996 and 1997 included in the Company's Annual Report on Form 10-K
filed February 2, 1998 ("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.
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.
The Company's consolidated financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that may be necessary should the Company, contrary to plans and
expectations, be unable to continue as a going concern.
2. LONG-TERM DEBT
On February 4, 1997, the Company entered into the Second Amended Facility,
which replaced the Company's previous revolving credit agreement, increased the
revolving line of credit from $250 million to $285 million and had a maturity
date of June 30, 1998. The Second Amended Facility also required mandatory loan
commitment reductions to $200 million and $150 million on July 31, 1997 and
January 31, 1998, respectively. 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 had adopted a plan to
divest HRI. On May 28, 1997, the Company was successful in divesting HRI through
an initial public offering of 100% of its stock. This sale generated
approximately $117 million of net proceeds that were used to reduce the
Company's borrowings under the Second Amended Facility and it also reduced the
loan commitment under the Second Amended Facility to $168 million, which more
than satisfied the required reduction for July 31, 1997.
On September 18, 1997, the Company entered into a letter agreement with the
requisite lenders under the Second Amended Facility which, among other things
(i) waived the Company's compliance with the remaining financial covenants and
(ii) required the Company to repay all loans and terminate all the lenders'
commitments by November 30, 1997. On October 24, 1997, the Company entered into
a letter agreement with the requisite lenders under the Second Amended Facility
which, among other things, waived any defaults or events of default which might
otherwise result in the event of certain restatements of the Company's financial
statements and extended the mandatory repayment and termination date to January
31, 1998.
On November 19, 1997, the Company entered into the First Modification of
the Second Amended Facility ("The First Modification"), which among other
things: (i) waived any defaults or events of default which might otherwise
result from the restatement of the Company's financial statements as reported in
this Form 10-Q; (ii) eliminated the step-down in loan commitments to $150
million scheduled to occur on January 31, 1998; and (iii) reinstated the
maturity of the Second Amended Facility to June 30, 1998. The First
Modification, which is filed as Exhibit 10.9 to this Form 10-Q and incorporated
herein by reference, also establishes certain financial covenants for the fiscal
year 1997 and for monthly and quarterly periods in fiscal year 1998.
6
<PAGE> 7
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Since the Second Amended Facility matures on June 30, 1998, all amounts
outstanding under the Second Amended Facility have been classified as current in
the accompanying September 30, 1997 balance sheet. 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, capital expenditures and the Company's
ability to declare or pay cash dividends on its voting common stock ("Common
Stock"). The Second Amended Facility provides for "base rate" loans that bear
interest equal to prime plus 1% as long as certain financial covenants are met.
At September 30, 1997, the Company had $147.9 million in borrowings outstanding
under the Second Amended Facility that bore interest at 9.5%.
In connection with the Second Amended Facility, the Company issued the
lenders warrants with vesting of 1% of the Company's Common Stock on each of
January 1, 1998 and April 1, 1998, provided that the Second Amended Facility has
not been repaid and terminated prior to such vesting dates. Prior to July 1,
1997, the Company had not ascribed any value to these warrants because the
warrants vest only if amounts are outstanding or commitments are not terminated
under the Second Amended Facility on December 31, 1997. Management continues to
believe the Company may generate sufficient cash flows from the refinancing of
the Second Amended Facility or from asset sales to repay all borrowings under
and terminate the Second Amended Facility by December 31, 1997. However, due to
the uncertainty of completing a refinancing of the Second Amended Facility prior
to such time, the Company ascribed a value of $4,969,000 to the warrants vesting
on January 1, 1998 and amortized $2,338,000 to interest expense as of September
30, 1997.
3. LEGAL MATTERS
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.
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices"). Medaphis first became aware of the
investigation on June 13, 1995 when search warrants were executed on the
Designated Offices and it and MPSC received grand jury subpoenas. Medaphis
received an additional grand jury subpoena on August 22, 1997, with which it is
complying. The subpoena requires, among other things, records of any audit or
investigative reports relating to the billing of payors globally from
radiological services during the period January 1, 1991 to date and any refunds
owed to or issued to payors with respect to such global billing reports in the
Company's various offices, including the Designated Offices. Although the
precise scope of the 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 billing and collection
practices in the Designated Offices. No charges or claims by the government have
been made. Although the Company continues to believe that the principal focus of
the investigation remains on the billing and collection practices in the
Designated Offices, there can be no assurance that the investigation will not
expand to other offices, that the investigation will be resolved promptly, that
additional subpoenas or search warrants will not be received by Medaphis or MPSC
or that the investigation will not have a material adverse effect on the
Company. The Company recorded charges of $12 million in the third quarter of
1995, $2 million in the fourth quarter of 1996 and a credit of $2.8 million in
the third quarter of 1997, solely for legal and administrative fees, costs and
expenses it anticipates incurring in connection with the investigation and the
putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the investigation. The charges are
intended to cover only the
7
<PAGE> 8
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
anticipated expenses of the 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.
MPSC has become aware of apparently inadvertent computer software errors
affecting some of its electronic billing to carriers in the State of California.
The error relates to global billing (i.e., billing for the professional and
technical components of a service) for certain radiological services under
circumstances where the radiologist is only entitled to bill for the
professional component of such services. The Company believes such inadvertent
errors may have caused overpayments on certain claims submitted on behalf of
clients in the State of California. The full extent of overpayments by carriers
and beneficiaries has not been determined, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, 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 alleged 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, which argued that the Consolidated
Complaint failed to state a claim upon which relief may be granted. 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 contained any claims based on the
Securities Act of 1933, as amended (the "1933 Act"), and the Company's
underwriters and outside directors were no longer named as defendants. On June
26, 1996, the court denied plaintiffs' motion to certify plaintiffs' class. The
plaintiffs and the defendants agreed to settle this action on a class-wide basis
for $4.75 million, subject to court approval (the "1995 Class Action
Settlement"). The 1995 Class Action Settlement included the related putative
class action lawsuit currently pending in the Superior Court of Cobb County,
Georgia, described more fully below. On October 29, 1997 the court certified a
class for settlement purposes, approved the settlement and entered final
judgment dismissing the action with prejudice. One of Medaphis' directors and
officers' liability insurance carriers has paid $3.7 million of the 1995 Class
Action Settlement. The Company accrued approximately $1.2 million in the quarter
ended December 31, 1996 for the anticipated balance of the 1995 Class Action
Settlement and to pay certain fees incident thereto. On November 6, 1997, the
Company paid the remaining $1.05 million balance of the settlement.
On November 5, 1996, Medaphis, Randolph G. Brown, a former officer and
director, and Michael R. Cote and James S. Douglass, former officers, were named
as defendants in a putative shareholder class action lawsuit filed in Superior
Court of Cobb County, State of Georgia. This lawsuit was brought on behalf of a
putative class of purchasers of Medaphis Common Stock during the period from
March 29, 1995 through June 15, 1995. Plaintiffs sought compensatory damages and
costs. Pursuant to the 1995 Class Action Settlement, the claims in this state
action were settled and were dismissed without prejudice.
As originally disclosed in its Form 10-K, the Company learned in March 1997
that the government is investigating allegations concerning the Company's wholly
owned subsidiary, Gottlieb's Financial Services, Inc. ("GFS"). In 1993, Medaphis
acquired GFS, an emergency room physician billing company located in
Jacksonville, Florida, which had developed a computerized coding system. In
1994, Medaphis acquired and merged into GFS another emergency room physician
billing company, Physician Billing, Inc., located in Grand Rapids, Michigan. For
the year ended December 31, 1996, GFS represented approximately 7% of
8
<PAGE> 9
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Medaphis' revenue. During that year, GFS processed approximately 5.6 million
claims, approximately 2 million of which were made to government programs. The
government has requested that GFS voluntarily produce records, and GFS is
complying with that request. Although the precise scope and subject matter of
the investigation are not known to the Company, Medaphis believes that the
investigation, which is being participated in by federal law enforcement
agencies having both civil and criminal authority, involves GFS's billing
procedures and the computerized coding system used in Jacksonville and Grand
Rapids to process claims and may lead to claims of errors in billing. There can
be no assurance that the investigation will be resolved promptly or that the
investigation will not have a material adverse effect upon Medaphis. No charges
or claims by the government have been made. Currently, the Company has recorded
charges of $2 million and $1 million in the second and third quarters of 1997,
respectively, solely for legal and administrative fees, costs and expenses in
connection with the investigation, which charges do not include any provision
for fines, penalties, damages, assessments, judgments or sanctions that may
arise out of this matter.
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.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then 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. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleges violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint is brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common Stock between February 6, 1996 and October 21, 1996.
The Consolidated Second Amended 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"). The
Consolidated Second Amended Complaint seeks compensatory and rescissory damages,
as well as fees, interest and other costs. On February 14, 1997, the defendants
moved to dismiss the Consolidated Second Amended Complaint in its entirety. On
May 27, 1997, the court denied defendants' motion to dismiss. Discovery
currently is proceeding. 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 such 1933
Act claims.
The parties have entered into a memorandum of understanding dated August
14, 1997 (the "Memorandum of Understanding") to settle the 1996 putative
shareholder class action litigation which is the subject of the Consolidated
Second Amended Complaint on a class-wide basis for $20 million in cash (to be
paid by the Company's directors' and officers' liability insurance carriers),
3,355,556 shares of Medaphis Common Stock, and warrants to purchase 5,309,523
shares of Medaphis Common Stock at $12 per share for a five-year period. The
Memorandum of Understanding also includes: (i) an obligation on the part of
Medaphis to contribute up to 600,000 additional shares of Common Stock to the
settlement under certain conditions if the aggregate value of the Medaphis
Common Stock proposed to be issued in the settlement falls below $30.2 million
during a specified time period; and (ii) certain anti-dilution rights in favor
of plaintiffs with respect to certain future issuances of shares of Medaphis
Common Stock or warrants or rights to acquire Medaphis Common Stock to settle
existing civil litigation and claims currently pending or asserted against the
Company, subject to a 5.0 million share basket below which there will be no
dilution adjustments. The aggregate value of the Medaphis Common Stock during
the specified time period is now known, and, as a result, all of the additional
600,000 shares of Medaphis Common Stock will be included in the settlement. The
Memorandum of Understanding
9
<PAGE> 10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
also contains other conditions including, but not limited to, consent and
approval of the Company's insurance carriers and the insurance carriers' payment
of the cash portion of the settlement, the Company's receiving assurances from
its independent accountants that the proposed settlement will not adversely
affect pooling-of-interests accounting treatment on previous acquisitions (which
assurances have been received by the Company), the execution of mutually
acceptable settlement papers and the approval of the settlement by the court.
The Company recorded a $52.5 million charge in the quarter ended September 30,
1997 for this settlement. Such amount has been reflected as a non-current
liability as the Company does not anticipate satisfying the obligation within
the next twelve months due to the anticipated time required to receive the
requisite approvals.
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 behalf of the Company. 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 all other 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, 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. On February 5, 1997 the Court overruled defendants demurrer. On March
18, 1997, the court denied the plaintiff's motion for a preliminary injunction.
On July 16, 1997, plaintiff filed an amended complaint adding several new
parties, including current and former directors and former and current officers
of Medaphis. All of the newly added defendants have responded to the amended
complaint. 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 such 1933 Act claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger 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 Brown). Plaintiffs seek
compensatory and punitive damages, as well as fees, interest and other costs. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
1933 Act and common law and new parties, including former officers of Medaphis,
Medaphis' former outside auditors and BSG. On or about October 29, 1997 all
defendants filed motions to dismiss the amended complaint.
10
<PAGE> 11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through September 30, 1998.
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
non-compete covenants and contract provisions between Medaphis and plaintiffs.
Defendants have filed a motion to dismiss the complaint. Discovery has been
stayed pending resolution of the motion to dismiss.
On August 12, 1997, George W. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Securities Exchange Act of 1934
on behalf of all persons who purchased or otherwise acquired Medaphis Common
Stock between February 6, 1996 and October 21, 1996. The complaint also asserts
claims under the 1933 Act on behalf of a sub-class consisting of all persons and
entities who, in connection with the merger of the Company and HDS, acquired
options to purchase shares of Medaphis Common Stock between February 6, 1996 and
October 21, 1996. The complaint seeks rescission, rescissory and compensatory
damages, and interest, fees and other costs. Defendants have not yet responded
to the complaint.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits. The Company has entered into
standstill and tolling agreements with these and certain other stockholders of
recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, 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 ending December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996, and June 30, 1996.
In addition, the Company believes that the Commission is investigating the
Company's restatement of its interim financial statements for each quarter of
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. Further, there can be no assurance 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
11
<PAGE> 12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the lawsuits, the written demands and the pending governmental investigations
will not have a material adverse effect upon the Company.
4. RESTRUCTURING AND OTHER CHARGES
Components of restructuring and other charges are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1997 1996 1997 1996
-------- -------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED, (AS RESTATED,
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C> <C> <C>
Restructuring charges............................. $ 5,465 $ 2,317 $ 5,465 $ 8,666
Software abandonment.............................. -- 6,862 -- 6,862
Property and equipment impairment................. 6,959 6,394 6,959 6,394
Legal costs....................................... 600 5,000 2,600 5,000
Pooling charges................................... (46) (1,013) (46) 9,852
Severance costs................................... 859 1,727 1,683 1,727
Other............................................. -- 3,247 -- 3,228
------- ------- ------- -------
$13,837 $24,534 $16,661 $41,729
======= ======= ======= =======
</TABLE>
Restructuring Charges. In early 1995, the Company initiated a
reengineering program focused upon its billing and accounts receivable
management operations (the "Reengineering Project"). There were two components
of the Reengineering Project: (1) workflow, process and operational improvements
along with new technology development, and (2) office consolidation within its
wholly owned operating subsidiary, Medaphis Physician Services Corporation
("MPSC") (the "MPSC Restructuring Plan"). The Company had recorded a
restructuring reserve for the exit costs associated with the MPSC Restructuring
Plan in 1995. In August 1996, the Company revised the MPSC Restructuring Plan
and reduced the reserves established in 1995 by $1.8 million. During the first
half of 1996, the Company incurred $5.2 million of costs that were related to
the Reengineering Project, which had not previously been reserved. In September
1997, the Company reevaluated the adequacy of the reserves established for the
MPSC Restructuring Plan and recorded an additional charge of $1.7 million.
During the third quarter of 1996, the Company adopted a plan to consolidate
its system integration businesses, BSG Corporation ("BSG"), Rapid Systems
Solutions, Inc. ("Rapid Systems") and Imonics Corporation ("Imonics")(the "BSG
Group Restructuring"). In connection with the BSG Group Restructuring, Medaphis
recorded charges of $1.3 million for the costs associated with the termination
of certain leases and $2.8 million for severance costs for the Imonics employees
who had been notified of their termination. Medaphis had previously recorded an
additional $1.2 million of severance costs for Imonics employees in the second
quarter of 1996.
In August 1997, the Company adopted a plan to combine the operations of its
technology companies, the BSG and HIT Groups, into Per-Se Technologies (the
"Per-Se Restructuring"). In connection with the Per-Se Restructuring, the
Company recorded charges of $2.7 million for the costs associated with the
termination of certain leases and $1.1 million for severance costs related to
the employees who had been notified of their termination by September 30, 1997.
12
<PAGE> 13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The type and amount of restructuring reserves established and paid in the
nine months ended September 30, 1997 are described below:
<TABLE>
<CAPTION>
RESERVE PAID RESERVE
BALANCE THROUGH BALANCE
DECEMBER 31, RESERVE SEPTEMBER 30, SEPTEMBER 30,
1996 ADDITIONS 1997 1997
------------ --------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Lease termination costs................. $ 7,514 $4,395 $(3,249) $ 8,660
Severance............................... 2,748 1,070 (2,356) 1,462
Other................................... 1,222 -- (1,166) 56
------- ------ ------- -------
$11,484 $5,465 $(6,771) $10,178
======= ====== ======= =======
</TABLE>
Software Abandonment. In connection with the BSG Group Restructuring, the
Company abandoned certain of the Imonics software development projects and,
during the period ended September 30, 1996, recorded a charge for the write-off
of $6.9 million of capitalized software development costs related to these
projects.
Property and Equipment Impairment. In connection with the BSG Group
Restructuring and the revised MPSC Restructuring Plan, the Company assessed the
recoverability of its long-lived assets and recorded impairment losses of $6.4
million in the three month period ended September 30, 1996.
In connection with the Per-Se Restructuring and the Company's assessment of
the recoverability of certain of its long-lived assets, the Company recorded a
charge of $7.0 million for impairment losses during the quarter ended September
30, 1997.
Legal Costs. The Company recorded charges of $5.0 million and $3.0 million
in September 1996 and 1997, respectively, for the legal and administrative fees,
costs and expenses it anticipated incurring in connection with the various 1996
lawsuits and shareholder demands filed against the Company and certain of its
former officers, one of whom was also a director.
In June 1997 and September 1997, the Company recorded charges of $2.0
million and $1.0 million, respectively, for the legal and administrative fees,
costs and expenses it has incurred and plans to incur in connection with the
federal inquiry of the billing procedures at GFS.
In September 1997, the Company also evaluated the adequacy of the reserves
established for the federal investigation in California and the turnaround plan
adopted in December 1996 and reduced these reserves by $3.4 million.
13
<PAGE> 14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pooling Charges. In 1995 and 1996, Medaphis acquired eight companies in
merger transactions accounted for under the pooling of interests method of
accounting. In connection therewith, the Company incurred transaction fees,
costs and expenses, which have been reflected in Medaphis' operating results and
are set forth below as (income)/expense:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- --------------
1997 1996 1997 1996
----- ------- ----- ------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED, (AS RESTATED,
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C> <C> <C>
Automation Atwork Companies................................. $ -- $ (22) $ -- $ (430)
HRI......................................................... -- (13) -- (778)
Consort Technologies, Inc................................... -- (3) -- (529)
Intelligent Visual Computing, Inc. ("IVC").................. -- (31) -- 169
Rapid Systems............................................... (15) (236) (15) 664
BSG......................................................... (14) (321) (14) 5,893
HDS......................................................... (17) (387) (17) 4,863
----- ------- ----- ------
$ (46) $(1,013) $ (46) $9,852
===== ======= ===== ======
</TABLE>
Severance Costs. In accordance with its involuntary severance benefit
plan, the Company recorded a charge of $0.9 million in September 1996 to reflect
the expense for employees' rights to involuntary severance benefits that have
accumulated to date.
The Company also recorded charges of $0.8 million and $0.9 million in the
third quarter of 1996 and 1997, respectively, for compensation costs associated
with members of the former executive management team. The Company recorded $0.8
million of compensation costs associated with former executive management in the
second quarter of 1997.
Other Costs. During the third quarter of 1996, the Company canceled an
initiative to develop an on-line practice management system. The Company
recorded a charge of approximately $2.0 million relating to the write-off of the
deferred costs associated with this project. The Company also accrued $1.3
million for certain liabilities associated with the Company's billing and
accounts receivable management services operations.
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
loss and pro forma net loss per common share are presented as if the entities
had been "C" corporations during the nine months ended September 30, 1996.
Effective income tax rates for the periods presented vary from statutory
rates primarily as a result of nondeductible expenses associated with the
proposed settlement of litigation and merger transactions.
6. RESTATEMENT OF THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-AND
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
In March 1997, as a result of a review initiated by senior management and
the Audit Committee of the Board of Directors 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
14
<PAGE> 15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 as set forth herein. These errors and irregularities consisted
primarily of the following: (i) incorrect quarterly recording of revenues and
the related costs and expenses for certain contracts; (ii) incorrect quarterly
recording of certain liabilities for employee bonuses and related expenses;
(iii) 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 (iv) incorrect
depreciation of certain assets related to the Company's comprehensive
reengineering and consolidation project.
During the third quarter of 1997, in connection with a refinancing effort,
management evaluated certain revenue recognition practices at HDS, which was
acquired in a merger transaction in June 1996 and accounted for as a "pooling of
interests." These practices related principally to revenue recognized in fiscal
years 1994, 1995 and 1996. As a result of this evaluation, management has
determined that the revenue was improperly recognized and, accordingly, has
restated the Company's financial statements for the period ended September 30,
1996 and will be restating the Company's financial statements for all of the
other periods indicated. The effect of such restatements on the Company's net
income (loss) for the years ended December 31, 1994, 1995, and 1996 was $(5.8)
million, $(1.1) million and $(7.3) million, respectively. The cumulative
reduction in assets caused by the restatements was $20.5 million.
As a result of the HDS related restatement, Deloitte & Touche, the
predecessor accountant, withdrew its audit opinion dated March 31, 1997 covering
the Company's 1994, 1995 and 1996 fiscal years. Consequently, the Company
engaged Price Waterhouse to re-audit the Company's financial statements for its
1995 and 1996 fiscal years and audit the Company's nine-month period ending
September 30, 1997.
Subsequent to the restatement related to HDS, and in connection with the
reaudit of the Company's fiscal years ended December 31, 1995 and 1996 and the
audit of the Company's nine months ended September 30, 1997 by Price Waterhouse,
the Board of Directors of the Company determined, upon recommendation of the
Audit Committee of the Board, to restate the results of such periods to account
for the December 1995 acquisition of Medical Management Sciences, Inc. ("MMS")
on a purchase accounting basis. The MMS transaction had been accounted for as a
pooling of interest.
The impact on both restatements on the 1996 and 1997, three- and nine-month
results of operations are presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1996
--------------------------------------------------------------
AS RESTATED AS RESTATED IN THE
AS ORIGINALLY IN THE 1996 SEPTEMBER 30, 1997
REPORTED FORM 10-K FORM 10-Q AS RESTATED
------------- ----------- ------------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue.............. $126,731 $132,874 $132,121 $132,121
Salaries and wages... 109,615 106,473 106,473 106,473
Other Operating
expenses........... 39,016 39,370 39,370 39,370
Depreciation......... 6,221 7,201 7,201 7,201
Amortization......... 4,937 4,809 4,809 6,234
Loss before income
taxes.............. (60,617) (52,613) (53,366) (54,975)
Net loss............. (36,995) (32,127) (32,599) (34,009)
Pro forma net loss... (36,370) (31,502) (31,974) (33,384)
Pro forma net loss
per common share... $ (0.51) $ (0.44) $ (0.45) (0.47)
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1996
--------------------------------------------------------------
AS RESTATED AS RESTATED IN THE
AS ORIGINALLY IN THE 1996 SEPTEMBER 30, 1997
REPORTED FORM 10-K FORM 10-Q AS RESTATED
------------- ----------- ------------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue.............. $465,551 $464,842 $455,138 $455,138
Salaries and wages... 292,843 293,425 293,425 293,425
Other Operating
expenses........... 117,169 118,594 118,594 118,594
Depreciation......... 16,496 19,981 19,981 19,981
Amortization......... 14,672 15,026 15,026 19,299
Loss before income
taxes.............. (25,248) (31,384) (41,088) (45,909)
Net loss............. (20,933) (24,565) (30,645) (34,870)
Pro forma net loss... (19,954) (23,586) (29,666) (33,891)
Pro forma net loss
per common share... $ (0.28) $ (0.33) $ (0.42) $ (0.48)
</TABLE>
15
<PAGE> 16
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1997
----------------------- -----------------------
AS AS
ORIGINALLY AS ORIGINALLY AS
REPORTED RESTATED REPORTED RESTATED
----------- --------- ----------- ---------
(IN THOUSANDS, (IN THOUSANDS,
EXCEPT PER SHARE DATA) EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue............................................. $124,649 $124,649 $423,162 $423,162
Salaries and wages.................................. 95,544 95,544 281,508 281,508
Other operating expenses............................ 37,818 37,818 115,841 115,841
Depreciation........................................ 7,505 7,505 21,540 21,540
Amortization........................................ 4,374 5,798 13,729 18,001
Income (loss) before income taxes................... (94,175) (95,599) (98,034) (102,306)
Income (loss) before extraordinary item............. (79,984) (81,209) (81,858) (88,533)
Pro Forma net income (loss) (79,984) (81,209) (5,467) (9,142)
Pro Forma net income per common share............... $ (1.10) $ (1.11) $ (0.08) $ (0.13)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
----------------------------------
AS AS
ORIGINALLY PREVIOUSLY AS
REPORTED RESTATED RESTATED
---------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current Assets.............................................. 269,385 255,239 255,239
Total Assets................................................ 815,624 793,903 936,854
Current Liabilities......................................... 193,752 198,747 198,747
Total Liabilities........................................... 423,334 428,329 428,329
Total Stockholders' Equity.................................. 392,290 365,574 508,525
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. 199,682 199,682
Total Assets................................................ 735,462 874,737
Current Liabilities......................................... 296,291 150,911
Total Liabilities........................................... 367,123 367,123
Total Stockholders' Equity.................................. 368,339 507,614
</TABLE>
16
<PAGE> 17
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AS
PREVIOUSLY AS
REPORTED RESTATED
---------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1994
Revenue................................................... $ 398,934 $ 390,204
Pro forma net income...................................... 32,523 24,874
Pro forma net income per share............................ $ 0.51 $ 0.41
FOR THE YEAR ENDED DECEMBER 31, 1995
Revenue................................................... $ 559,877 $ 558,155
Pro forma net loss........................................ (5,621) (19,625)
Pro forma net loss per share.............................. $ (0.15) $ (0.17)
FOR THE YEAR ENDED DECEMBER 31, 1996
Revenue................................................... $ 608,313 $ 596,714
Pro forma net loss........................................ (123,642) (130,909)
Pro forma net loss per share.............................. $ (1.74) $ (1.84)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
Revenue................................................... $ 295,516 $ 298,513
Restructuring and other changes........................... 2,000 2,824
Net income................................................ 74,304 74,517
Pro forma net income per share............................ $ 0.99 $ 0.99
</TABLE>
7. NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") 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 and shall be effective for financial
statements for both interim and annual periods ending after December 15, 1997.
This pronouncement cannot be adopted early. The following table presents basic
and diluted weighted average shares outstanding and a calculation of the pro
forma net loss per share using the guidelines of SFAS No. 128.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1997 1996 1997 1996
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Basic weighted average shares outstanding............. 72,942 71,665 72,542 71,123
======== ======== ======== ========
Pro forma net loss before extraordinary item.......... $(81,209) $(33,384) $(85,533) $(33,891)
Extraordinary income on sale of HRI................... -- -- 76,391 --
-------- -------- -------- --------
Pro forma net loss.................................... $(81,209) $(33,384) $ (9,142) $(33,891)
======== ======== ======== ========
Basic earnings per share(1):
Pro forma net loss before extraordinary item........ $ (1.11) $ (0.47) $ (1.16) $ (0.48)
Extraordinary income on sale of HRI................. -- -- 1.05 --
-------- -------- -------- --------
Pro forma net loss.................................. $ (1.11) $ (0.47) $ (0.13) $ (0.48)
======== ======== ======== ========
</TABLE>
- ---------------
(1) Diluted earnings per share equals basic earnings per share due to the
reported losses before extraordinary item.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 establishes
17
<PAGE> 18
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
standards for the way companies report information about operating segments
including the related disclosures about products and services. The Company has
elected to adopt SFAS No. 131 during the period ended September 30, 1997. See
Note 8 where the Company discloses information about its operating segments.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 "Software Revenue Recognition" ("SOP 97-2").
SOP 97-2 is effective for transactions entered into in fiscal years beginning
after December 15, 1997. The Company is currently assessing the impact of SOP
97-2 on the Company's financial position and results of operation.
8. SEGMENT REPORTING
Medaphis has five reportable segments: Physician Services, Hospital
Services, HRI, HIT, and the BSG Group. Physician Services is a leading provider
of business management solutions and claims processing to physicians in the
United States. Hospital Services is a leading provider of business management
services to hospitals in the United States. HRI provided subrogation and related
recovery services primarily to healthcare payors. HRI was sold on May 28, 1997.
HIT provides application software and systems integration services to both
hospitals and physicians. The BSG Group provides full-service systems
integration, information technology consulting and tailored software development
to more than 100 clients in a variety of markets, including healthcare.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies included in the Form 10-K.
Medaphis evaluates each segments' performance based on operating profit or loss.
The Company also accounts for intersegment sales as if the sales were to third
parties.
18
<PAGE> 19
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's reportable segments are strategic business units that offer
different products and services. Information concerning the operations in these
reportable segments is as follows:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1997 1996 1997 1996
-------- -------- --------- --------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED (AS RESTATED
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C> <C> <C>
Revenue:
Physician Services........................................ $ 59,971 $ 71,723 $ 206,685 $222,676
Hospital Services......................................... 24,179 21,485 73,096 66,806
HRI....................................................... -- 7,790 14,720 23,116
HIT....................................................... 19,146 19,151 62,319 55,208
BSG Group................................................. 21,677 13,214 67,375 89,853
Corporate and eliminations................................ (324) (1,242) (1,033) (2,521)
-------- -------- --------- --------
$124,649 $132,121 $ 423,162 $455,138
======== ======== ========= ========
Operating profit (loss)(1):
Physician Services........................................ (12,110) (3,840) (6,131) (6,131)
Hospital Services......................................... 777 2,387 7,179 11,736
HRI....................................................... -- 1,857 3,685 6,342
HIT....................................................... 1,647 4,933 12,839 15,322
BSG Group................................................. (3,879) (24,599) (4,370) (5,434)
Corporate and eliminations................................ (8,450) (7,894) (26,930) (17,995)
-------- -------- --------- --------
$(22,015) $(27,156) $ (13,728) $ 3,840
======== ======== ========= ========
Interest expense, net....................................... $ 7,246 $ 3,284 $ 19,417 $ 8,019
======== ======== ========= ========
Restructuring and other charges (including litigation
settlement):
Physician Services........................................ 4,894 5,713 6,894 10,841
Hospital Services......................................... -- -- -- --
HRI....................................................... -- (13) -- (778)
HIT....................................................... 3,253 (357) 3,253 3,959
BSG Group................................................. 2,430 14,193 2,430 22,709
Corporate................................................. 55,760 4,999 56,584 4,999
-------- -------- --------- --------
$ 66,337 $ 24,535 $ 69,161 $ 41,730
======== ======== ========= ========
Income before income taxes and extraordinary item........... $(95,598) $(54,975) $(102,306) $(45,909)
======== ======== ========= ========
Depreciation and amortization:
Physician Services........................................ 8,596 8,156 25,989 23,957
Hospital Services......................................... 1,540 1,217 4,143 3,606
HRI....................................................... -- 236 401 643
HIT....................................................... 1,645 1,462 4,614 4,306
BSG Group................................................. 1,118 1,930 3,292 5,630
Corporate................................................. 403 433 1,102 1,137
-------- -------- --------- --------
$ 13,302 $ 13,434 $ 39,541 $ 39,279
======== ======== ========= ========
Capital expenditures:
Physician Services........................................ 2,181 2,791 4,000 21,452
Hospital Services......................................... 2,949 1,961 5,938 5,489
HRI....................................................... -- 329 108 1,144
HIT....................................................... 603 831 1,914 2,694
BSG Group................................................. 949 4,007 2,045 12,386
Corporate................................................. 824 339 1,193 1,634
-------- -------- --------- --------
$ 7,506 $ 10,258 $ 15,198 $ 44,799
======== ======== ========= ========
</TABLE>
19
<PAGE> 20
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, 1997 DECEMBER 31, 1997
------------------- ------------------
<S> <C> <C>
Identifiable assets:
Physician Services........................................ $571,544 $610,150
Hospital Services......................................... 105,931 97,626
HRI....................................................... -- 23,863
HIT....................................................... 76,736 67,961
BSG Group................................................. 36,770 51,972
Corporate................................................. 83,756 85,282
-------- --------
$874,737 $936,854
======== ========
</TABLE>
- ---------------
(1) Operating profit (loss) is revenue less salaries and wages, other operating
expenses, depreciation and amortization.
20
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Medaphis is a leading provider of business management services, systems
integration services and medical software, primarily to the healthcare provider
market. Medaphis serves approximately 20,700 physicians and 2,700 hospitals
predominantly in North America, as well as internationally. Medaphis is well-
positioned to capitalize on the healthcare industry trends towards
consolidation, managed care and cost containment through a broad range of
services and products that enable clients to provide quality patient care
efficiently and cost effectively. The Company's large client base and national
presence further support the Company's competitive position. The Company
provides its services and products through its Healthcare Services Group, which
includes Physicians Services and Hospital Services, and its Information
Technology Group, recently renamed Per-Se Technologies.
During the past year a new management team has been assembled to address a
number of issues that had arisen in recent years and substantially weakened the
Company's financial condition. In February 1997, after assessing various
alternatives and refinancing the Company's senior debt, new management announced
its 1997 operating plan refocusing the Company on its core businesses of
providing business management services and information products to healthcare
providers. The major components of the plan included: (i) exiting non-core
business; (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
client service; and (v) implementing cross-selling initiatives.
Medaphis has already completed certain phases of this operating plan.
Medaphis sold its non-core insurance subrogation business, Healthcare Recoveries
Inc. ("HRI"), on May 28, 1997, for net proceeds of approximately $117 million,
through an initial public offering of 100% of HRI's common stock. Medaphis also
completed its assessment of its systems integration businesses (the "BSG Group")
and determined that the BSG Group is compatible with its core business of
delivering solutions to the healthcare market. As a result, in August 1997,
management decided to retain the BSG Group and to consolidate its operations
with the operations of HIT. This combination will assist Medaphis in continuing
its 1997 operating plan by reducing duplicative costs and creating efficiencies
via the combination of management and administrative functions at these
operations. During the third quarter of 1997, the Company recorded approximately
$3.7 million in restructuring charges related to this combination and recorded
other charges of $10.1 million, principally relating to the impairment of fixed
assets. (See "Results of Operations" for additional information).
The Company also reached a proposed settlement in 1997 with the plaintiffs
in the major class-action securities lawsuits pending against it, and during the
third quarter of 1997 the Company recorded a non-cash charge of $52.5 million
related to this proposed settlement.
During the third quarter of 1997, in connection with a refinancing effort,
management and its independent accountants evaluated certain revenue recognition
practices at HDS, which was acquired in a merger transaction in June 1996 and
accounted for as a "pooling-of-interests." These practices related principally
to revenue recognized in fiscal years 1994, 1995 and 1996. As a result of this
evaluation, management, with concurrence from its independent accountants, has
determined that the revenue was improperly recognized and, accordingly, has
restated the Company's financial statements for all of the periods indicated.
The effect of such restatements on the Company's net income (loss) for all of
the years ended December 31, 1994, 1995, and 1996 was ($5.9) million, ($1.1)
million and ($7.3) million, respectively.
TRENDS IN HEALTHCARE INDUSTRY
Medaphis' business is impacted by, among other things, 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 government agencies 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
21
<PAGE> 22
of services purchased by government agencies and others but not paid by them
(i.e., "cost shifting"). The increasing complexity in the reimbursement system
resulting from continuing changes in laws, regulations, rules and protocols
relative to billing for services provided to patients mandated by federal and
state agencies and private payors and the 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 these 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. The federal government has
initiated a series of programs to investigate broadly the billing practices of
healthcare providers. Management believes that these trends have adversely
affected and could continue to adversely affect the rate of the revenue growth
and profit margins of the Company's operations.
RESULTS OF OPERATIONS
The following table presents certain items reflected in the Company's
statements of operations as a percentage of revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenue.............................. 100.0% 100.0% 100.0% 100.0%
Salaries and wages................... 76.7 80.6 66.5 64.5
Other operating expenses............. 30.3 29.8 27.4 26.1
Depreciation......................... 6.0 5.5 5.1 4.4
Amortization......................... 4.7 4.7 4.3 4.2
Interest expense, net................ 5.8 2.5 4.6 1.8
Litigation settlement................ 42.1 -- 12.4 --
Restructuring and other charges...... 11.1 18.4 3.9 9.2
----- ----- ----- -----
Total expenses............. 176.7 141.5 124.2 110.2
Loss before income taxes
and extraordinary item............. (76.7) (41.5) (24.2) (10.2)
----- ----- ----- -----
Income tax benefit................... (11.5) (15.9) (4.0) (2.4)
----- ----- ----- -----
Loss before extraordinary item....... (65.2) (25.6) (20.2) (7.8)
Extraordinary income on sale of HRI,
net of tax......................... -- -- 18.0 --
----- ----- ----- -----
Net loss................... (65.2) (25.6) (2.2) (7.8)
Pro forma income tax adjustments..... -- 0.5 -- 0.2
----- ----- ----- -----
Pro forma net loss......... (65.2)% (25.1)% (2.2)% (7.6)%
===== ===== ===== =====
</TABLE>
22
<PAGE> 23
Revenue. Revenue classified by the Company's different operating segments
is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1997 1996 1997 1996
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Physician Services...................... $ 59,971 $ 71,723 $206,685 $222,676
Hospital Services....................... 24,179 21,485 73,096 66,806
HRI..................................... -- 7,790 14,720 23,116
HIT..................................... 19,146 19,151 62,319 55,208
BSG Group............................... 21,677 13,214 67,375 89,853
Corporate and eliminations.............. (324) (1,242) (1,033) (2,521)
-------- -------- -------- --------
$124,649 $132,121 $423,162 $455,138
======== ======== ======== ========
</TABLE>
Physician Services' revenue for the three- and nine-month periods ended
September 30, 1997 declined 16% and 7%, respectively. Both comparisons were also
unfavorably impacted by a one-time adjustment to revenue of $10.7 million in the
third quarter of 1997 that resulted from a detailed review, performed by the
Company, to update the assumptions and methodology underlying the calculation of
unbilled accounts receivable for Physician Services. Excluding this adjustment,
three-and-nine-month sales were down 1% and 2%, respectively, versus the prior
year figures. During 1997, management's emphasis has been on enhancing client
service to its existing clients and not on expanding the client base.
Hospital Services' revenue for both the three- and nine-month periods ended
September 30, 1997 increased 13% and 9%, respectively, as compared to the
comparable periods in 1996. These increases reflect internally-generated volume
growth.
On May 28, 1997 Medaphis completed the sale of HRI and, as a result, there
are only five months of revenue in 1997 compared with nine months in 1996.
HIT's revenue for the three-month period ended September 30, 1997 was flat
when compared with the three-month period ended September 30, 1996, as the sale
of one Ulticare software license during this quarter was essentially offset by
lower revenue in the scheduling systems division. HIT's revenue increased 13% in
the nine-month period ended September 30, 1997 versus the prior year period,
principally reflecting higher revenue associated with the Ulticare software
product.
The BSG Group's revenue in 1996 includes the results of the Company's
wholly-owned operating subsidiary, Imonics Corporation ("Imonics"), which was
shut down at the end of 1996. Imonics generated $(10.0) million and $12.3
million of revenue during the three- and nine-month periods ended September 30,
1996, respectively. Excluding the Imonics revenue, the BSG Group's revenue
decreased 7% and 13.1% for the three- and nine-month periods ended September 30,
1997, as compared with the three- and nine-month periods ended September 30,
1996, respectively. Disruptions associated with the restructuring of this
division have negatively affected revenue.
Salaries and Wages. Salaries and wages decreased to $95.5 million and
$281.5 million in the three- and nine-month periods ended September 30, 1997,
respectively, versus $106.5 million and $293.4 million in the comparable 1996
periods. Salaries and wages as a percentage of revenue for the three-month
period declined to 76.7% from 80.6% in 1996. The figures in both periods were
negatively impacted by unusual charges. In 1997, the percentage was inflated by
revenue adjustments, principally in Physician Services, while in 1996 the
percentage was inflated by the impact of certain Imonics charges. Excluding
these unusual charges, salaries and wages as a percentage of revenue increased
slightly on a year-to-year basis. Salaries and wages as a percentage of revenue
in the nine-month period ended September 30, 1997 increased to 66.5% of revenue
from 64.5% in the same period of 1996. The increase in salaries and wages as a
percentage of revenue is primarily due to the decline in revenue. The Company
has not reduced its employment levels proportionately with the decrease in
revenue because of a renewed emphasis on client service and expected growth in
Per-Se Technologies.
23
<PAGE> 24
Other Operating Expenses. Other operating expenses as a percentage of
revenue increased to 30.3% in the three-month period ended September 30, 1997
from 29.8% in the comparable period of 1996, and increased to 27.4% for the
nine-month period ended September 30, 1997 from 26.1% in the same period 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 decrease in the
Company's revenue. This increase is also attributable to professional fees the
Company has incurred to assist with a variety of financial, operational and
organizational projects undertaken by current management. The Company
anticipates it will continue to incur these professional fees for the remainder
of 1997. Other operating expenses are primarily comprised of postage, facility
and equipment rental, telecommunications, travel, outside consulting services
and office supplies.
Depreciation. Depreciation expense rose to $7.5 million in the third
quarter of 1997 as compared with $7.2 million in the third quarter of 1996 and
$21.5 million in the nine-month period ended September 30, 1997 as compared with
$20.0 million in the same period of 1996. These increases reflect the Company's
investment in property and equipment to support growth in its business.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $5.8 million in the third quarter of 1997 as compared with $6.2 million in
the third quarter of 1996 and $18.0 million in the nine-month period ended
September 30, 1997 as compared with $19.3 million in the same period of 1996.
The decreases are primarily due to the goodwill and software write-offs
associated with the shut down of Imonics.
Operating Profit (Loss). The operating loss for the third quarter shrank
by 19% to $22.0 million in 1997 from $27.2 million in 1996. Excluding the impact
of unusual adjustments, principally impacting revenue (see Revenues for
additional information), the operating loss declined by 32% to $2.0 million from
$2.9 million. This improvement principally reflects higher earnings at HIT and
improved results at Physician Services, to near breakeven in this year's third
quarter from a $2.4 million loss in 1996. These improvements in results of
operations were partially offset by unfavorable Hospital Services and BSG
comparisons and the absence of HRI operating profits due to the sale of that
business in the first half of 1997.
Interest. Net interest expense was $7.2 million in the third quarter of
1997 as compared with $3.3 million in the third quarter of 1996 and $19.4
million in the nine-month period ended September 30, 1997 as compared with $8.0
million in the same period of 1996. The increases in interest expense were due
to increased borrowing under the Company's credit facilities to fund the
Company's reengineering program in 1996, which was subsequently abandoned, its
working capital needs in both 1996 and 1997, amortization of debt issuance costs
and increased interest rates. Management expects to receive approximately $11
million (based on current interest rates) in annualized interest expense savings
as a result of the pay down of the Second Amended and Restated Credit Agreement
(the "Second Amended Facility") with the net proceeds from the sale of HRI.
Management also anticipates that interest rate fluctuations and changes in the
amount of borrowings under its Second Amended Facility will impact future
interest expense.
Restructuring and Other Charges. Components of restructuring and other
charges are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1997 1996 1997 1996
-------- -------- ------- -------
(AS RESTATED (AS RESTATED
SEE NOTE 6) SEE NOTE 6)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Restructuring charges............................. $ 5,465 $ 2,317 $ 5,465 $ 8,666
Software abandonment.............................. -- 6,862 -- 6,862
Property and equipment impairment................. 6,959 6,394 6,959 6,394
Legal costs....................................... 600 5,000 2,600 5,000
Pooling charges................................... (46) (1,013) (46) 9,852
Severance costs................................... 859 1,727 1,683 1,727
Other............................................. -- 3,247 -- 3,228
------- ------- ------- -------
$13,837 $24,534 $16,661 $41,729
======= ======= ======= =======
</TABLE>
24
<PAGE> 25
Restructuring Charges. In early 1995, the Company initiated a
reengineering program focused upon its billing and accounts receivable
management operations (the "Reengineering Project"). There were two
components of the Reengineering Project: (i) workflow, process and
operational improvements along with new technology development, and (ii)
office consolidation within its wholly owned operating subsidiary, Medaphis
Physician Services Corporation ("MPSC") (the "MPSC Restructuring Plan").
The Company had recorded a restructuring reserve for the exit costs
associated with the MPSC Restructuring Plan in 1995. In August 1996, the
Company revised the MPSC Restructuring Plan and reduced the reserves
established in 1995 by $1.8 million. During the first half of 1996, the
Company incurred $5.2 million of costs that were related to the
Reengineering Project, which had not previously been reserved. In September
1997, the Company reevaluated the adequacy of the reserves established for
the MPSC Restructuring Plan and recorded an additional charge of $1.7
million.
During the third quarter of 1996, the Company adopted a plan to consolidate
its system integration businesses, BSG Corporation ("BSG"), Rapid Systems
Solutions, Inc. ("Rapid Systems") and Imonics Corporation ("Imonics")(the
"BSG Group Restructuring"). In connection with the BSG Group Restructuring,
Medaphis recorded charges of $1.3 million for the costs associated with the
termination of certain leases and $2.8 million for severance costs for the
Imonics employees who had been notified of their termination. Medaphis had
previously recorded an additional $1.2 million of severance costs for
Imonics employees in the second quarter of 1996.
In August 1997, the Company adopted a plan to combine the operations of its
technology companies, the BSG and HIT Groups, into Per-Se Technologies (the
"Per-Se Restructuring"). In connection with the Per-Se Restructuring, the
Company recorded charges of $2.7 million for the costs associated with the
termination of certain leases and $1.1 million for severance costs related
to the employees who had been notified of their termination by September
30, 1997.
Software Abandonment. In connection with the BSG Group Restructuring,
the Company abandoned certain of the Imonics software development projects
and recorded a charge in the period ended September 30, 1996 for the
write-off of $6.9 million of capitalized software development costs related
to these projects.
Property and Equipment Impairment. In connection with the BSG Group
Restructuring and the revised MPSC Restructuring Plan, the Company assessed
the recoverability of its long-lived assets and recorded impairment losses
of $6.4 million in the three-month period ended September 30, 1996.
In connection with the Per-Se Restructuring and the Company's
assessment of the recoverability of certain of its long-lived assets, the
Company recorded a charge of $7.0 million for impairment losses during the
quarter ended September 30, 1997.
25
<PAGE> 26
Legal Costs. The Company recorded charges of $5.0 million and $3.0
million in September 1996 and 1997, respectively, for the legal and
administrative fees, costs and expenses it anticipated incurring in
connection with the various 1996 lawsuits and shareholder demands filed
against the Company and certain of its former officers, one of whom was
also a director.
In June 1997 and September 1997, the Company recorded charges of $2.0
million and $1.0 million, respectively, for the legal and administrative
fees, costs and expenses it has incurred and plans to incur in connection
with the federal inquiry of the billing procedures at GFS.
In September 1997, the Company also evaluated the adequacy of the
reserves established for the federal investigation in California and the
turnaround plan adopted in December 1996 and reduced these reserves by $3.4
million.
Pooling Charges. In 1995 and 1996, Medaphis acquired seven companies
in merger transactions accounted for under the pooling of interests method
of accounting. In connection therewith, the Company incurred transaction
fees, costs and expenses, which have been reflected in Medaphis' operating
results and are set forth below as (income)/expense:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- --------------
1997 1996 1997 1996
----- ------- ----- ------
(IN THOUSANDS) (IN THOUSANDS)
(AS RESTATED, SEE NOTE 6)
<S> <C> <C> <C> <C>
Automation Atwork Companies............... $ -- $ (22) $ -- $ (430)
HRI....................................... -- (13) -- (778)
Consort Technologies, Inc................. -- (3) -- (529)
Intelligent Visual Computing, Inc.
("IVC")................................. -- (31) -- 169
Rapid Systems............................. (15) (236) (15) 664
BSG....................................... (14) (321) (14) 5,893
HDS....................................... (17) (387) (17) 4,863
----- ------- ----- ------
$ (46) $(1,013) $ (46) $9,852
===== ======= ===== ======
</TABLE>
Severance Costs. In accordance with its involuntary severance benefit
plan, the Company recorded a charge of $0.9 million in September 1996 to
reflect the expense for employees' rights to involuntary severance benefits
that have accumulated to date.
The Company also recorded charges of $0.8 million and $0.9 million in
the third quarter of 1996 and 1997, respectively, for compensation costs
associated with members of the former executive management team. The
Company recorded $0.8 million of compensation costs associated with former
executive management in the second quarter of 1997.
Other Costs. During the third quarter of 1996, the Company canceled
an initiative to develop an on-line practice management system. The Company
recorded a charge of approximately $2.0 million relating to the write-off
of the deferred costs associated with this project. The Company also
accrued $1.3 million for certain liabilities associated with the Company's
billing and accounts receivable management services operations.
Income Taxes. Effective income tax rates for the periods presented
vary from statutory rates primarily as a result of nondeductible expenses
associated with the proposed settlement of litigation and merger
transactions. Pro forma adjustments for income taxes have been provided in
1996 for companies which had elected to be treated as "S" Corporations
under the Internal Revenue Code of 1986, as amended, prior to merging with
the Company.
Extraordinary Item. On May 28, 1997, Medaphis sold HRI through an
initial public offering of 100% of its stock, which generated net proceeds
to the Company of approximately $117 million. Medaphis had acquired HRI on
August 28, 1995 through a business combination accounted for as a
pooling-of-interests.
26
<PAGE> 27
LIQUIDITY AND CAPITAL RESOURCES
On February 4, 1997, the Company entered into the Second Amended Facility,
which replaced the Company's previous revolving credit agreement, increased the
revolving line of credit from $250 million to $285 million and matured on June
30, 1998. 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, capital expenditures and the Company's ability to declare or pay cash
dividends on its common stock. The Second Amended Facility provides for "base
rate" loans that bear interest equal to prime plus 1% as long as certain
financial covenants are met. At September 30, 1997, the Company had $147.9
million in borrowings outstanding under the Second Amended Facility that bore
interest at 9.5%.
The Second Amended Facility required mandatory loan commitment reductions
to $200 million and $150 million on July 31, 1997 and January 31, 1998,
respectively. On May 28, 1997, in connection with the divestiture of HRI through
an initial public offering of 100% of its stock, the Company used the net
proceeds from the HRI sale in the amount of approximately $117 million to reduce
the Company's borrowings under the Second Amended Facility and the loan
commitment under the Second Amended Facility to $168 million, which more than
satisfied the required reduction for July 31, 1997.
On September 18, 1997, the Company entered into a letter agreement with the
requisite lenders under the Second Amended Facility which, among other things
(1) waived the Company's compliance with the remaining financial covenants and
(2) required the Company to repay all loans and terminate all the lenders'
commitments by November 30, 1997. On October 24, 1997, the Company entered into
a letter agreement with the requisite lenders under the Second Amended Facility
which, among other things, waived any defaults or events of default which might
otherwise result in the event of certain restatements of the Company's financial
statements and extended the mandatory repayment and termination date to January
31, 1998.
On November 19, 1997, the Company entered into the First Modification of
the Second Amended and Restated Credit Agreement ("The First Modification"),
which among other things: (1) waived any defaults or events of default which
might otherwise result from the restatement of the Company's financial
statements as reported in this Form 10-Q; (2) eliminated the step-down in loan
commitments to $150 million scheduled to occur on January 31, 1998; and (3)
reinstated the maturity of the Second Amended Facility to June 30, 1998. The
First Modification, which is filed as Exhibit 10.9 to this Form 10-Q and
incorporated herein by reference, also establishes certain financial covenants
for the fiscal year 1997 and for monthly and quarterly periods in fiscal year
1998.
Since the Second Amended Facility matures on June 30, 1998, all amounts
outstanding under the Second Amended Facility have been classified as current in
the September 30, 1997 balance sheet. Excluding the borrowings under the Second
Amended Facility, the Company had approximately $51.3 million of working
capital, which included $6.7 million of cash at September 30, 1997. Also at
September 30, 1997, the Company had approximately $20 million available under
the Second Amended Facility. The Company used $4.8 million of cash for operating
activities during the nine months ended September 30, 1997 as compared with $7.5
million during the nine months ended September 30, 1996. The increase in the
Company's operating cash flow resulted primarily from the collection of
outstanding receivables and management's cash management initiative.
In connection with the Second Amended Facility, the Company issued the
lenders warrants with vesting of 1% of Medaphis' voting common stock (the
"Common Stock") on each of January 1, 1998 and April 1, 1998, provided that the
Second Amended Facility has not been repaid and terminated prior to such vesting
dates. Prior to July 1, 1997, the Company had not ascribed any value to these
warrants because the warrants vest only if amounts are outstanding or
commitments are not terminated under the Second Amended Facility on December 31,
1997. Management continues to believe the Company may generate sufficient cash
flows from the refinancing of the Second Amended Facility or from asset sales to
repay all borrowings under and terminate the Second Amended Facility by December
31, 1997. However, due to the uncertainty of
27
<PAGE> 28
completing a refinancing of the Second Amended Facility, the Company ascribed a
value of $4,969,000 to the warrants vesting on January 1, 1998 and amortized
$2,338,000 to interest expense as of September 30, 1997.
During the remainder of 1997 and, if necessary, the first quarter of 1998,
the Company expects to continue to explore a refinancing of its bank credit
facilities to enhance its credit, liquidity and financial flexibility and to
enable the Company under its current financial forecast to meet its committed
and other capital needs and scheduled debt repayments throughout 1998 and later
years. In that connection, the Company also intends to explore other
alternatives, including the possible divestiture of additional assets and the
sale of debt or equity securities. These refinancing efforts currently include,
but are not necessarily limited to, (1) discussions with its existing lending
syndicate for a longer term committed facility and increased liquidity; and (2)
as previously announced, a refinancing package, the components of which are a
$100 million senior bank financing facility and the completion of an offering of
at least $125 million in senior subordinated notes. The Company previously
announced that the senior bank refinancing commitment letter expired on November
15, 1997 and the planned closing of the refinancing package would be delayed
beyond November 30, 1997. There can be no assurance, however, as to the
Company's ability to effect any such refinancing or modifications in its capital
structure or as to the terms thereof.
Although the Company's liquidity is presently sufficient to meet its
current and, subject to effecting the refinancings or modifications described in
the preceding paragraph, its anticipated needs, should events negatively impact
the Company's forecasts, the Company may need to consider alternative sources of
funds, a reduction in capital expenditures, a more significant restructuring of
its capital structure or a combination of one or more of the foregoing.
OTHER MATTERS
During the third quarter of 1997, in connection with a refinancing effort,
management evaluated certain revenue recognition practices at HDS, which was
acquired in a merger transaction in June 1996 and accounted for as a
"pooling-of-interests." These practices related principally to revenue
recognized in fiscal years 1994, 1995 and 1996. As a result of this evaluation,
management has determined that the revenue was improperly recognized and,
accordingly, has restated the Company's financial statements for all of the
periods indicated. The effect of such restatements on the Company's net income
(loss) for all of the years ended December 31, 1994, 1995, and 1996 was ($5.8)
million, ($1.1) million and ($7.3) million, respectively.
As a result of the HDS related restatement, Deloitte & Touche, the
predecessor accountants, withdrew its audit opinion dated March 31, 1997 in
respect of the Company's 1994, 1995 and 1996 fiscal years. Consequently, the
Company engaged Price Waterhouse to re-audit the Company's financial statements
for its 1995 and 1996 fiscal years and audit the Company's nine-month period
ending September 30, 1997.
Subsequent to the restatement related to HDS, and in connection with the
reaudit of the Company's fiscal years ended December 31, 1995 and 1996 and the
audit of the Company's nine months ended September 30, 1997 by Price Waterhouse,
the Board of Directors of the Company determined, upon recommendation of the
Audit Committee of the Board, to restate the results of such periods to account
for the December 1995 acquisition of Medical Management Sciences, Inc. ("MMS")
on a purchase accounting basis. The MMS transaction had been accounted for as a
pooling of interests.
In March 1997, as a result of a review initiated by senior management and
the Audit Committee of the Board of Directors 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 as set forth herein. These errors and irregularities consisted
primarily of the following: (i) incorrect quarterly recording of revenues and
the related costs and expenses for certain contracts; (ii) incorrect quarterly
recording of certain liabilities for employee bonuses and related expenses;
(iii) 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
28
<PAGE> 29
Company's earnings subsequent to those acquisitions; and (iv) incorrect
depreciation of certain assets related to the Company's comprehensive
reengineering and consolidation project.
The impact of the restatements is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1996
--------------------------------------------------------------
AS RESTATED AS RESTATED IN THE
AS ORIGINALLY IN THE 1996 SEPTEMBER 30, 1997
REPORTED FORM 10-K FORM 10-Q AS RESTATED
------------- ----------- ------------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue.............. $126,731 $132,874 $132,121 $132,121
Salaries and wages... 109,615 106,473 106,473 106,473
Other Operating
expenses........... 39,016 39,370 39,370 39,370
Depreciation......... 6,221 7,201 7,201 7,201
Amortization......... 4,937 4,809 4,809 6,234
Loss before income
taxes.............. (60,617) (52,613) (53,366) (54,975)
Net loss............. (36,995) (32,127) (32,599) (34,009)
Pro forma net loss... (36,370) (31,502) (31,974) (33,384)
Pro forma net loss
per common share... $ (0.51) $ (0.44) $ (0.45) (0.47)
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1996
--------------------------------------------------------------
AS RESTATED AS RESTATED IN THE
AS ORIGINALLY IN THE 1996 SEPTEMBER 30, 1997
REPORTED FORM 10-K FORM 10-Q AS RESTATED
------------- ----------- ------------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue.............. $465,551 $464,842 $455,138 $455,138
Salaries and wages... 292,843 293,425 293,425 293,425
Other Operating
expenses........... 117,169 118,594 118,594 118,594
Depreciation......... 16,496 19,981 19,981 19,981
Amortization......... 14,672 15,026 15,026 19,299
Loss before income
taxes.............. (25,248) (31,384) (41,088) (45,909)
Net loss............. (20,933) (24,565) (30,645) (34,870)
Pro forma net loss... (19,954) (23,586) (29,666) (33,891)
Pro forma net loss
per common share... $ (0.28) $ (0.33) $ (0.42) $ (0.48)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1997
----------------------- -----------------------
AS AS
ORIGINALLY AS ORIGINALLY AS
REPORTED RESTATED REPORTED RESTATED
----------- --------- ----------- ---------
(IN THOUSANDS, (IN THOUSANDS,
EXCEPT PER SHARE DATA) EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue............................................. $124,649 $124,649 $423,162 $423,162
Salaries and wages.................................. 95,544 95,544 281,508 281,508
Other operating expenses............................ 37,818 37,818 115,841 115,841
Depreciation........................................ 7,505 7,505 21,540 21,540
Amortization........................................ 4,374 5,798 13,729 18,001
Income (loss) before income taxes................... (94,175) (95,599) (98,034) (102,306)
Income (loss) before extraordinary item............. (79,984) (81,209) (81,858) (88,533)
Pro Forma net income (loss) (79,984) (81,209) (5,467) (9,142)
Pro Forma net income per common share............... $ (1.10) $ (1.11) $ (0.08) $ (0.13)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
----------------------------------
AS AS
ORIGINALLY PREVIOUSLY AS
REPORTED RESTATED RESTATED
---------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current Assets.............................................. 269,385 255,239 255,239
Total Assets................................................ 815,624 793,903 936,854
Current Liabilities......................................... 193,752 198,747 198,747
Total Liabilities........................................... 423,334 428,329 428,329
Total Stockholders' Equity.................................. 392,290 365,574 508,525
</TABLE>
29
<PAGE> 30
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
1997
---------------------
AS
ORIGINALLY AS
REPORTED RESTATED
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Current Assets.............................................. 199,682 199,682
Total Assets................................................ 735,462 874,737
Current Liabilities......................................... 296,291 150,911
Total Liabilities........................................... 367,123 367,123
Total Stockholders' Equity.................................. 368,339 507,614
</TABLE>
<TABLE>
<CAPTION>
AS PREVIOUSLY REPORTED AS RESTATED
---------------------- -----------
<S> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1994
Revenue................................................... $ 398,934 $ 390,204
Pro forma net income...................................... 32,523 24,874
Pro forma net income per share............................ $ 0.51 $ 0.41
FOR THE YEAR ENDED DECEMBER 31, 1995
Revenue................................................... $ 559,877 $ 558,155
Pro forma net loss........................................ (5,621) (19,625)
Pro forma net loss per share.............................. $ (0.15) $ (0.17)
FOR THE YEAR ENDED DECEMBER 31, 1996
Revenue................................................... $ 608,313 $ 596,714
Pro forma net loss........................................ (123,642) (130,909)
Pro forma net loss per share.............................. $ (1.74) $ (1.84)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
Revenue................................................... $ 295,516 $ 298,513
Restructuring and other changes........................... 2,000 2,824
Net income................................................ 74,304 74,517
Pro forma net income per share............................ $ 0.99 $ 0.99
</TABLE>
30
<PAGE> 31
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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.
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices"). Medaphis first became aware of the
investigation on June 13, 1995 when search warrants were executed on the
Designated Offices and it and MPSC received grand jury subpoenas. Medaphis
received an additional grand jury subpoena on August 22, 1997, with which it is
complying. The subpoena requires, among other things, records of any audit or
investigative reports relating to the billing of payors globally from
radiological services during the period January 1, 1991 to date and any refunds
owed to or issued to payors with respect to such global billing reports in the
Company's various offices, including the Designated Offices. Although the
precise scope of the 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 billing and collection
practices in the Designated Offices. No charges or claims by the government have
been made. Although the Company continues to believe that the principal focus of
the investigation remains on the billing and collection practices in the
Designated Offices, there can be no assurance that the investigation will not
expand to other offices, that the investigation will be resolved promptly, that
additional subpoenas or search warrants will not be received by Medaphis or MPSC
or that the investigation will not have a material adverse effect on the
Company. The Company recorded charges of $12 million in the third quarter of
1995 and $2 million in the fourth quarter of 1996 and a credit of $2.8 million
in the third quarter of 1997, solely for legal and administrative fees, costs
and expenses it anticipates incurring in connection with the investigation and
the putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the investigation. The charges are
intended to cover only the anticipated expenses of the 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.
MPSC has become aware of apparently inadvertent computer software errors
affecting some of its electronic billing to carriers in the State of California.
The error relates to global billing (i.e., billing for the professional and
technical components of a service) for certain radiological services under
circumstances where the radiologist is only entitled to bill for the
professional component of such services. The Company believes such inadvertent
errors have caused overpayments on certain claims submitted on behalf of clients
in the State of California. The full extent of overpayments by carriers and
beneficiaries has not been determined, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, 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 alleged 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, which argued that the Consolidated
Complaint failed to state a claim upon which relief may be granted. 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
31
<PAGE> 32
Complaint no longer contained any claims based on the Securities Act of 1933, as
amended (the "1933 Act"), and the Company's underwriters and outside directors
were no longer named as defendants. On June 26, 1996, the court denied
plaintiffs' motion to certify plaintiffs' class. The plaintiffs and the
defendants agreed to settle this action on a class-wide basis for $4.75 million,
subject to court approval (the "1995 Class Action Settlement"). The 1995 Class
Action Settlement included the related putative class action lawsuit filed in
the Superior Court of Cobb County, Georgia, described more fully below. On
October 29, 1997, the court certified a class for settlement purposes, approved
the settlement and entered final judgment dismissing the action with prejudice.
One of the Company's directors and officers' liability insurance carriers has
paid $3.7 million of the 1995 Class Action Settlement. The Company accrued
approximately $1.2 million in the quarter ended December 31, 1996 for the
anticipated balance of the 1995 Class Action Settlement and to pay certain fees
incident thereto. On November 6, 1997, the Company paid the remaining $1.05
million balance of the settlement.
On November 5, 1996, Medaphis, Randolph G. Brown, a former officer and
director, and Michael R. Cote and James S. Douglass, former officers, were named
as defendants in a putative shareholder class action lawsuit filed in Superior
Court of Cobb County, State of Georgia. This lawsuit was brought on behalf of a
putative class of purchasers of Medaphis Common Stock during the period from
March 29, 1995 through June 15, 1995. Plaintiffs sought compensatory damages and
costs. Pursuant to the 1995 Class Action Settlement, the claims in this state
action were settled and were dismissed without prejudice.
As originally disclosed in its Form 10-K, the Company learned in March 1997
that the government is investigating allegations concerning the Company's wholly
owned subsidiary, Gottlieb's Financial Services, Inc. ("GFS"). In 1993, Medaphis
acquired GFS, an emergency room physician billing company located in
Jacksonville, Florida, which had developed a computerized coding system. In
1994, Medaphis acquired and merged into GFS another emergency room physician
billing company, Physician Billing, Inc., located in Grand Rapids, Michigan. For
the year ended December 31, 1996, GFS represented approximately 7% of Medaphis'
revenue. During that year, GFS processed approximately 5.6 million claims,
approximately 2 million of which were made to government programs. The
government has requested that GFS voluntarily produce records, and GFS is
complying with that request. Although the precise scope and subject matter of
the investigation are not known to the Company, Medaphis believes that the
investigation, which is being participated in by federal law enforcement
agencies having both civil and criminal authority, involves GFS's billing
procedures and the computerized coding system used in Jacksonville and Grand
Rapids to process claims and may lead to claims of errors in billing. There can
be no assurance that the investigation will be resolved promptly or that the
investigation will not have a material adverse effect upon Medaphis. No charges
or claims by the government have been made. Currently, the Company has recorded
charges of $2 million and $1 million in the second and third quarter of 1997,
respectively, solely for legal and administrative fees, costs and expenses in
connection with the investigation, which charges do not include any provision
for fines, penalties, damages, assessments, judgments or sanctions that may
arise out of this matter.
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.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then 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. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleges violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint is brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common Stock between February 6, 1996 and October 21, 1996.
The Consolidated Second Amended Complaint also asserts claims on behalf of a
sub-class of all persons who acquired Medaphis Common Stock pursuant to the
32
<PAGE> 33
merger between Medaphis and Health Data Sciences Corporation ("HDS"). The
Consolidated Second Amended Complaint seeks compensatory and recissory damages,
as well as fees, interest and other costs. On February 14, 1997, the defendants
moved to dismiss the Consolidated Second Amended Complaint in its entirety. On
May 27, 1997, the court denied defendants' motion to dismiss. Discovery
currently is proceeding. 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 such 1933
Act claims.
The parties have entered into a memorandum of understanding dated August
14, 1997 (the "Memorandum of Understanding") to settle the 1996 putative
shareholder class action litigation which is the subject of the Consolidated
Second Amended Complaint on a class-wide basis for $20 million in cash (to be
paid by the Company's directors' and officers' liability insurance carriers),
3,355,556 shares of Medaphis Common Stock, and warrants to purchase 5,309,523
shares of Medaphis Common Stock at $12 per share for a five-year period. The
Memorandum of Understanding also includes: (i) an obligation on the part of
Medaphis to contribute up to 600,000 additional shares of Common Stock to the
settlement under certain conditions if the aggregate value of the Medaphis
Common Stock proposed to be issued in the settlement falls below $30.2 million
during a specified time period; and (ii) certain anti-dilution rights in favor
of plaintiffs with respect to certain future issuances of shares of Medaphis
Common Stock or warrants or rights to acquire Medaphis Common Stock to settle
existing civil litigation and claims currently pending or asserted against the
Company, subject to a 5.0 million share basket below which there will be no
dilution adjustments. The aggregate value of the Medaphis Common Stock during
the specified time period is now known, and, as a result, all of the additional
600,000 shares of Medaphis Common Stock will be included in the settlement. The
Memorandum of Understanding also contains other customary terms and conditions
including, but not limited to, consent and approval of the Company's insurance
carriers and the insurance carriers' payment of the cash portion of the
settlement, the Company's receiving assurances from its independent accountants
that the proposed settlement will not adversely affect pooling-of-interests
accounting treatment on previous acquisitions (which assurances have been
received by the Company), the execution of mutually acceptable settlement papers
and the approval of the settlement by the court. The Company recorded a $52.5
million charge in the quarter ended September 30, 1997 for this settlement.
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 behalf of the Company. 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 all other 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, 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. On February 5, 1997 the court overruled defendants demurrer. On March
18, 1997, the court denied the plaintiff's motion for a preliminary injunction.
On July 16, 1997, plaintiff filed an amended complaint adding several new
parties, including current and former directors and current and former officers
of Medaphis. All of the newly added defendants have responded to the amended
complaint. 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
33
<PAGE> 34
1933 Act but the Company believes that it has substantial defenses to the
alleged damages relating to such 1933 Act claims.
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger 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 Brown). Plaintiffs seek
compensatory and punitive damages, as well as fees, interest and other costs. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
1933 Act and common law and new parties, including former officers of Medaphis,
Medaphis' former outside auditors and BSG. On or about October 29, 1997 all
defendants filed motions to dismiss the amended 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. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through September 30, 1998.
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
non-compete covenants and contract provisions between Medaphis and plaintiffs.
Defendants have filed a motion to dismiss the complaint. Discovery has been
stayed pending resolution of the motion to dismiss.
On August 12, 1997, George W. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Securities Exchange Act of 1934
on behalf of all persons who purchased or otherwise acquired Medaphis Common
Stock between February 6, 1996 and October 21, 1996. The complaint also asserts
claims under the 1933 Act on behalf of a sub-class consisting of all persons and
entities who, in connection with the merger of the Company and HDS, acquired
options to purchase shares of Medaphis Common Stock between February 6, 1996 and
October 21, 1996. The complaint seeks rescission, rescissory and compensatory
damages, and interest, fees and other costs. Defendants have not yet responded
to the complaint.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits. The Company has entered into
standstill and tolling agreements with these and certain other stockholders of
recently acquired companies.
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<PAGE> 35
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, 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 ending December 31, 1995 and
its restated unaudited balance sheets as of March 31, 1996 and June 30, 1996. In
addition, the Company believes that the Commission is investigating the
Company's restatement of its interim financial statements for each quarter of
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. Further, there can be no assurance 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<C> <C> <S>
2.1 -- Merger Agreement, dated as of March 15, 1996, by and among
Registrant, BSGSub, Inc. and BSG Corporation (incorporated
by reference to Exhibit 2.1 to Registration Statement on
Form S-4, file No. 333-2506).
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 of
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
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
Registration Statement on Form 8-A/A, filed on March 28,
1995).
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to Registration Statement on Form S-8, File No.
333-03213).
3.5 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 3.5 to Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 1997).
3.6 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.6 to Quarterly Report on Form 10-Q
for the Quarterly Period Ended June 30, 1997).
10.1* -- Third Amendment to the Amended and Restated Medaphis
Employees' Retirement Savings Plan.
10.2* -- First Amendment to the Medaphis Deferred Compensation Plan.
10.3* -- Second Amendment to the Medaphis Deferred Compensation Plan.
10.4* -- Written description of Registrant's Non-Employee Director
Compensation Plan.
10.5* -- Medaphis Corporation Non-Employee Director Deferred Stock
Credit Plan.
10.6* -- Waiver and Extension Letter Agreement, dated September 18,
1997, with respect to the Second Amended and Restated Credit
Agreement, dated February 4, 1997, among Registrant, the
lenders signatory thereto and SunTrust Bank, Atlanta, as
agent.
</TABLE>
35
<PAGE> 36
<TABLE>
<C> <C> <S>
10.7 -- Waiver and Extension Letter Agreement, dated October 24,
1997, with respect to the Second Amended and Restated Credit
Agreement, dated February 4, 1997, among Registrant, the
lenders signatory thereto and SunTrust Bank, Atlanta, as
agent (incorporated by reference to Exhibit 10.1 to Current
Report on Form 8-K filed on October 27, 1997).
10.8 -- Waiver and Extension Letter Agreement, dated October 24,
1997, with respect to the Participation Agreement, dated
April 21, 1995, as amended, among Registrant, SunTrust Bank,
Atlanta, and Creditanstalt Corporate Finance, Inc., and
SunTrust Bank, Atlanta, as agent (incorporated by reference
to Exhibit 10.2 to Current Report on Form 8-K filed on
October 27, 1997).
10.9* -- First Modification, dated November 19, 1997, of the Second
Amended and Restated Credit Agreement, dated February 4,
1997, among Registrant, the lenders signatory thereto and
SunTrust Bank, Atlanta, as agent.
10.10* -- Employment Agreement dated July 28, 1997, between Registrant
and Randolph L.M. Hutto.
10.11* -- Employment Agreement dated September 30, 1997, between
Registrant and Mark P. Colonnese.
10.12* -- Separation Agreement dated as of May 28, 1997, between
Registrant and Healthcare Recoveries, Inc.
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>
- ---------------
* Filed with original Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 1997.
(b) Reports on Form 8-K
The Company has filed the following reports on Form 8-K or 8-K/A during the
quarter ended September 30, 1997:
<TABLE>
<CAPTION>
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILING DATE
- ------------- ---------- -------------- -------------
<S> <C> <C> <C>
Changes in Registrant's Certifying Accountants,
Dismissal of Deloitte & Touche LLP................... No June 27, 1997 July 7, 1997
Changes in Registrant's Certifying Accountants,
Deloitte & Touche LLP Letter of agreement............ No June 27, 1997 July 10, 1997
Changes in Registrant's Certifying Accountants,
Appointment of Price Waterhouse LLP.................. No July 9, 1997 July 11, 1997
</TABLE>
36
<PAGE> 37
SIGNATURES
Pursuant to the requirements of the Securities and 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/ ALLEN W. RITCHIE
------------------------------------
Allen W. Ritchie
Senior Vice President,
Chief Financial Officer
By: /s/ MARK P. COLONNESE
------------------------------------
Mark P. Colonnese
Vice President and
Corporate Controller
(Principal Accounting Officer)
Date: February 2, 1998
37
<PAGE> 1
EXHIBIT 11
MEDAPHIS CORPORATION
COMPUTATION OF PRIMARY AND FULLY DILUTED EARNINGS PER SHARE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
DESCRIPTION 1997 1996 1997 1996
- ----------------------------- --------- --------- --------- ---------
(As Restated, See Note 6) (As Restated, See Note 6)
<S> <C> <C> <C> <C>
PRIMARY AND FULLY
Weighted average shares outstanding
during the period 72,942 71,665 72,542 71,123
Shares issuable upon assumed exercise
of stock options, less amounts assumed
repurchased under the treasury stock
method - - - -
--------- --------- --------- ---------
Total weighted average common stock
and common stock equivalent outstanding
during the period 72,942 71,665 72,542 71,123
========= ========= ========= =========
Pro forma net income (loss) before extraordinary item $ (81,209) $ (34,384) $ (85,533) $ (33,891)
Extraordinary income on sale of HRI - - 76,391 -
--------- --------- --------- ---------
Pro forma net income (loss) $ (81,209) $ (34,384) $ (9,142) $ (33,891)
========= ========= ========= =========
Pro forma net income (loss) per common share:
Pro forma net income (loss) before extraordinary item $ (1.11) $ (0.47) $ (1.18) $ (0.48)
Extraordinary income on sale of HRI - - 1.05 -
--------- --------- --------- ---------
Pro forma net income (loss) $ (1.11) $ (0.47) $ (0.13) $ (0.48)
========= ========= ========= =========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MEDAPHIS CORPORATION FOR THE NINE MONTHS ENDED
SEPTEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 6,710
<SECURITIES> 0
<RECEIVABLES> 177,152
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 199,682
<PP&E> 80,756
<DEPRECIATION> 0
<TOTAL-ASSETS> 874,737
<CURRENT-LIABILITIES> 150,911
<BONDS> 0
0
0
<COMMON> 731
<OTHER-SE> 507,614
<TOTAL-LIABILITY-AND-EQUITY> 874,737
<SALES> 0
<TOTAL-REVENUES> 423,162
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 506,051
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,417
<INCOME-PRETAX> (102,306)
<INCOME-TAX> (16,773)
<INCOME-CONTINUING> (85,533)
<DISCONTINUED> 0
<EXTRAORDINARY> 76,391
<CHANGES> 0
<NET-INCOME> (9,142)
<EPS-PRIMARY> (0.13)
<EPS-DILUTED> (0.13)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MEDAPHIS CORPORATION FOR THE NINE MONTH PERIOD ENDED
SEPTEMBER 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BE REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 455,138
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 493,028
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,019
<INCOME-PRETAX> (45,909)
<INCOME-TAX> (11,039)
<INCOME-CONTINUING> (34,870)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (33,891)
<EPS-PRIMARY> (0.48)
<EPS-DILUTED> (0.48)
</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 disclosures contained in the Annual Report on Form 10-K
to which this statement is appended as an exhibit and also include the
following:
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE DEBT
The Company has substantial indebtedness and, as a result, significant debt
service obligations. The Company's ability to make payments on its debt
obligations will depend on its future operating performance, which will be
affected by prevailing economic conditions and financial, business and other
factors, certain of which are beyond the Company's control. If the Company is
unable to service its indebtedness, it will be required to adopt alternative
strategies, which may include actions such as reducing or delaying capital
expenditures, selling assets, restructuring or refinancing its indebtedness or
seeking additional equity capital. There can be no assurance that any of these
strategies could be effected on satisfactory terms.
The degree to which the Company is leveraged could have important
consequences, including: (i) the Company's ability to obtain additional
financing in the future for working capital, capital expenditures, acquisitions
or other general corporate purposes may be impaired; (ii) a substantial portion
of the Company's cash flow from operations may be dedicated to the payment of
principal and interest on its indebtedness, thereby reducing the funds available
to the Company for its operations; (iii) the Company's existing indebtedness
contains, and future financings are expected to contain, financial and other
restrictive covenants, including without limitation those restricting the
incurrence of additional indebtedness, the creation of liens, the payment of
dividends, sales of assets, capital expenditures, prepayment and those requiring
maintenance of minimum net worth, minimum EBITDA, minimum interest coverage and
maximum leverage requirements; (iv) certain of the Company's borrowings are and
will continue to be at variable rates of interest which expose the Company to
the risk of increases in interest rates; and (v) the Company may be more
leveraged than certain of its competitors, which may place the Company at a
relative competitive disadvantage and make the Company more vulnerable to
changes in its industry and changing economic conditions. As a result of the
<PAGE> 2
Company's level of indebtedness, its financial capacity to respond to market
conditions, extraordinary capital needs and other factors may be limited.
LITIGATION AND GOVERNMENT INVESTIGATIONS
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.
The United States Attorney's Office for the Central District of California
is conducting an investigation of the billing and collection practices in two
offices of the Company's wholly owned subsidiary, Medaphis Physician Services
Corporation ("MPSC"), which offices are located in Calabasas and Cypress,
California (the "Designated Offices") (the "California Investigation"). Medaphis
first became aware of the California Investigation on June 13, 1995 when search
warrants were executed on the Designated Offices and it and MPSC received grand
jury subpoenas. Medaphis received an additional grand jury subpoena on August
22, 1997, with which it is complying. The subpoena requires, among other things,
records of any audit or investigative reports relating to the billing of payors
globally for radiological services during the period January 1, 1991 to date and
any refunds owed to or issued to payors with respect to such global billing
reports in the Company's various offices, including the Designated Offices.
Although the precise scope of the California 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
billing and collection practices in the Designated Offices. No charges or claims
by the government have been made. Although the Company continues to believe that
the principal focus of the California Investigation remains on the billing and
collection practices in the Designated Offices, there can be no assurance that
the California Investigation will not expand to other offices, that the
California Investigation will be resolved promptly, that additional subpoenas or
search warrants will not be received by Medaphis or MPSC or that the California
Investigation will not have a material adverse effect on the Company. The
Company recorded charges of $12 million in the third quarter of 1995, $2 million
in the fourth quarter of 1996 and a credit of $2.8 million in the third quarter
of 1997, solely for legal and administrative fees, costs and expenses it
anticipates incurring in connection with the California Investigation and the
putative class action lawsuits described below which were filed in 1995
following the Company's announcement of the California Investigation. The
charges are intended to cover only the anticipated expenses of the California
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.
MPSC has become aware of apparently inadvertent computer software errors
affecting some of its electronic billing to carriers in the State of California.
The error relates to global billing (i.e., billing for the professional and
technical components of a service) for certain radiological services under
circumstances where the radiologist is only entitled to bill for the
professional component of such services. The Company believes such inadvertent
errors may have caused overpayments on certain claims submitted on behalf of
clients in the State of California. The full extent of overpayments by carriers
and beneficiaries has not been determined, but as notifications to the affected
clients and carriers occur, and refunds or offsets are sought, the Company may
be required to return to clients its portion of fees previously collected, and
may receive claims for alleged damages as a result of the error.
Following the announcement of the investigation by the United States
Attorney's Office for the Central District of California, 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 alleged 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, which argued that the Consolidated
Complaint failed to state a claim upon which
2
<PAGE> 3
relief may be granted. 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 contained
any claims based on the Securities Act of 1933, as amended (the "1933 Act"), and
the Company's underwriters and outside directors were no longer named as
defendants. On June 26, 1996, the court denied plaintiffs' motion to certify
plaintiffs' class. The plaintiffs and the defendants agreed to settle this
action on a class-wide basis for $4.75 million, subject to court approval (the
"1995 Class Action Settlement"). The 1995 Class Action Settlement included the
related putative class action lawsuit currently pending in the Superior Court of
Cobb County, Georgia, described more fully below. On October 29, 1997 the court
certified a class for settlement purposes, approved the settlement and entered
final judgment dismissing the action with prejudice. One of Medaphis' directors
and officers' liability insurance carriers has paid $3.7 million of the 1995
Class Action Settlement. The Company accrued approximately $1.2 million in the
quarter ended December 31, 1996 for the anticipated balance of the 1995 Class
Action Settlement and to pay certain fees incident thereto. On November 6, 1997,
the Company paid the remaining $1.05 million balance of the settlement.
On November 5, 1996, Medaphis, Randolph G. Brown, a former officer and
director, and Michael R. Cote and James S. Douglass, former officers, were named
as defendants in a putative shareholder class action lawsuit filed in Superior
Court of Cobb County, State of Georgia. This lawsuit was brought on behalf of a
putative class of purchasers of Medaphis Common Stock during the period from
March 29, 1995 through June 15, 1995. Plaintiffs sought compensatory damages and
costs. Pursuant to the 1995 Class Action Settlement, the claims in this state
action were settled and were dismissed without prejudice.
The Company learned in March 1997 that the government is investigating
allegations concerning the Company's wholly owned subsidiary, Gottlieb's
Financial Services, Inc. ("GFS") (the "GFS Investigation"). In 1993, Medaphis
acquired GFS, an emergency room physician billing company located in
Jacksonville, Florida, which had developed a computerized coding system. In
1994, Medaphis acquired and merged into GFS another emergency room physician
billing company, Physician Billing, Inc., located in Grand Rapids, Michigan. For
the year ended December 31, 1996, GFS represented approximately 7% of Medaphis'
revenue. During that year, GFS processed approximately 5.6 million claims,
approximately 2 million of which were made to government programs. The
government has requested that GFS voluntarily produce records, and GFS is
complying with that request. Although the precise scope and subject matter of
the GFS Investigation are not known to the Company, Medaphis believes that the
GFS Investigation, which is being participated in by federal law enforcement
agencies having both civil and criminal authority, involves GFS's billing
procedures and the computerized coding system used in Jacksonville and Grand
Rapids to process claims and may lead to claims of errors in billing. There can
be no assurance that the GFS Investigation will be resolved promptly or that the
GFS Investigation will not have a material adverse effect upon Medaphis. No
charges or claims by the government have been made. Currently, the Company has
recorded charges of $2 million and $1 million in the second and third quarters
of 1997, respectively, solely for legal and administrative fees, costs and
expenses in connection with the GFS Investigation, which charges do not include
any provision for fines, penalties, damages, assessments, judgments or sanctions
that may arise out of this matter.
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.
Following the Company's August 14, 1996 announcement regarding earnings
expectations and certain charges, Medaphis and certain of its then 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. On February 3, 1997, the plaintiffs filed a Consolidated Second
Amended Complaint (the "Consolidated Second Amended Complaint"). In general, the
Consolidated Second Amended Complaint alleges violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint is brought on behalf of a class of persons who purchased or otherwise
acquired Medaphis Common
3
<PAGE> 4
Stock between February 6, 1996 and October 21, 1996. The Consolidated Second
Amended 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"). The Consolidated Second Amended
Complaint seeks compensatory and rescissory damages, as well as fees, interest
and other costs. On February 14, 1997, the defendants moved to dismiss the
Consolidated Second Amended Complaint in its entirety. On May 27, 1997, the
court denied defendants' motion to dismiss. 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 such 1933 Act claims.
The parties entered into a Stipulation and Agreement of Settlement dated
December 15, 1997 (the "Stipulation") to settle the 1996 putative shareholder
class action litigation which is the subject of the Consolidated Second Amended
Complaint on a class-wide basis for $20 million in cash (to be paid by the
Company's directors' and officers' liability insurance carriers), 3,955,556
shares of Medaphis Common Stock, and warrants to purchase 5,309,523 shares of
Medaphis Common Stock at $12 per share for a five-year period which were valued
at $22.3 million using an option pricing model. The Stipulation also includes,
among other things: (i) a complete release of claims against the Company, the
individual defendants and certain related persons and entities; and (ii) certain
anti-dilution rights in favor of plaintiffs with respect to certain future
issuances of shares of Medaphis Common Stock or warrants or rights to acquire
Medaphis Common Stock to settle existing civil litigation and claims pending or
asserted against the Company, subject to a 5.0 million share basket below which
there will be no dilution adjustments. The Stipulation also contains other
conditions including, but not limited to, consent and approval of the Company's
insurance carriers and the insurance carriers' payment of the cash portion of
the settlement, and the final approval of the settlement by the court. On
December 15, 1997, the court granted preliminary approval to the settlement and
conditionally certified the classes for settlement purposes only. The Company
recorded a $52.5 million charge in the quarter ended September 30, 1997 for this
settlement. Such amount has been reflected as a non-current liability as the
Company does not anticipate satisfying the obligation with current assets.
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 behalf of the Company. 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 all other 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, 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. On February 5, 1997 the Court overruled defendants demurrer. On March
18, 1997, the court denied the plaintiff's motion for a preliminary injunction.
On July 16, 1997, plaintiff filed an amended complaint adding several new
parties, including current and former directors and former and current officers
of Medaphis. All of the newly added defendants have responded to the amended
complaint. As a result of the Company's restatements 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 such 1933 Act
claims.
4
<PAGE> 5
A putative class action complaint was filed by Ernest Hecht and Stephen D.
Strandberger 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 Brown). Plaintiffs seek
compensatory and punitive damages, as well as fees, interest and other costs. On
April 18, 1997, the Medaphis defendants and BSG defendants filed motions to
dismiss the complaint. On or about July 3, 1997, in lieu of responding to these
motions, the plaintiffs filed an amended complaint, adding new claims under the
1933 Act and common law and new parties, including former officers of Medaphis,
Medaphis' former outside auditors and BSG. On or about October 29, 1997 all
defendants filed motions to dismiss the amended 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. The indemnification demand claims damages of $35 million (the maximum
damages payable by Medaphis under the indemnification agreement) for the alleged
breach by Medaphis of its representations and warranties made in the merger
agreement between Medaphis and BSG. On December 31, 1996, Medaphis entered into
a standstill and tolling agreement with Mr. Noorda, Mr. Papermaster and other
former BSG shareholders, which, as extended, runs through September 30, 1998.
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
non-compete covenants and contract provisions between Medaphis and plaintiffs.
Defendants have filed a motion to dismiss the complaint. Discovery has been
stayed pending resolution of the motion to dismiss.
On August 12, 1997, George W. Stickel filed a putative class action
complaint against Medaphis, Randolph W. Brown, Michael R. Cote and James S.
Douglass in the United States District Court for the Northern District of
Georgia. The complaint asserts claims under the Securities Exchange Act of 1934
on behalf of all persons who purchased or otherwise acquired Medaphis Common
Stock between February 6, 1996 and October 21, 1996. The complaint also asserts
claims under the 1933 Act on behalf of a sub-class consisting of all persons and
entities who, in connection with the merger of the Company and HDS, acquired
options to purchase shares of Medaphis Common Stock between February 6, 1996 and
October 21, 1996. The complaint seeks rescission, rescissory and compensatory
damages, and interest, fees and other costs. Defendants have not yet responded
to the complaint.
The Company also has received other written demands from various
stockholders, including stockholders of recently acquired companies. To date,
these other stockholders have not filed lawsuits. The Company has entered into
standstill and tolling agreements with these and certain other stockholders of
recently acquired companies.
On January 8, 1997, the Securities and Exchange Commission (the
"Commission") notified the Company that it was conducting a formal, 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
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Company's loss for the quarter ending September 30, 1996 and its restated
consolidated financial statements for the three months and year ending December
31, 1995 and its restated unaudited balance sheets as of March 31, 1996, and
June 30, 1996. In addition, the Company believes that the Commission is
investigating the Company's restatement of its interim financial statements for
each quarter of 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. Further, there can be no assurance 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.
DEPENDENCE ON TURNAROUND; FUTURE OPERATING RESULTS; MANAGEMENT
The Company suffered several setbacks in recent years, including (i)
government investigations into: (a) the billing and collection practices in two
offices of Medaphis Physicians Services Corporation ("MPSC") (the "California
Investigation"), and (b) the billing procedures and computerized coding system
used in Gottlieb's Financial Services, Inc. ("GFS") to process claims, which may
lead to claims of errors in billing (the "GFS Investigation"); (ii) the failure
of prior managements' acquisition strategy to integrate companies acquired;
(iii) several restatements of various financial statements of the Company,
including restatements of the Company's fiscal 1994, 1995, 1996 and interim 1997
financial statements; (iv) the discontinuance of the operations of one of the
businesses acquired; (v) the abandonment of an extensive reengineering program
that failed to realize the improvement in customer service and reduction of
costs that were expected; (vi) a steep drop in the price of its common stock;
and (vii) the filing of various lawsuits and claims made against the Company,
including multiple putative shareholder class action lawsuits alleging
violations of the federal securities laws. Consequently, the Company has been
operating in what is commonly described as a "turnaround" situation. In addition
to the risks generally associated with any entity in a turnaround situation, the
Company faces certain challenges more specific to its operations, including: (i)
integrating several recent acquisitions into its ongoing operations; (ii)
shifting its strategic focus from acquiring compatible businesses to running its
existing businesses efficiently and profitably; (iii) successfully completing
the combination of the operations of BSG Corporation ("BSG") and Healthcare
Information Technologies ("HIT") under the Per-Se name, following the
reorganization of its Imonics Corporation ("Imonics"), BSG and BSG Government
Solutions, Inc. (formerly Rapid Systems Solutions, Inc.) ("BSG Government")
subsidiaries and the shutdown of Imonics; (iv) managing existing customers'
perceptions of the Company's continued viability and refocusing on the high
levels of customer service required to develop new customers and retain existing
customers; (v) combating employee turnover, particularly in light of declines in
the market value of the Company's common stock (the value of which often plays a
role in compensation of employees); (vi) reducing costs and increasing
efficiencies; and (vii) reevaluating the efficiency of its operations following
the Company's 1996 abandonment of its reengineering initiative to develop a
unified billing and information hardware and software system across all of its
operating platforms, the costs of which were subsequently determined to outweigh
the benefits.
There can be no assurance that the Company will successfully meet these or
other operating challenges or that the Company's operating plans ultimately will
be successful. Any failure with respect to the foregoing could have a material
adverse effect on the Company.
The Company's success in general, and the successful implementation of its
operating plans in particular, is dependent upon, among other things, the
continued contributions of the Company's senior management. There can be no
assurance that the Company's management will be successful and the loss of
services of those members could have a material adverse effect on the Company's
businesses.
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RESTATEMENT OF FINANCIAL STATEMENTS; ACCOUNTING ISSUES
In October 1996, the Company restated its financial results for the year
and three months ended December 31, 1995. This restatement related primarily to
a side letter relating to a license agreement entered into by Imonics in
December 1995, which created a contingency upon license fees payable under the
agreement. The contingency occurred, entitling the purchaser to a refund and
cancellation of the contract. The license fee revenue payable under the
agreement and recognized by the Company during the fourth quarter of 1995,
together with previously deemed immaterial amounts, resulted in an aggregate
reduction to net income for the quarter and year ended December 31, 1995 of $5.1
million.
As a result of a review initiated by senior management and the Audit
Committee of the Board of Directors in March 1997 prior to completion of the
audit process for the Company's 1996 fiscal year, information was developed
indicating that certain revenues and expenses may have been recorded incorrectly
between certain quarters during 1996. In addition, Deloitte & Touche LLP
("Deloitte & Touche") provided to senior management of the Company a letter
relating to the Company's internal control structure resulting from Deloitte &
Touche's audit of the Company's financial statements for the year ended December
31, 1996. This letter reflected Deloitte & Touche's view that inadequate
internal controls over the preparation of interim financial information for each
fiscal quarter of 1996 constituted a material weakness in internal controls
which resulted in certain errors and irregularities in the financial information
for such quarters. The Company previously disclosed in its Form 10-K for its
fiscal year ended December 31, 1996 that such errors and irregularities in its
financial information had occurred for each fiscal quarter of 1996. In
connection with the issuance of Deloitte & Touche's audit report dated March 31,
1997 on the Company's financial statements for the year ended December 31, 1996,
the Company recorded all adjustments to its interim financial statements deemed
appropriate for such errors and irregularities and consequently restated such
interim financial statements. All adjustments were for interim period
transactions and had no effect on the Company's 1996 annual pro forma net loss.
The reports of Deloitte & Touche on the Company's financial statements for
the fiscal year ended December 31, 1996, dated March 31, 1997, included an
unqualified opinion with an explanatory paragraph that stated Deloitte &
Touche's conclusion that uncertainty then existed regarding the ability of the
Company to continue as a going concern due to a mandatory commitment reduction
in the Company's Existing Credit Facility that was required by July 31, 1997.
However, the Company satisfied such commitment reduction on May 28, 1997 by
applying the proceeds of the sale of HRI.
On June 30, 1997, following a competitive review and request for proposal
process in which Deloitte & Touche, the Company's then-present auditors, and a
number of other nationally recognized accounting firms participated, the Company
notified Deloitte & Touche that it had been dismissed as the Company's principal
accountants and that the Company intended to engage new principal accountants.
This action was recommended by the Audit Committee of the Company's Board of
Directors, and the Board approved such change on June 27, 1997. On July 9, 1997,
the Company engaged Price Waterhouse LLP ("Price Waterhouse") as the Company's
new principal accountants.
During the third quarter of 1997, in connection with a refinancing effort
of the Company's then credit agreement, management evaluated certain revenue
practices at Health Data Sciences Corporation ("HDS"), a wholly-owned subsidiary
of the Company which was acquired by the Company in a merger transaction in June
1996 that was accounted for as a pooling of interests. These practices related
principally to revenue recognized in fiscal years 1994, 1995 and 1996. As
disclosed by the Company in its Form 10-Q for its fiscal quarter ending
September 30, 1997, management determined that certain revenue of HDS was
improperly recognized and, accordingly, determined to restate its financial
statements for its 1994, 1995 and 1996 fiscal years and the first two fiscal
quarters of its 1997 fiscal year. The effect of such restatements on the
Company's net income (loss) for the years ended December 31, 1994, 1995 and 1996
was ($5.8) million, $(1.1) million and $(7.3) million, respectively. The
cumulative reduction in assets caused by such restatement was $20.5 million.
As a result of the HDS-related restatements, Deloitte & Touche withdrew its
audit opinion dated March 31, 1997 in respect of the Company's 1994, 1995 and
1996 fiscal years. Consequently, the Company
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engaged Price Waterhouse to re-audit the Company's 1995 and 1996 fiscal years
and audit the Company's nine-month period ending September 30, 1997. The Company
determined to further restate the results of such periods to account for the
December 1995 acquisition by the Company of Medical Management Sciences, Inc.
("MMS") on a purchase accounting basis. Such acquisition had previously been
accounted for as a pooling of interests.
Financial statements for the Company's 1995, 1996 and 1997 fiscal years
reflecting the HDS and MMS related restatements are being filed by the Company
as an exhibit to the Annual Report on Form 10-K to which this exhibit is
appended. Such financial statements were audited by Price Waterhouse and
accompanied by their audit opinion which was unqualified and was not subject to
any modifying paragraphs.
While the Company restated its 1994 financial statements, it has not
reaudited such financial statements. Consequently, the Company may not be in
full compliance with the reporting requirements of applicable securities laws.
There can be no assurances that any such failure to be in compliance will not
have a material adverse consequence for the Company.
In addition, the Company received a subpoena from the Securities and
Exchange Commission (the "Commission") in connection with an on-going Commission
investigation on January 2, 1998. The subpoena seeks information in connection
with the November 19 and December 23, 1997 restatements and certain charges
taken by the Company in the third quarter of 1997. There can be no assurances
that the results of such inquiry will not have a material adverse effect on the
Company or that further restatements of the Company's financial statements will
not be required.
There can be no assurance that there will not be additional adjustments to
or reserves taken in the Company's financial statements in respect of the
pending or future lawsuits and government investigations.
EVOLVING INDUSTRY STANDARDS; RAPID TECHNOLOGICAL CHANGES
The markets for Medaphis' software products and services are characterized
by rapidly changing technology, evolving industry standards and frequent new
product introductions. Medaphis' success in its business will depend in part
upon its continued ability to enhance its existing products and services, to
introduce new products and services quickly and cost-effectively to meet
evolving customer needs, to achieve market acceptance for new product and
service offerings and to respond to emerging industry standards and other
technological changes. There can be no assurance that Medaphis will be able to
respond effectively to technological changes or new industry standards.
Moreover, there can be no assurance that competitors of Medaphis will not
develop competitive products, or that any such competitive products will not
have an adverse effect upon Medaphis' operating results.
The Company intends further to refine, enhance and develop certain of the
Company's existing software and billing systems and to change all of the
Company's billing and accounts receivable management services operations over to
the Company's most proven software systems and technology to reduce the number
of systems and technologies 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 successful in refining, enhancing and
developing its software and billing systems going forward, that the costs
associated with refining, enhancing and developing such software and systems
will not increase significantly in future periods, that the Company will be able
successfully to 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.
CLIENT/SERVER INFORMATION TECHNOLOGY PRODUCTS
Medaphis' client/server information technology business involves, among
other things, projects designed to reengineer significant customer 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
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to attract new client/server information technology business, result in the
payment of damages to the customer, jeopardize the Company's ability to collect
for services already performed on the project and otherwise adversely affect its
results of operations.
POTENTIAL "YEAR 2000" PROBLEMS
It is possible that the Company's currently installed computer systems,
software products or other business systems, or those of the Company's
customers, vendors or resellers, working either alone or in conjunction with
other software or systems, will not accept input of, store, manipulate and
output dates for the years 1999, 2000 or thereafter without error or
interruption (commonly known as the "Year 2000" problem). The Company has
conducted a review of its business systems, including its computer systems, and
is querying its customers, vendors and resellers as to their progress in
identifying and addressing problems that their computer systems may face in
correctly interrelating and processing date information as the year 2000
approaches and is reached. However, there can be no assurance that the Company
will identify all such Year 2000 problems in its computer systems or those of
its customers, vendors or resellers in advance of their occurrence or that the
Company will be able to successfully remedy any problems that are discovered.
The expenses of the Company's efforts to identify and address such problems, or
the expenses or liabilities to which the Company may become subject as a result
of such problems, could have a material adverse effect on the Company's
business, financial condition and results of operations. The revenue stream and
financial stability of existing customers may be adversely impacted by Year 2000
problems, which could cause fluctuations in the Company's revenues. In addition,
failure of the Company to identify and remedy Year 2000 problems could put the
Company at a competitive disadvantage relative to companies that have corrected
such problems.
COMPETITION; INDUSTRY AND MARKET CHANGES
The business of providing management services and information technology to
physicians and hospitals is highly competitive. Medaphis competes with certain
national and regional physician and hospital reimbursement organizations and
collection businesses (including local independent operating companies), certain
national information and data processing organizations and certain physician
groups and hospitals that provide their own business management services.
Potential industry and market changes that could adversely affect the billing
and collection aspects of Medaphis' business include (i) a significant increase
in managed care providers relative to conventional fee-for-service providers,
potentially resulting in substantial changes in the medical reimbursement
process, or the Company's failure to respond to such changes and (ii) new
alliances between healthcare providers and third-party payors in which
healthcare providers are employed by such third-party payors. The business of
providing application software, information technology and consulting services
is also highly competitive and Medaphis faces competition from certain national
and regional companies in connection with its technology operations. Certain of
Medaphis' competitors have longer operating histories and greater financial,
technical and marketing resources than Medaphis. There can be no assurance that
competition from current or future competitors will not have a material adverse
effect upon Medaphis.
The Company's business is affected by, among other things, 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 paid the prices established
by providers while other healthcare payors, notably government agencies and
managed care companies, have paid 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 government agencies and
others but not paid for 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 accounts receivable 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 the providers' responses to these pressures,
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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 affecting 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 adversely affected and could continue to
adversely affect the revenues and profit margins of the Company's operations.
GOVERNMENTAL INVESTIGATORY RESOURCES AND HEALTHCARE REFORM
The federal government in recent years has placed increased scrutiny on the
billing and collection practices of healthcare providers and related entities,
and particularly on possibly fraudulent billing practices. This heightened
scrutiny has resulted in a number of high profile civil and criminal
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) (codified
in scattered sections of the United States Code, including 18, 26, 29 and 42
U.S.C.), which includes an expansion of provisions relating to fraud and abuse,
creates additional criminal offenses relating to healthcare benefit programs,
provides for forfeitures and asset-freezing orders in connection with such
healthcare offenses and contains provisions for instituting greater coordination
of federal, state and local enforcement agency resources and actions.
In recent years, the focus of healthcare legislation has been on budgetary
and related funding mechanism issues. 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 and would make significant
changes in the Medicare and Medicaid programs. The Clinton Administration has
proposed alternate measures to reduce, to a lesser extent, projected increases
in Medicare and Medicaid expenditures. Neither proposal has become law and
Medaphis anticipates that both the Clinton Administration and the Republican
majorities in Congress will introduce legislation in 1998 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, including 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 through integrated delivery systems may result in a decrease in
demand for Medaphis billing and collection services for particular physician
practices.
EXISTING GOVERNMENT REGULATION
Existing government regulation can adversely affect Medaphis' business
through, among other things, its potential to reduce the amount of reimbursement
received by Medaphis' clients for healthcare services. Medaphis' medical billing
and collection activities are also governed by numerous federal and state civil
and criminal laws. 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.
Submission of claims for services or procedures that are not provided as
claimed, or which otherwise violate the regulations, may lead to civil monetary
penalties, criminal fines, imprisonment and/or exclusion
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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
"whistle-blower" 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, 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. Some state
laws also provide for false claims actions, including actions initiated by a qui
tam plaintiff. Medaphis is currently the subject of several federal
investigations, and 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. Any such proceeding or investigation
could have a material adverse effect upon the Company.
Credit collection practices and activities are regulated by both federal
and state law. The Federal Fair Debt Collection Practices Act (the "Federal Fair
Debt Act") sets forth various provisions designed to eliminate abusive,
deceptive and unfair debt collection practices by debt collectors. Various
states have also promulgated laws and regulations that govern credit collection
practices. AssetCare, Inc. a subsidiary of the Company, is registered as a debt
collector in 26 states; however, there can be no assurance that the Company and
its subsidiaries (other than AssetCare), will not be subjected to regulation as
a "debt collector" under the Federal Fair Debt Act or as a "collection agency"
under certain state collection agency laws and regulations. In the event that
the Company or a subsidiary of the Company other than AssetCare is subjected to
such regulation, its impact on the Company cannot be predicted.
The ownership and operation of hospitals is subject to comprehensive
regulation by federal and state governments which may adversely affect hospital
reimbursement. Such regulation could have an adverse effect on the operations of
hospitals in general, and consequently reduce the amount of the Company's
revenue related to its hospital clients.
There can be no assurance that current or future government regulations or
healthcare reform measures will not have a material adverse effect upon
Medaphis' business.
NASD ACTIONS. There can be no assurances that the NASD will not suspend
trading in the Company's common stock or de-list the Company's Common Stock as a
result of either the restatements described in this Form 10-K or the withdrawal
by Deloitte & Touche LLP of its opinions in respect of the financial statements
for the Company's 1994, 1995 and 1996 fiscal years.
VOLATILITY OF STOCK PRICE. Medaphis believes factors such as announcements
with respect to the investigation of the billing practices of certain offices of
MPSC by the United States Attorney's Office for the Central District of
California, 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.
This Safe Harbor Statement supersedes the Safe Harbor Statements filed as
Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1997 and as Exhibit 99.6 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
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