<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
<TABLE>
<C> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>
COMMISSION FILE NUMBER 000-19480
MEDAPHIS CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 58-1651222
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2700 CUMBERLAND PARKWAY, SUITE 300 30339
ATLANTA, GEORGIA (Zip code)
(Address of principal executive offices)
</TABLE>
(770) 444-5300
Registrant's telephone number, including area code:
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares of stock outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT MAY 1, 1998
----- --------------------------
<S> <C>
Common Stock
$0.01 par value 78,251,728 shares
Non-voting Common Stock
$0.01 par value 0 shares
</TABLE>
================================================================================
<PAGE> 2
MEDAPHIS CORPORATION
FORM 10-Q
FOR THE FISCAL QUARTER ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Part I: Financial Information............................... 1
Consolidated Balance Sheets as of March 31, 1998 and
December 31, 1997...................................... 1
Consolidated Statements of Operations for the three months
ended March 31, 1998 and 1997.......................... 2
Consolidated Statements of Cash Flows for the three months
ended March 31, 1998 and 1997.......................... 3
Notes to Consolidated Financial Statements................ 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 14
Part II: Other Information.................................. 19
Legal Proceedings......................................... 19
Other Matters............................................. 24
Exhibits and Reports on Form 8-K.......................... 25
</TABLE>
---------------------
THIS FORM 10-Q AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY
MEDAPHIS CORPORATION OR ITS REPRESENTATIVES CONTAIN STATEMENTS WHICH MAY
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT
OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF MEDAPHIS CORPORATION AND MEMBERS OF ITS MANAGEMENT
TEAM AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-Q, AND ARE
HEREBY INCORPORATED HEREIN BY REFERENCE. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS, THE
OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER
TIME.
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 7,125 $ 17,794
Restricted cash........................................... 8,467 5,576
Accounts receivable, billed............................... 104,662 100,813
Accounts receivable, unbilled............................. 73,821 75,888
Other..................................................... 13,334 12,365
--------- ---------
Total current assets.............................. 207,409 212,436
Property and equipment...................................... 80,346 72,763
Deferred income taxes....................................... 67,936 60,857
Intangible assets........................................... 511,019 515,939
Other....................................................... 13,599 12,032
--------- ---------
$ 880,309 $ 874,027
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 10,119 $ 12,256
Accrued compensation...................................... 31,807 36,506
Accrued expenses.......................................... 53,571 56,295
Current portion of long-term debt......................... 10,834 11,490
Deferred income taxes..................................... 2,392 2,392
--------- ---------
Total current liabilities......................... 108,723 118,939
Long-term debt.............................................. 213,073 189,451
Accrued litigation settlement............................... 52,500 52,500
Other obligations........................................... 11,255 11,356
--------- ---------
Total liabilities................................. 385,551 372,246
--------- ---------
Stockholders' Equity:
Preferred stock, no par value, 20,000 authorized in 1998
and 1997; none issued.................................. -- --
Common stock, voting, $0.01 par value, 200,000 authorized
in 1998 and 1997; issued and outstanding 74,002 in 1998
and 73,204 in 1997..................................... 740 732
Common stock, non-voting, $0.01 par value, 600 authorized
in 1998 and 1997; none issued.......................... -- --
Paid-in capital........................................... 682,674 678,998
Accumulated deficit....................................... (188,656) (177,949)
--------- ---------
Total stockholders' equity........................ 494,758 501,781
--------- ---------
$ 880,309 $ 874,027
========= =========
</TABLE>
See notes to consolidated financial statements.
1
<PAGE> 4
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1998 1997
-------- --------
<S> <C> <C>
Revenue..................................................... $140,340 $147,546
-------- --------
Salaries and wages.......................................... 88,198 93,578
Other operating expenses.................................... 39,339 40,242
Depreciation................................................ 8,304 6,985
Amortization................................................ 6,118 6,114
Interest expense, net....................................... 6,375 6,115
Restructuring and other charges............................. 561 --
-------- --------
Total expenses.................................... 148,895 153,034
-------- --------
Loss before income taxes and extraordinary item............. (8,555) (5,488)
Income tax benefit.......................................... (3,405) (2,424)
-------- --------
Loss before extraordinary item.............................. (5,150) (3,064)
Extraordinary item: early extinguishment of debt, net of
tax....................................................... (5,557) --
-------- --------
Net loss.......................................... $(10,707) $ (3,064)
======== ========
Basic net loss per common share:
Loss before extraordinary item............................ $ (0.07) $ (0.04)
Extraordinary item: early extinguishment of debt, net of
tax.................................................... (0.08) --
-------- --------
Net loss.......................................... $ (0.15) $ (0.04)
======== ========
Weighted average shares outstanding......................... 73,479 72,235
======== ========
</TABLE>
See notes to consolidated financial statements.
2
<PAGE> 5
MEDAPHIS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
-------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(10,707) $(3,064)
Adjustments to reconcile net loss to net cash (used for)
provided by operating activities:
Depreciation and amortization.......................... 14,422 13,099
Early extinguishment of debt........................... 9,231 --
Gain on sale of property and equipment................. -- (102)
Deferred income taxes.................................. (7,079) (2,429)
Changes in assets and liabilities, excluding effects of
acquisitions:
Accounts receivable, billed.......................... (3,849) (1,905)
Accounts receivable, unbilled........................ 2,067 4,893
Accounts payable..................................... (2,137) 2,933
Accrued compensation................................. (4,676) 3,754
Accrued expenses..................................... (5,455) (10,260)
Other, net........................................... (350) (1,042)
-------- -------
Net cash (used for) provided by operating
activities....................................... (8,533) 5,877
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (15,638) (3,400)
Proceeds from sale of property and equipment.............. -- 3,644
Software development costs................................ (1,304) (1,398)
Other..................................................... (418) (769)
-------- -------
Net cash used for investing activities............ (17,360) (1,923)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................... 756 194
Proceeds from the exercise of employee stock options...... 2,907 3,424
Proceeds from borrowings.................................. 242,000 10,000
Principal payments of long-term debt...................... (219,076) (12,020)
Deferred financing costs.................................. (11,363) (3,009)
-------- -------
Net cash provided by (used for) financing
activities....................................... 15,224 (1,411)
-------- -------
CASH:
Net change................................................ (10,669) 2,543
Balance at beginning of period............................ 17,794 7,631
-------- -------
Balance at end of period.................................. $ 7,125 $10,174
======== =======
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest............................................... $ 3,853 $ 4,615
Income taxes........................................... 616 612
Non-cash investing and financing activities:
Additions to capital lease obligations................. 42 --
</TABLE>
See notes to consolidated financial statements
3
<PAGE> 6
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Medaphis Corporation ("Medaphis" or the "Company") are presented in accordance
with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. For further
information, the reader of this Form 10-Q may wish to refer to the audited
consolidated financial statements of the Company for the fiscal year ended
December 31, 1997 included in the Company's Annual Report on Form 10-K filed
February 2, 1998.
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.
NOTE 2 -- 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, 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.
Investigations such as the California Investigation can be initiated
following the commencement of qui tam litigation which is commenced under
applicable state and federal statutes and is maintained under court seal without
disclosure to the defendant. Under the applicable statutes, the United States
and the State of California may elect to intervene fully or partially in qui tam
litigation, and proceed with the action. The United States typically will
provide a defendant with the opportunity to enter into settlement negotiations
prior to the intervention of the United States in the matter. An application by
the United States to partially lift the seal in qui tam litigation in order to
make disclosure of the complaint available to the defendant often precedes such
settlement discussions.
On February 6, 1998, on application of the United States, the United States
District Court for the Central District of California issued an order partially
lifting the seal on the qui tam suit entitled United States of America and State
of California, ex rel. Relator I and Relator II v. Compmed Corporation, Medaphis
Corporation, Does 1 to 200, Inclusive. Civil Action No. 94-8158 LGB (kx). On
February 11, 1998, the United States provided Medaphis with a copy of the
Complaint, Substitution of Attorney, and Order which prohibited the Company from
making any use of the Complaint, including any public disclosure, other than for
the purposes of settlement negotiations, without further order of the Court. On
February 12, 1998, upon the joint application of Medaphis and the United States,
the Court issued an order modifying its February 6, 1998 order to allow Medaphis
to make public disclosures concerning the Complaint and its contents to the
extent that
4
<PAGE> 7
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Medaphis determined such disclosures were required by applicable securities
laws, provided that such disclosure did not reveal the Relators' identities.
According to the Complaint, filed December 20, 1995 by the Relators and
which contains allegations raised by them, the action is to recover damages and
civil penalties on behalf of the United States and the State of California
arising out of alleged false claims presented by the defendants on behalf of
their clients for payment under various state and federal insurance programs. No
charges or claims by the government have been made. The Complaint includes
causes of action under the Federal False Claims Act, 31 U.S.C. sec 3729 et seq.,
and the California False Claims Act, Cal. Gov't Code sec. 12650 et seq. The
Complaint also includes causes of action relating to Medaphis's termination of
Relator II, including a count under the state and federal whistleblower
protection statutes. The Complaint alleges overpayments of approximately
$20,500,000 together with treble damages and additional penalties based on
statutory civil penalties. The Complaint alleges that at least 50,000 separate
false claims were filed under federal programs and at least 8,000 separate false
claims were filed under state programs. The Complaint also alleges unspecified
compensatory, general and punitive damages on behalf of Relator II on his or her
employment claims. The allegations in the Complaint are limited to the office of
CompMed (acquired by Medaphis) in Culver City, California. Medaphis believes
that this Complaint relates to and concerns the California Investigation.
Medaphis is engaged in discussions with the United States and California, and
intends to pursue settlement discussions with the United States, the State of
California, and the Relators. The Company has agreed with the government to toll
applicable statutes of limitations through September 30, 1998, and anticipates
executing an agreement to that effect.
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 or the qui
tam suit will be resolved promptly, that additional subpoenas or search warrants
will not be received by Medaphis or MPSC or that the California Investigation or
the qui tam suit 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.
In September 1996, MPSC became 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, which impacts only certain managed care plans,
cannot be determined by the Company, 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. The Company is
unable to estimate the possible range of loss, if any.
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
5
<PAGE> 8
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
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 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. On May 19, 1997, the plaintiffs and the defendants entered into a
stipulation and settlement agreement, pursuant to which the parties 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 28, 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 directly for the benefit of the plaintiffs. 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.
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan are
investigating allegations concerning the Company's wholly owned subsidiary,
Gottlieb's Financial Services, Inc. ("GFS") (the "GFS Investigation"). Beginning
in February, 1998, the Office of the Inspector General of Health and Human
Services has requested information from GFS following an audit of a GFS client.
GFS has complied with those requests. 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 each of the years ended
December 31, 1996 and 1997, GFS represented approximately 7% of Medaphis'
revenue. During those years, GFS processed approximately 5.6 million and 6.25
million claims, respectively, approximately 2 million and 2.3 million of which,
respectively, were made to government programs. The government has requested
that GFS voluntarily produce records, and GFS has complied 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 is in discussions with the United States and intends to
pursue settlement discussions with the United States.
In addition, the Company decided in April 1998 to transition from the
computerized coding system to manual coding. There can be no assurances that the
Company will not be subject to customer complaints, claims and contract
terminations as a result of the coding system transition or modifications
previously made to the system.
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)
6
<PAGE> 9
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
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 alleged violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint was 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 asserted claims on behalf of a
sub-class of all persons who acquired Medaphis Common Stock pursuant to the
merger between Medaphis and HDS. The Consolidated Second Amended Complaint
sought 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.
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. 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's insurance carriers consented to the settlement and funded the $20
million cash portion. On March 25, 1998, the Court granted final approval of the
settlement and entered final judgment dismissing the action.
The Company recorded a $52.5 million charge in the quarter ended September
30, 1997 in connection with the Stipulation. This charge is comprised of the
following: (i) $30.2 million representing the original 3,355,556 shares of
common stock valued at the fair value of a common share on the date that the
material terms of the agreement were reached or approximately $9 per share and
(ii) $22.3 million representing the fair value of the warrants on the date the
material terms of the agreement were reached, valued using the Black-Scholes
option pricing model with the following assumptions: expected life -- 5 years,
risk free interest rate -- 6%, dividend rate -- 0% and expected volatility
factor -- 60%. No accounting recognition was required for the additional 600,000
shares to be issued pursuant to the agreement as these shares represent the
maximum number of contingent shares that were issuable based on certain stock
price contingencies during the ten day period prior to October 11, 1997. As a
result of the actual decline in the Company's stock price during such period,
the Stipulation required that the maximum number of contingent shares be
awarded; however, no additional accounting charge is required in connection with
the award of such contingent shares. Although the exact timing of the issuance
of the 3,955,556 shares is not known, the Company does not expect such shares to
be issued before the second quarter of 1998. Additionally, no accounting
recognition has been afforded the cash portion of the Stipulation as this amount
is the responsibility of the insurance carriers. Such amount has
7
<PAGE> 10
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
been paid directly to an escrow account for the benefit of the plaintiffs by the
insurance carriers. The Company has classified the entire $52.5 million
liability associated with the settlement as noncurrent as such obligation will
be settled with equity (common stock and warrants) rather than current assets as
the exact timing of such settlement is not determinable.
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 unspecified 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, which motion is still pending. The Company is unable to
estimate a possible range of loss.
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 in excess of $100 million,
rescission, injunctive relief and costs. The Company is unable to estimate a
possible range of loss. 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 Securities Act, but the Company
believes that it has substantial defenses to the alleged damages relating to
such Securities 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
unspecified compensatory and punitive damages, as well as fees, interest and
other costs. The Company is unable to estimate a possible range of loss. 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
Securities 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 May 12,
1998, the court ruled in favor of defendants on the motions, dismissing all of
plaintiffs' claims with prejudice and without leave to amend. The Company
expects that the judge will sign an order to that effect, at which time
statutory appeal periods will begin to run.
8
<PAGE> 11
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (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 June 30, 1998. The
standstill and tolling agreement extends any applicable statute of limitations
for claims by the former BSG shareholders and provides that neither party will
file suit against the other prior to the expiration of the agreement.
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 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.
The Company is unable to estimate a possible range of loss. 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 D. 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 Exchange Act 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 Securities Act on behalf of a subclass 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, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The Company is unable
to estimate a possible range of loss.
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.
On January 8, 1997, 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 and the November 19, 1997 and December 23,
1997 restatements of the Company's financial statements. The Company intends to
cooperate fully with the Commission in its investigation.
9
<PAGE> 12
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
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, including, without limitation, the Company's results of operations,
financial position and cash flow. Because the Company is unable to estimate a
range of loss with respect to any of the pending claims, the Company has not
accrued any amounts for any contingent liability with respect to such claims.
NOTE 3 -- RESTRUCTURING AND OTHER CHARGES
In the first quarter of 1998, the Company recorded a charge of $0.6 million
for the severance costs associated with a former executive.
The description of the type and the amount of exit costs applied against
each reserve in the quarter ended March 31, 1998 are as follows:
<TABLE>
<CAPTION>
RESERVE RESERVE
BALANCE COSTS APPLIED BALANCE
12/31/97 AGAINST RESERVE 3/31/98
-------- --------------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Lease termination costs.............................. $8,015 $ (804) $7,211
Severance............................................ 1,357 (801) 556
------ ------- ------
$9,372 $(1,605) $7,767
====== ======= ======
</TABLE>
NOTE 4 -- LONG-TERM DEBT
On February 20, 1998, the Company sold $175 million of senior notes (the
"Notes"). The Notes bear interest at the rate of 9 1/2% per annum, payable
semi-annually on February 15 and August 15 of each year, commencing on August
15, 1998. The Notes will mature on February 15, 2005. The Notes will be
redeemable at the option of the Company, in whole or in part, at any time on or
after February 15, 2002, at a declining premium to par until 2004 and at par
thereafter, plus accrued and unpaid interest. In addition, at any time on or
prior to February 15, 2001, the Company may redeem up to 35% of the original
principal amount of the Notes at a redemption price equal to 109.5% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, with the net cash proceeds of one or
more equity offerings; provided that at least $100 million aggregate principal
amount of the Notes remain outstanding immediately following any such
redemption.
Payment of principal, of premium, if any, and interest on the Notes will be
fully and unconditionally guaranteed, on a senior unsecured basis, jointly and
severally by all of the Company's present and future domestic restricted
subsidiaries (the "Subsidiary Guarantors"). The financial statements of the
Subsidiary Guarantors have not been presented as all subsidiaries, except for
certain insignificant foreign subsidiaries, have provided guarantees and the
parent company does not have any significant operations or assets, separate from
its investment in subsidiaries. Any non-guarantor subsidiaries are insignificant
individually and in the aggregate to the consolidated financial statements.
The Company also entered into a new $100 million credit facility (the
"Credit Facility") on February 20, 1998. The Company has the option of making
"LIBOR" based loans or "base rate" loans under the Credit Facility. LIBOR based
loans bear interest at LIBOR plus amounts ranging from 1.0% to 2.75% based on
the
10
<PAGE> 13
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Company's leverage ratio, as defined in the Credit Facility. Base rate loans
bear interest at prime plus amounts ranging from 0.0% to 1.75% based on the
Company's leverage ratio, as defined. In addition the Company pays a quarterly
commitment fee on the unused portion of the Credit Facility ranging from 0.25%
to 0.75% per annum based on the Company's leverage ratio. The Credit Facility
contains 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, and
prepayment of the Notes and those requiring maintenance of minimum net worth,
minimum EBITDA (as defined), minimum interest coverage and maximum leverage.
Amounts outstanding under the Credit Facility will be due on February 20, 2001.
At March 31, 1998, the Company had $36 million in borrowings outstanding under
the Credit Facility at interest rates ranging from 8.1% to 8.2%.
The Company used the proceeds from the offering of the Notes, together with
the initial borrowing under the Credit Facility and available cash, to repay the
$210 million borrowings under the then-current loan facility plus accrued
interest. As a result of this early extinguishment of debt, the Company recorded
an extraordinary charge of $5.6 million, net of tax of $3.6 million, to
write-off the unamortized costs associated with the previous debt facility.
NOTE 5 -- NEW ACCOUNTING PRONOUNCEMENTS
In October 1997, the American Institute of Certified Public Accountants
(the "AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition ("SOP 97-2"). SOP 97-2 is effective for transactions entered into in
the first quarter of 1998. In March 1998, the AICPA issued SOP 98-4, Deferral of
the Effective Date of a Provision of SOP 97-2, "Software Revenue Recognition,"
("SOP 98-4"). SOP 98-4 defers for one year the application of certain passages
in SOP 97-2. Prior to SOP 97-2, the Company had generally recorded the revenue
associated with its various software products upon delivery of the product and
when no significant contractual obligations remained outstanding. The adoption
of SOP 97-2 changes the way the Company records revenue for one of its software
products, ULTICARE(R), from upon delivery to a percentage-of-completion method
over the life of the installation period. The adoption of SOP 97-2 had no impact
on the Company's operating results for the three months ended March 31, 1998, as
the Company did not enter into any new software licenses for ULTICARE in the
first quarter. SOP 97-2 will not materially impact the pattern of revenue
recognition for all of the Company's other software products.
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1
provides guidance on the accounting for the costs of computer software developed
or obtained for internal use and is effective for financial statements for
fiscal years beginning after December 15, 1998. The Company does not believe
that SOP 98-1 will have a material impact on the Company's results of
operations.
NOTE 6 -- SEGMENT REPORTING
Medaphis provides its services and products through its Healthcare Services
Group and Per-Se Technologies. The Healthcare Services Group provides business
management services to physicians and hospitals, including the collection of
clinical data, data input, medical coding, billing, cash collections and
accounts receivable management. The Healthcare Services Group consists of two
reportable segments based on the clients they serve: (i) Physician Services,
which is a leading provider of business management solutions and claims
processing to physicians in the United States; and (ii) Hospital Services, which
is a leading provider of business management services to hospitals in the United
States. Per-Se Technologies ("Per-Se") provides application software and a broad
range of information technology and consulting services to healthcare and other
service-oriented markets. Per-Se is organized into two reportable segments based
on their different service offerings: (i) Per-Se Software Products, which
provides application software and system integration services; and (ii) Per-Se
Consulting Services, which provides full-service systems integration,
11
<PAGE> 14
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
information technology consulting and tailored software development. HRI
provided subrogation and related recovery services primarily to healthcare
payors. HRI was sold on May 28, 1997.
Medaphis evaluates each segment's performance based on operating profit or
loss. The Company also accounts for intersegment sales as if the sales were to
third parties.
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
MARCH 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Revenue:
Physician Services........................................ $ 70,099 $ 71,760
Hospital Services......................................... 25,271 23,756
Per-Se Software Products.................................. 23,712 19,690
Per-Se Consulting Services................................ 21,706 23,810
HRI....................................................... -- 8,916
Eliminations.............................................. (448) (386)
-------- --------
$140,340 $147,546
======== ========
Operating profit(loss)(1):
Physician Services........................................ $ 1,564 $ 1,241
Hospital Services......................................... 1,773 2,483
Per-Se Software Products.................................. 2,593 2,818
Per-Se Consulting Services................................ 555 274
HRI....................................................... -- 2,253
Corporate................................................. (8,104) (8,442)
-------- --------
$ (1,619) $ 627
======== ========
Interest expense, net....................................... $ 6,375 $ 6,115
-------- --------
Restructuring and other charges:
Physician Services........................................ $ -- $ --
Hospital Services......................................... -- --
Per-Se Software Products.................................. -- --
Per-Se Consulting Services................................ -- --
HRI....................................................... -- --
Corporate................................................. 561 --
-------- --------
$ 561 $ --
-------- --------
Loss before income taxes.................................... $ (8,555) $ (5,488)
======== ========
Depreciation and amortization:
Physician Services........................................ $ 8,404 $ 8,494
Hospital Services......................................... 1,799 1,278
Per-Se Software Products.................................. 2,162 1,710
Per-Se Consulting Services................................ 1,211 1,045
HRI....................................................... -- 245
Corporate................................................. 846 327
-------- --------
$ 14,422 $ 13,099
======== ========
</TABLE>
12
<PAGE> 15
MEDAPHIS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Capital expenditures:
Physician Services........................................ $ 11,934 $ 1,272
Hospital Services......................................... 1,470 786
Per-Se Software Products.................................. 1,198 665
Per-Se Consulting Services................................ 221 609
HRI....................................................... -- 51
Corporate................................................. 815 17
-------- --------
$ 15,638 $ 3,400
======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
------------------------
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Identifiable Assets:
Physician Services........................................ $569,787 $563,825
Hospital Services......................................... 108,758 106,479
Per-Se Software Products.................................. 68,689 72,505
Per-Se Consulting Services................................ 32,200 30,489
HRI....................................................... -- --
Corporate................................................. 100,875 100,729
-------- --------
$880,309 $874,027
======== ========
</TABLE>
- ---------------
(1) Excludes restructuring and other charges and interest expense.
13
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Medaphis Corporation, a corporation organized in 1985 under the laws of the
State of Delaware ("Medaphis" or the "Company") is a leader in delivering
healthcare information and business management services, together with enabling
technologies in selected industries. Medaphis believes it is well-positioned to
capitalize on the healthcare industry trends toward consolidation, managed care
and cost containment through a broad range of services and products that enable
customers to provide quality patient care efficiently and cost effectively.
Servicing over 20,000 physicians and 2,700 hospitals, predominantly in North
America, the Company's large client base and national presence further support
the Company's competitive position. Medaphis provides its services and products
through its Healthcare Services Group and through Per-Se Technologies, its
Information Technology Group.
The Healthcare Services Group provides a range of business management
services to physicians and hospitals, including clinical data collection, data
input, medical coding, billing, cash collections and accounts receivable
management. These services are designed to assist customers with the business
management functions associated with the delivery of healthcare services,
allowing physicians and hospital staffs to focus on providing quality patient
care. These services also assist physicians and hospitals in improving cash
flows and reducing administrative costs and burdens. Per-Se Technologies
provides application software and a broad range of information technology and
consulting services to healthcare and other service-oriented markets such as
energy, communications and financial services.
Medaphis markets its services and products primarily to integrated
healthcare delivery networks, hospitals, physician practices, long-term care
facilities, home health providers and managed care providers.
RESULTS OF OPERATIONS
The following table shows the amount and the percentage of revenue for
items reflected in the Company's Statements of Operations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------------
1998 1997
---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenue.................................................. $140,340 100.0% $147,546 100.0%
Salaries and wages....................................... 88,198 62.9 93,578 63.4
Other operating expenses................................. 39,339 28.0 40,242 27.3
Depreciation............................................. 8,304 5.9 6,985 4.7
Amortization............................................. 6,118 4.4 6,114 4.1
Interest expense, net.................................... 6,375 4.5 6,115 4.1
Restructuring and other charges.......................... 561 0.4 -- --
-------- ----- -------- -----
Loss before income taxes and extraordinary item.......... (8,555) (6.1) (5,488) (3.6)
Income tax benefit....................................... (3,405) (2.4) (2,424) (1.6)
-------- ----- -------- -----
Loss before extraordinary item........................... (5,150) (3.7) (3,064) (2.0)
Extraordinary item: early extinguishment of debt, net of
tax.................................................... (5,557) (3.9) -- --
-------- ----- -------- -----
Net loss....................................... $(10,707) (7.6)% $ (3,064) (2.0)%
======== ===== ======== =====
</TABLE>
14
<PAGE> 17
Revenue. Revenue classified by the Company's different reportable segments
is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Physician Services........................................ $ 70,099 $ 71,760
Hospital Services......................................... 25,271 23,756
Per-Se Software Products.................................. 23,712 19,690
Per-Se Consulting Services................................ 21,706 23,810
HRI....................................................... -- 8,916
Eliminations.............................................. (448) (386)
-------- --------
$140,340 $147,546
======== ========
</TABLE>
The 2% decrease in Physician Services' revenue in the first quarter of 1998
from the same period of 1997 is attributable to system and process changes in
the first quarter of 1998 which delayed the Company's ability to record certain
revenue. Management believes these changes were one-time events that will not be
recurring. During the quarter, management at Physician Services continued its
emphasis on customer service and not revenue growth.
The 6% increase in Hospital Services' revenue for the three months ended
March 31, 1998, as compared to the same period of the prior year, reflects
volume growth.
Per-Se Software Products' revenue increased 20% during the three months
ended March 31, 1998 as compared with the same period for the prior year. This
increase is primarily a result of an increase in the amount of revenue
associated with the Company's ULTICARE(R) software product.
The 9% decrease in the Per-Se Consulting Services' revenue is primarily a
result of the Company's late 1997 decision to downsize this segment, which
created less billable hours in the first quarter of 1998 as compared to the
first quarter of 1997.
Medaphis divested HRI in May 1997 through an initial public offering of
100% of its stock.
Salaries and Wages. Salaries and wages decreased to 62.9% of revenue in
the first quarter of 1998 from 63.4% in the first quarter of 1997. The decrease
in salaries and wages, as a percentage of revenue, is a direct result of the
Company's restructuring and cost containment initiatives implemented during the
third and fourth quarters of 1997.
Other Operating Expenses. Other operating expenses increased to 28.0% of
revenue in the first quarter of 1998 compared to 27.3% in the first quarter of
1997. The increase in other operating expenses as a percentage of revenue for
1998, as compared with 1997, is primarily due to third party commission costs
and increased marketing costs associated with the Per-Se Software Products
segment. Other operating expenses are primarily comprised of postage, facility
and equipment rental, telecommunications, travel, outside consulting and legal
services and office supplies.
Depreciation. Depreciation expense was $8.3 million in the first quarter
of 1998 as compared with $7.0 million in the first quarter of 1997. This
increase reflects the Company's investment in property and equipment to support
its business.
Amortization. Amortization of intangible assets, which are primarily
associated with the Company's acquisitions and internally developed software,
was $6.1 million in both the first quarters of 1998 and 1997.
Interest. Net interest expense was $6.4 million in the first quarter of
1998 as compared with $6.1 million in the first quarter of 1997. The increase is
primarily due to the increased borrowing rate associated with the $210 million
loan facility entered into in December 1997 (the "Bridge Notes"), which was
outstanding for approximately two months in 1998.
15
<PAGE> 18
Restructuring and Other Charges. In the first quarter of 1998, the Company
recorded a charge of $0.6 million for the severance costs associated with a
former executive.
Income Taxes. Effective income tax rates for the periods presented vary
from statutory rates primarily as a result of nondeductible goodwill associated
with merger transactions consummated by the Company in previous years.
As of March 31, 1998, the Company had recorded a net deferred tax asset of
$67.9 million primarily reflecting a tax benefit of $104.3 million for net
operating loss carryforwards ("NOLs") offset by a valuation allowance of $26.5
million. The valuation allowance primarily reflects the Company's assessment of
the uncertainty associated with the realizability of NOLs assumed in certain
business combinations; a full valuation allowance has been provided on such
amounts. With respect to the deferred tax assets for which a valuation allowance
has not been provided, realizability of such amount is dependent on the Company
generating sufficient taxable income prior to the expiration of such NOLs.
Currently, the Company's NOLs are scheduled to expire in varying amounts from
1998 through 2011; however, no material amounts are scheduled to expire prior to
2008. Although realization is not assured, based on the Company's current
analyses and estimates, management believes it is more likely than not that the
Company will generate sufficient taxable income to fully realize the deferred
tax asset prior to the expiration of the carryforward period. In addition, if
future taxable income is not sufficient to fully utilize the deferred tax asset,
other tax planning strategies are available to the Company, which makes it more
likely than not that the Company will be able to utilize the deferred tax asset.
Extraordinary Item. The Company used the proceeds from the February 1998
issuance of the Notes (as defined) and the Credit Facility (as defined) to pay
off the Company's Bridge Notes. The Company recorded a charge of $5.6 million,
net of tax of $3.6 million, to write-off the unamortized costs associated with
the Bridge Notes.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $98.7 million at March 31, 1998,
including $7.1 million of cash.
The Company's operating activities used $8.5 million of cash during the
three months ended March 31, 1998 as compared with the generation of cash of
$5.9 million during the three months ended March 31, 1997. The decrease in the
Company's operating cash flows resulted primarily from the timing of payment and
reduction of current liabilities.
Purchases of property and equipment were $15.6 million in the first quarter
of 1998 compared to $3.4 million in the prior year comparable quarter. The
increase reflects the purchase for approximately $10 million of certain real
property that the Company was leasing.
On February 20, 1998, the Company sold $175 million of senior notes (the
"Notes"). The Notes bear interest at the rate of 9 1/2% per annum, payable
semi-annually on February 15 and August 15 of each year, commencing on August
15, 1998. The Notes will mature on February 15, 2005. The Notes will be
redeemable at the option of the Company, in whole or in part, at any time on or
after February 15, 2002, at a declining premium to par until 2004 and at par
thereafter, plus accrued and unpaid interest. In addition, at any time on or
prior to February 15, 2001, the Company may redeem up to 35% of the original
principal amount of the Notes at a redemption price equal to 109.5% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, with the net cash proceeds of one or
more equity offerings; provided that at least $100 million aggregate principal
amount of the Notes remain outstanding immediately following any such
redemption.
Payment of principal, of premium, if any, and interest on the Notes will be
fully and unconditionally guaranteed, on a senior unsecured basis, jointly and
severally by all of the Company's present and future domestic restricted
subsidiaries (the "Subsidiary Guarantors"). The financial statements of the
Subsidiary Guarantors have not been presented as all subsidiaries, except for
certain insignificant foreign subsidiaries, have provided guarantees and the
parent company does not have any significant operations or assets, separate from
its investment in subsidiaries. Any non-guarantor subsidiaries are insignificant
individually and in the aggregate to the consolidated financial statements.
16
<PAGE> 19
The Company also entered into a new $100 million credit facility (the
"Credit Facility") on February 20, 1998. The Company has the option of making
"LIBOR" based loans or "base rate" loans under the Credit Facility. LIBOR based
loans bear interest at LIBOR plus amounts ranging from 1.0% to 2.75% based on
the Company's leverage ratio, as defined in the Credit Facility. Base rate loans
bear interest at prime plus amounts ranging from 0.0% to 1.75% based on the
Company's leverage ratio, as defined. In addition the Company pays a quarterly
commitment fee on the unused portion of the Credit Facility ranging from 0.25%
to 0.75% per annum based on the Company's leverage ratio. The Credit Facility
contains 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, and
prepayment of the Notes, those requiring maintenance of minimum net worth,
minimum EBITDA (as defined) and minimum interest coverage and limiting leverage.
Amounts outstanding under the Credit Facility will be due on February 20, 2001.
At March 31, 1998, the Company had $36 million in borrowings outstanding under
the Credit Facility at interest rates ranging from 8.1% to 8.2%.
As disclosed in Part II, Item 5 -- Other Information, the Company recently
decided to transition from the computerized coding system used by GFS for
emergency room physician billing to manual coding. The Company does not expect
to incur any material extraordinary charges as a result of the transition from
the computerized coding system. However, there can be no assurance that any
third party claims or lost business relating to transition from, or
modifications previously made to, the GFS coding system will not have a material
adverse effect on the Company, including, without limitation, on the Company's
revenue, results of operations, financial condition or cash flow.
The Company believes that its cash flow, together with available borrowings
under the Credit Facility, will be sufficient to permit the Company to meet its
operating expenses and to service its debt requirements as they become due for
the foreseeable future, however, there can be no assurance that such results
will be achieved. The Company is a party to legal actions and government
investigations as described in Part II, Item 1 -- Legal Proceedings. There can
be no assurance that these actions or investigations will not have a disruptive
effect upon the operations of the business or that the resolution of these
actions and investigations will not have a material adverse effect on the
Company's liquidity or financial position. 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 the following
consequences: (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; and (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. In addition, the Credit Facility and the Indenture
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, and
prepayments of indebtedness and, with respect to the Credit Facility only, those
requiring maintenance of minimum net worth, minimum EBITDA and minimum interest
coverage and limiting leverage.
OTHER MATTERS
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. Through its review, the Company has identified a
number of older legacy systems
17
<PAGE> 20
that will be abandoned in favor of a limited number of more efficient processing
systems, rather than make all the systems Year 2000 compliant. GFS's
computerized coding system is one of the legacy systems from which the Company
has determined to transition. The Company believes that it is on target to have
completed these system migration efforts with respect to its Physician Services
and Hospital Services businesses in the first quarter of 1999. Per-Se
Technologies products are scheduled to be Year 2000 compliant with releases due
out in the third quarter of 1998. The estimated cost of the Company's Year 2000
compliance efforts is $10 million to $15 million over 1998 and 1999, the
majority of which represents redirection of internal resources. 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 revenue. 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.
18
<PAGE> 21
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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Other Matters."
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, 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.
Investigations such as the California Investigation can be initiated
following the commencement of qui tam litigation which is commenced under
applicable state and federal statutes and is maintained under court seal without
disclosure to the defendant. Under the applicable statutes, the United States
and the State of California may elect to intervene fully or partially in qui tam
litigation, and proceed with the action. The United States typically will
provide a defendant with the opportunity to enter into settlement negotiations
prior to the intervention of the United States in the matter. An application by
the United States to partially lift the seal in qui tam litigation in order to
make disclosure of the complaint available to the defendant often precedes such
settlement discussions.
On February 6, 1998, on application of the United States, the United States
District Court for the Central District of California issued an order partially
lifting the seal on the qui tam suit entitled United States of America and State
of California, ex rel. Relator I and Relator II v. Compmed Corporation, Medaphis
Corporation, Does 1 to 200, Inclusive. Civil Action No. 94-8158 LGB (kx). On
February 11, 1998, the United States provided Medaphis with a copy of the
Complaint, Substitution of Attorney, and Order which prohibited the Company from
making any use of the Complaint, including any public disclosure, other than for
the purposes of settlement negotiations, without further order of the Court. On
February 12, 1998, upon the joint application of Medaphis and the United States,
the Court issued an order modifying its February 6, 1998 order to allow Medaphis
to make public disclosures concerning the Complaint and its contents to the
extent that Medaphis determined such disclosures were required by applicable
securities laws, provided that such disclosure did not reveal the Relators'
identities.
According to the Complaint, filed December 20, 1995 by the Relators and
which contains allegations raised by them, the action is to recover damages and
civil penalties on behalf of the United States and the State of California
arising out of alleged false claims presented by the defendants on behalf of
their clients for payment under various state and federal insurance programs. No
charges or claims by the government have been made. The Complaint includes
causes of action under the Federal False Claims Act, 31 U.S.C. sec 3729 et seq.,
and the California False Claims Act, Cal. Gov't Code sec. 12650 et seq. The
Complaint also includes causes of action relating to Medaphis's termination of
Relator II, including a count under the state and federal whistleblower
protection statutes. The Complaint alleges overpayments of approximately
$20,500,000 together with treble damages and additional penalties based on
statutory civil penalties. The Complaint alleges that at least 50,000 separate
false claims were filed under federal programs and at least 8,000 separate false
claims were filed under state programs. The Complaint also alleges unspecified
compensatory, general and punitive damages on behalf of Relator II on his or her
employment claims. The allegations in the Complaint are limited to the office of
CompMed (acquired by Medaphis) in Culver City, California. Medaphis believes
that
19
<PAGE> 22
this Complaint relates to and concerns the California Investigation. Medaphis is
engaged in discussions with the United States and California, and intends to
pursue settlement discussions with the United States, the State of California,
and the Relators. The Company has agreed with the government to toll applicable
statutes of limitations through September 30, 1998, and anticipates executing an
agreement to that effect.
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 or the qui
tam suit will be resolved promptly, that additional subpoenas or search warrants
will not be received by Medaphis or MPSC or that the California Investigation or
the qui tam suit 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.
In September 1996, MPSC became 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, which impacts only certain managed care plans,
cannot be determined by the Company, 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. The Company is
unable to estimate the possible range of loss, if any.
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 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. On May 19, 1997, the plaintiffs and the
defendants entered into a stipulation and settlement agreement, pursuant to
which the parties 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 28, 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 directly for
the benefit of the plaintiffs. 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.
20
<PAGE> 23
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan are
investigating allegations concerning the Company's wholly owned subsidiary,
Gottlieb's Financial Services, Inc. ("GFS") (the "GFS Investigation"). Beginning
in February, 1998, the Office of the Inspector General of Health and Human
Services has requested information from GFS following an audit of a GFS client.
GFS has complied with those requests. 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 each of the years ended
December 31, 1996 and 1997, GFS represented approximately 7% of Medaphis'
revenue. During those years, GFS processed approximately 5.6 million and 6.25
million claims, respectively, approximately 2 million and 2.3 million of which,
respectively, were made to government programs. The government has requested
that GFS voluntarily produce records, and GFS has complied 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 is in discussions with the United States and intends to
pursue settlement discussions with the United States.
In addition, the Company decided in April 1998 to transition from the
computerized coding system to manual coding. There can be no assurances that the
Company will not be subject to customer complaints, claims and contract
terminations as a result of the coding system transition or modifications
previously made to the system. See "Management's Discussion and Analysis of
Results of Operations -- Liquidity and Capital Resources."
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 alleged violations of the federal
securities laws in connection with Medaphis' filings under the federal
securities acts and public disclosures. The Consolidated Second Amended
Complaint was 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 asserted claims on behalf of a
sub-class of all persons who acquired Medaphis Common Stock pursuant to the
merger between Medaphis and HDS. The Consolidated Second Amended Complaint
sought 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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Other Matters."
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
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<PAGE> 24
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. 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's insurance carriers consented to the settlement and funded the $20
million cash portion. On March 25, 1998, the Court granted final approval of the
settlement and entered final judgment dismissing the action.
The Company recorded a $52.5 million charge in the quarter ended September
30, 1997 in connection with the Stipulation. This charge is comprised of the
following: (i) $30.2 million representing the original 3,355,556 shares of
common stock valued at the fair value of a common share on the date that the
material terms of the agreement were reached or approximately $9 per share and
(ii) $22.3 million representing the fair value of the warrants on the date the
material terms of the agreement were reached, valued using the Black-Scholes
option pricing model with the following assumptions: expected life -- 5 years,
risk free interest rate -- 6%, dividend rate -- 0% and expected volatility
factor -- 60%. No accounting recognition was required for the additional 600,000
shares to be issued pursuant to the agreement as these shares represent the
maximum number of contingent shares that were issuable based on certain stock
price contingencies during the ten day period prior to October 11, 1997. As a
result of the actual decline in the Company's stock price during such period,
the Stipulation required that the maximum number of contingent shares be
awarded; however, no additional accounting charge is required in connection with
the award of such contingent shares. Although the exact timing of the issuance
of the 3,955,556 shares is not known, the Company does not expect such shares to
be issued before the second quarter of 1998. Additionally, no accounting
recognition has been afforded the cash portion of the Stipulation as this amount
is the responsibility of the insurance carriers. Such amount has been paid
directly to an escrow account for the benefit of the plaintiffs by the insurance
carriers. The Company has classified the entire $52.5 million liability
associated with the settlement as noncurrent as such obligation will be settled
with equity (common stock and warrants) rather than current assets as the exact
timing of such settlement is not determinable.
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 unspecified 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, which motion is still pending. The Company is unable to
estimate a possible range of loss.
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 in excess of $100 million,
rescission, injunctive relief and costs. The Company is unable to estimate a
possible range of loss. On January 10, 1997, the
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<PAGE> 25
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
Securities Act, but the Company believes that it has substantial defenses to the
alleged damages relating to such Securities 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
unspecified compensatory and punitive damages, as well as fees, interest and
other costs. The Company is unable to estimate a possible range of loss. 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
Securities 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 May 12,
1998, the court ruled in favor of defendants on the motions, dismissing all of
plaintiffs' claims with prejudice and without leave to amend. The Company
expects that the judge will sign an order to that effect, at which time
statutory appeal periods will begin to run.
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 June 30, 1998. The
standstill and tolling agreement extends any applicable statute of limitations
for claims by the former BSG shareholders and provides that neither party will
file suit against the other prior to the expiration of the agreement.
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 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.
The Company is unable to estimate a possible range of loss. 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 D. 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 Exchange Act on behalf of all
persons
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<PAGE> 26
who purchased or otherwise acquired Medaphis Common Stock between February 6,
1996 and October 21, 1996. The complaint also asserts claims under the
Securities Act on behalf of a subclass 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, unspecified rescissory and
compensatory damages, and interest, fees and other costs. The Company is unable
to estimate a possible range of loss.
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.
On January 8, 1997, 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 and the November 19, 1997 and December 23,
1997 restatements of the Company's financial statements. 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, including, without limitation, the Company's results of operations,
financial position and cash flow. Because the Company is unable to estimate a
range of loss with respect to any of the pending claims, the Company has not
accrued any amounts for any contingent liability with respect to such claims.
ITEM 5. OTHER MATTERS
In 1993, the Company acquired GFS, an emergency room physician billing
company, which had developed a computerized coding system. In 1994, the Company
acquired and merged into GFS another emergency room physician billing company,
Physician Billing, Inc., located in Grand Rapids, Michigan, which was then
migrated to the GFS coding system.
The GFS coding system was developed in-house at GFS in the 1980s using the
COBOL computer language. The program and its source code were not extensively
documented. In addition, the program was originally written to conform with
then-existing government billing regulations, which have since been changed. At
the time of these changes, and thereafter, the Company undertook some revisions
to the coding system. In March 1997, Medaphis learned that GFS was the target of
a government investigation. Although the precise scope and subject matter of the
government investigation are not known to the Company, Medaphis believes that
the investigation -- which is being participated in by several agencies having
administrative, civil and/or criminal authority -- involves GFS billing
procedures and the coding system used in both Grand Rapids and Jacksonville. See
Note 2 of Notes to Consolidated Financial Statements. Promptly after the Company
became aware of the GFS Investigation, the Company expanded its compliance
efforts with respect to the GFS coding system and undertook a substantial
process review using both internal resources and outside consultants.
The Company decided in April 1998 to transition GFS from the computerized
coding system to manual coding. The decision to terminate use of the coding
system was based on several factors. These included the high cost of continuing
management, compliance and quality assurance oversight and the failure to meet
the Company's current efficiency and productivity targets. In addition, the
system will not comply with anticipated
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<PAGE> 27
revisions to government billing regulations, and is not "Year 2000"compliant.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Other Matters." During the transition period, which should be
completed by the fall of 1998, GFS will continue to utilize the coding system in
conjunction with an increasing volume of manual coding and the Company will
continue to support GFS with its compliance and quality assurance programs in
support of both the coding system and manual coding.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 to
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to Registrant's Registration Statement on Form
S-8, File No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.6 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997)
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as the Borrower, various financial institutions from time to
time parties thereto, as the Lenders, DLJ Capital Funding,
Inc., as the Syndication Agent for the Lenders, and Wachovia
Bank, N.A., as the Administrative Agent for the Lenders
(including form of note) (incorporated by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.2 -- Subsidiary Guaranty dated February 20, 1998, among the
domestic subsidiaries of Registrant and Wachovia Bank, N.A.,
as Administrative Agent (incorporated by reference to
Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.3 -- Indenture dated as of February 20, 1998, among Registrant,
as Issuer, the Subsidiary Guarantors named in the Indenture
and State Street Bank and Trust Company, as Trustee
(including form of note) (incorporated by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.4 -- Registration Rights Agreement dated as of February 20, 1998,
among Registrant, the Subsidiary Guarantors, and Donaldson
Lufkin & Jenrette Securities Corporation (incorporated by
reference to Exhibit 4.15 to Registrant's Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Fifth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.28 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.2 -- Third Amendment to Medaphis Corporation Employee Stock
Purchase Plan (incorporated by reference to Exhibit 10.33 to
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.3 -- Fourth Amendment to the Amended and Restated Medaphis
Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.39 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
</TABLE>
25
<PAGE> 28
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
10.4 -- Employment Agreement dated January 25, 1998 between
Registrant and Allen W. Ritchie (incorporated by reference
to Exhibit 10.69 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997)
10.5 -- Employment Agreement dated January 27, 1998 between
Registrant and Kevin P. Castle
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>
(B) Reports on Form 8-K
The Company has filed the following reports on Form 8-K during the quarter
ended March 31, 1998:
<TABLE>
<CAPTION>
FINANCIAL
STATEMENTS
ITEM REPORTED FILED DATE OF REPORT FILE DATE
- ------------- ---------- -------------- ---------
<S> <C> <C> <C>
Establishment of $210 million term loan
to refinance existing bank facility;
restatement of Registrant's financial
statements to reflect treatment of
acquisition of Medical Management
Sciences, Inc. as a purchase rather
than a pooling of interests; release of
unqualified audit opinion of Price
Waterhouse............................. Yes(1) December 23, 1997 January 8, 1998
Underwritten commitment for $100 million
revolving credit facility and
announcement of certain management
changes................................ No January 26, 1998 January 28, 1998
Partial unsealing of QuiTam complaint
filed against Registrant on December
20, 1995............................... No February 11, 1998 February 13, 1998
Announcement of planned closing of
financing package...................... No February 17, 1998 February 18, 1998
Announcement of closing of $275 million
financing package...................... No February 13, 1998 March 2, 1998
</TABLE>
- ---------------
(1) Audited consolidated financial statements for the nine months ended
September 30, 1997 and the two years ended December 31, 1996.
26
<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDAPHIS CORPORATION
(Registrant)
Date: May 14, 1998
By: /s/ DAVID E. MCDOWELL
------------------------------------
David E. McDowell
Chairman and Chief Executive Officer
By: /s/ MARK P. COLONNESE
------------------------------------
Mark P. Colonnese
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
27
<PAGE> 30
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.1 to
Registrant's Registration Statement on Form S-1, File No.
33-42216)
3.2 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993)
3.3 -- Certificate of Amendment of Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 3.3 to
Registrant's Registration Statement on Form 8-A/A, filed on
May 22, 1996)
3.4 -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant (incorporated by reference to
Exhibit 4.4 to Registrant's Registration Statement on Form
S-8, File No. 333-03213)
3.5 -- Amended and Restated By-Laws of Registrant (incorporated by
reference to Exhibit 3.6 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997)
4.1 -- Credit Agreement dated February 13, 1998, among Registrant,
as the Borrower, various financial institutions from time to
time parties thereto, as the Lenders, DLJ Capital Funding,
Inc., as the Syndication Agent for the Lenders, and Wachovia
Bank, N.A., as the Administrative Agent for the Lenders
(including form of note) (incorporated by reference to
Exhibit 10.1 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.2 -- Subsidiary Guaranty dated February 20, 1998, among the
domestic subsidiaries of Registrant and Wachovia Bank, N.A.,
as Administrative Agent (incorporated by reference to
Exhibit 10.2 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.3 -- Indenture dated as of February 20, 1998, among Registrant,
as Issuer, the Subsidiary Guarantors named in the Indenture
and State Street Bank and Trust Company, as Trustee
(including form of note) (incorporated by reference to
Exhibit 10.3 to Registrant's Current Report on Form 8-K
filed on March 3, 1998)
4.4 -- Registration Rights Agreement dated as of February 20, 1998,
among Registrant, the Subsidiary Guarantors, and Donaldson
Lufkin & Jenrette Securities Corporation (incorporated by
reference to Exhibit 4.15 to Registrant's Registration
Statement on Form S-4, File No. 333-47409)
10.1 -- Fifth Amendment to Medaphis Corporation Non-Qualified Stock
Option Plan for Non-Executive Employees (incorporated by
reference to Exhibit 10.28 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.2 -- Third Amendment to Medaphis Corporation Employee Stock
Purchase Plan (incorporated by reference to Exhibit 10.33 to
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997)
10.3 -- Fourth Amendment to the Amended and Restated Medaphis
Employees' Retirement Savings Plan (incorporated by
reference to Exhibit 10.39 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997)
10.4 -- Employment Agreement dated January 25, 1998 between
Registrant and Allen W. Ritchie (incorporated by reference
to Exhibit 10.69 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997)
10.5 -- Employment Agreement dated January 27, 1998 between
Registrant and Kevin P. Castle
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>
<PAGE> 1
EXHIBIT 10.5
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is made and entered into
this 27th day of January, 1998, by and between MEDAPHIS CORPORATION, a Delaware
corporation (the "Company"), and Kevin P. Castle, a resident of the State of
Georgia (the "Employee").
Statement of Background Information
The Company renders to hospitals, physicians, and/or other healthcare
organizations and providers: (a) billing services, accounts receivable
management services, collection services, electronic claims services, financial
management services, and practice and facilities management services: (b)
eligibility verification and certification for Medicaid, Medicare and other
healthcare assistance programs; (c) filing and other medical claims
securitization services; (d) medical coverage information services; and (e)
medical and insurance claims monitoring and tracking services (collectively the
"Processing Business").
The Company also: (a) develops, markets and licenses to hospitals,
integrated healthcare delivery systems, and other healthcare providers and other
end users (collectively "Providers"), (i) strategic, operational and financial
information systems and services and decision support tools for healthcare
providers, (ii) software systems which provide claims and reimbursement services
and electronic claims processing, and (iii) software applications which assist
Providers with automated scheduling and resource management (the items discussed
in Sections (a)(i), (a)(ii) and (a)(iii) of this paragraph are referred to as
"Systems"), which Systems include, but are not limited to, nurse scheduling and
management information systems, operating room patient scheduling and surgery
information systems, enterprise wide patient scheduling and resource management
systems, enterprise-wide employee scheduling and management information systems
and related software interfaces to other information systems; and (b) provides
to Providers installation and support services related to the Company's Systems
(the "Systems Business").
The Company also renders professional services with respect to the
development of computer software, algorithms, design, documentation, and related
materials, and the development, design, deployment, and operation of local and
wide area computer networks, all in conjunction with the sale, design,
deployment, operation and maintenance of custom computer processing systems for
improvement of operational efficiency or functionality through the use of image
storage and processing, work flow technology, optical character recognition or
other related technologies (the "System Integration Business") (the Processing
Business, the Systems Business, the Systems Integration Business and any other
distinct business segment in which the Company engages during Employee's
employment are collectively referred to herein as the "Business").
In consideration of the mutual covenants, promises and conditions set forth
in this Agreement, and for other good and valuable consideration, the receipt
and sufficiency of which are hereby acknowledged, the parties agree as follows:
1. Employment. The Company hereby employs Employee and Employee hereby
accepts such employment upon the terms and conditions set forth in this
Agreement. For purposes of Sections 7 and 8 of this Agreement,
"employment" shall mean any period of time during which the Company is
paying the Employee salary, wages, or any other amounts, whether or not
the Employee is currently performing services for the Company at the
time of such payment.
2. Duties of Employee. Employee's title will be Senior Vice President,
Human Resources. Employee agrees to perform and discharge such duties
as may be assigned to Employee from time to time by the Company to the
reasonable satisfaction of the Company. Employee also agrees to comply
with all of the Company's
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<PAGE> 2
policies, standards and regulations and to follow the instructions and
directives of Employee's superiors within the Company, as promulgated
by the officers of the Company. Employee will devote Employee's full
professional and business-related time, skills and best efforts to such
duties and will not, during the term of this Agreement, be engaged
(whether or not during normal business hours) in any other business or
professional activity, whether or not such activity is pursued for
gain, profit or other pecuniary advantage, without the prior written
consent of Carl James Schaper, or his designee, which consent will not
be unreasonably withheld. This Section will not be construed to prevent
Employee from (a) investing personal assets in businesses which do not
compete with the Company in such form or manner that will not require
any services on the part of Employee in the operation or the affairs of
the companies in which such investments are made and in which
Employee's participation is solely that of an investor; (b) purchasing
securities in any corporation whose securities are listed on a national
securities exchange or regularly traded in the over-the-counter market,
provided that Employee at no time owns, directly or indirectly, in
excess of one percent (1%) of the outstanding stock of any class of any
such corporation engaged in a business competitive with that of the
Company; or (c) participating in conferences, preparing and publishing
papers or books or teaching, so long as Carl James Schaper, or his
designee, approves such participation, preparation and publication or
teaching prior to Employee's engaging therein, which approval will not
be unreasonably withheld.
3. Term. The term of this Agreement will be for a two (2) year period of
time, commencing as of February 1, 1998 and expiring on January 31,
2000, subject to earlier termination as provided for in Section 4 of
this Agreement. Following the initial two (2) year term of this
Agreement, the terms of this Agreement will continue to remain in
effect for additional terms of one (1) year, unless either party gives
notice of the intent to terminate this Agreement at least ninety (90)
days prior to the expiration of the original term or any renewal term
of this Agreement.
4. Termination.
(a) Termination by Company for Cause. Notwithstanding anything
contained in Section 3 to the contrary, the Company may terminate this
Agreement and all of its obligations hereunder immediately if any of
the following events occur:
(i) Employee materially breaches any of the terms or conditions set
forth in this Agreement and fails to cure such breach within ten (10)
days after Employee's receipt from the Company of written notice of
such breach (notwithstanding the foregoing, no cure period shall be
applicable to breaches by Employee of Sections 6, 7 or 8 of this
Agreement);
(ii) Employee engages in dishonest or illegal activities or commits or
is convicted of any crime involving fraud, deceit or moral turpitude;
or
(iii) Employee dies or becomes mentally or physically incapacitated or
disabled so as to be unable to perform Employee's duties under this
Agreement. Without limiting the generality of the foregoing, Employee's
inability to adequately perform services under this Agreement for a
period of sixty (60) consecutive days will be conclusive evidence of
such mental or physical incapacity or disability, unless such inability
to adequately perform services under this Agreement is pursuant to a
mental or physical incapacity or disability covered by the Family
Medical Leave Act, in which case such sixty (60)-day period shall be
extended to a one hundred and twenty (120)-day period.
(b) Termination by Company Without Cause. Notwithstanding anything
contained in Section 3 to the contrary, the Company may terminate
Employee's employment pursuant to this Agreement without cause upon at
least thirty (30) days' prior written notice to Employee. In the event
Employee's employment with
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<PAGE> 3
the Company is terminated by the Company without cause, Employee will
be entitled to receive salary continuation and health benefit
continuation (at the salary and health benefit levels set forth below
in Paragraph 5) for the balance of the term of this Agreement, or nine
(9) months of salary continuation, whichever amount is greater. If
Employee is terminated without cause under this Paragraph of the
Agreement, Employee will not be entitled to any other consideration or
be considered an employee of the Company for any other purposes,
including the vesting of stock options, beyond Employee's termination
date.
(c) Change in Control. In the event there is a change in control of
Medaphis Corporation, and (i) Employee's employment is terminated as a
direct result of such change of control, or (ii) Employee suffers a
material change in the terms and conditions of his employment (defined
as (a) a material reduction (greater than 10%) in Employee's then
current base salary; (b) a change in Employee's existing work location
to a work location more than 50 miles from Employee's existing work
location, except for required travel on the Company's business to an
extent consistent with Employee's then present business travel
obligations; or (c) an assignment to any duties inconsistent in a
material adverse respect with Employee's then current position, duties,
or responsibilities, other than an insubstantial and inadvertent act
that is remedied by the Company promptly after receipt of notice
thereof given by Employee) within one (1) year of such change in
control, Employee will be entitled to receive a payment equal to the
greater of (1) nine (9) months of salary continuation at Employee?s
then current base salary, or (2) those payments due and owing to
Employee under the remaining term of this Agreement, whichever is
greater. For purposes of this Agreement, a "change in control" of
Medaphis Corporation shall be deemed to occur upon any of the
following:
(i) a consolidation or merger of Medaphis Corporation with or into any
other corporation, or any other entity or person, other than a
wholly-owned subsidiary of Medaphis Corporation, excluding any
transaction in which stockholders of Medaphis Corporation prior to the
transaction will maintain voting control or own at least 50% of the
resulting entity after the transaction;
(ii) any corporate reorganization, including an exchange offer, in
which Medaphis Corporation shall not be the continuing or surviving
entity resulting from such reorganization, excluding any transaction in
which stockholders of the Medaphis Corporation prior to the transaction
will maintain voting control or own at least 50% of the resulting
entity after the transaction; or
(iii) the sale of a substantial portion of Medaphis Corporation?s
assets, which shall be deemed to occur on the date that any one person,
or more than one person acting as a group, acquires (or has acquired
during the 12-month period ending on the date of the most recent
acquisition by such person or persons) assets from Medaphis Corporation
that (a) have a total fair market value equal to more than 50% of the
total fair market value of all the assets of Medaphis Corporation,
immediately prior to such acquisition or acquisitions, or (b)
represents a majority of the common stock of any (1) subsidiary of
Medaphis Corporation, the revenues of which, in the most recent fiscal
year, represent more than 75% of the consolidated gross revenues of
Medaphis Corporation and its subsidiaries. Notwithstanding the
foregoing, a transfer of assets or common stock in a subsidiary by
Medaphis Corporation will not be treated as a sale of a substantial
portion of Medaphis Corporation?s assets if the assets are transferred
to an entity, 50% or more of the total value or voting power of which
is owned, directly or indirectly, by Medaphis Corporation.
5. Compensation and Benefits.
a) Annual Salary. During the term of this Agreement and for all
services rendered by Employee under this Agreement, the Company will
pay Employee a base salary of Two Hundred Thousand Dollars (200,000.00)
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<PAGE> 4
per annum in equal bi-weekly installments. Such annual salary will be
subject to adjustments by any increases given in the normal course of
business.
b) Incentive Compensation. Employee shall be eligible to participate in
the Medaphis Corporation and its Subsidiary Corporations Incentive
Compensation Plan at a participation category of fifty percent (50%) of
Employee's base salary, payable at the discretion of the Medaphis
Corporation Board of Directors.
c) Stock Options. As soon as reasonably practicable after the signing
of this Agreement, and subject to the approval of the Compensation
Committee of the Board of Directors of Medaphis Corporation, the
Company will cause Medaphis to issue to Employee, effective as of the
date approved by the Compensation Committee of the Board of Directors
of Medaphis Corporation, options to purchase One Hundred Thousand
(100,000) shares of Medaphis Common Stock pursuant to the terms and
conditions of the Amended and Restated Medaphis Corporation
Non-Qualified Stock Option Plan ("Stock Option Plan"), as amended. Such
options will vest at the rate of thirty-three and one-third percent
(33.33%) per year for a three-year period beginning on the starting
date of this Agreement, subject to the terms and conditions of the
Stock Option Plan. Such options shall vest in full immediately upon the
occurrence of certain change in control events outlined in the Stock
Option Plan. Employee shall be considered for additional grants of
options to purchase shares of Medaphis common stock in a manner which
is consistent with other senior officers of the Company. However,
nothing in this Agreement shall give rise to a contractual right to
Employee to receive grants of additional stock options of Medaphis.
Further, Medaphis has no obligation to Employee to create parity with
any other Medaphis executives with respect to any options granted to
such other executives.
d) Other Benefits. Employee will be entitled to such fringe benefits as
may be provided from time-to-time by the Company to its employees,
including, but not limited to, group health insurance, life and
disability insurance and any other fringe benefits now or hereafter
provided by the Company to its employees, if and when Employee meets
the eligibility requirements for any such benefit. The Company reserves
the right to change or discontinue any employee benefit plans or
programs now being offered to its employees; provided, however, that
all benefits provided for employees of the same position and status as
Employee will be provided to Employee on an equal basis.
e) Business Expenses. Employee will be reimbursed for all reasonable
expenses incurred in the discharge of Employee's duties under this
Agreement pursuant to the Company's standard reimbursement policies.
f) Withholding. The Company will deduct and withhold from the payments
made to Employee under this Agreement, state and federal income taxes,
FICA and other amounts normally withheld from compensation due
employees.
g) Signing Bonus. Upon execution of this Agreement, the Company will
pay Employee a signing bonus in the amount of Twenty-Five Thousand
Dollars ($25,000.00). Employee will be eligible to receive an
additional Twenty-Five Thousand Dollars ($25,000.00) following the
first anniversary date of Employee's commencement of employment with
the Company. In the event Employee voluntarily resigns for any reason
during the initial year of his employment with the Company, Employee
agrees that he will repay the initial Twenty-Five Thousand Dollar
signing bonus.
6. Non-Disclosure of Proprietary Information. Employee recognizes and
acknowledges that the Trade Secrets (as defined below) and Confidential
Information (as defined below) of the Company and its affiliates and
all physical embodiments thereof (as they may exist from time-to-time,
collectively, the "Proprietary Information") are valuable, special and
unique assets of the Company's and its affiliates' businesses.
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<PAGE> 5
Employee further acknowledges that access to such Proprietary
Information is essential to the performance of Employee's duties under
this Agreement. Therefore, in order to obtain access to such
Proprietary Information, Employee agrees that, except with respect to
those duties assigned to him by the Company, Employee shall hold in
confidence all Proprietary Information and will not reproduce, use,
distribute, disclose, publish or otherwise disseminate any Proprietary
Information, in whole or in part, and will take no action causing, or
fail to take any action necessary to prevent causing, any Proprietary
Information to lose its character as Proprietary Information, nor will
Employee make use of any such information for Employee's own purposes
or for the benefit of any person, firm, corporation, association or
other entity (except the Company) under any circumstances.
For purposes of this Agreement, the term "Trade Secrets" means
information, including, but not limited to, any technical or
nontechnical data, formula, pattern, compilation, program, device,
method, technique, drawing, process, financial data, financial plan,
product plan, list of actual or potential customers or suppliers, or
other information similar to any of the foregoing, which derives
economic value, actual or potential, from not being generally known to,
and not being readily ascertainable by proper means by, other persons
who can derive economic value from its disclosure or use. For purposes
of this Agreement, the term "Trade Secrets" does not include
information that Employee can show by competent proof (i) was known to
Employee and reduced to writing prior to disclosure by the Company (but
only if Employee promptly notifies the Company of Employee's prior
knowledge); (ii) was generally known to the public at the time the
Company disclosed the information to Employee; (iii) became generally
known to the public after disclosure by the Company through no act or
omission of Employee; or (iv) was disclosed to Employee by a third
party having a bona fide right both to possess the information and to
disclose the information to Employee. The term "Confidential
Information" means any data or information of the Company, other than
trade secrets, which is valuable to the Company and not generally known
to competitors of the Company. The provisions of this Section 6 will
apply to Trade Secrets for so long as such information remains a trade
secret and to Confidential Information during Employee's employment
with the Company and for a period of two (2) years following any
termination of Employee's employment with the Company for whatever
reason.
7.A. Non-Competition Covenant. During Employee's employment by the Company
and for a period of two (2) years following any termination of
Employee's employment for whatever reason, Employee will not, directly
or indirectly, on Employee's own behalf or in the service of or on
behalf of any other individual or entity, compete with the Company
within the Geographical Area (as hereinafter defined). The term
"compete" means to engage in, have any equity or profit interest in,
make any loan to or for the benefit of, or render any services of any
kind to, directly or indirectly, on Employee's own behalf or in the
service of or on behalf of any other individual or entity, either as a
proprietor, employee, agent, independent contractor, consultant,
director, officer, partner or stockholder (other than a stockholder of
a corporation listed on a national securities exchange or whose stock
is regularly traded in the over-the-counter market, provided that
Employee at no time owns, directly or indirectly, in excess of one
percent (1%) of the outstanding stock of any class of any such
corporation) of any business which provides Business products or
services. For purposes of this Agreement, the term "Geographical Area"
means the territory located within a seventy-five (75) mile radius of
each facility for which Employee has management responsibility during
Employee's employment with the Company.
B. Non-Solicitation of Clients Covenant. Employee agrees that during
Employee's employment by the Company and for a period of two (2) years
following the termination of Employee's employment for whatever reason,
Employee will not, directly or indirectly, on Employee's own behalf or
in the service of or on behalf of any other individual or entity,
divert, solicit or attempt to solicit any individual or entity (i) who
is a client of the Company at any time during the six (6)-month period
prior to Employee's termination of employment with the Company
("Client"), or was actively sought by the Company as a prospective
client, and (ii) with whom
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<PAGE> 6
Employee had material contact while employed by the Company to provide
Business services or products to such Clients or prospects.
C. Construction. The parties hereto agree that any judicial authority
construing all or any portion of this Section 7 or Section 8 below may,
if it chooses, sever any portion of the Geographical Area, client base,
prospective relationship or prospect list or any prohibited business
activity from the coverage of such Section and to apply the provisions
of such Section to the remaining portion of the Geographical Area, the
client base or the prospective relationship or prospect list, or the
remaining business activities not so severed by such judicial
authority. In addition, it is the intent of the parties that the
judicial authority may, if it chooses, replace each such severed
provision with a provision as similar in terms to such severed
provision as may be possible and be legal, valid and enforceable. It is
the intent of the parties that Sections 7 and 8 be enforced to the
maximum extent permitted by law. In the event that any provision of
either such Section is determined not to be specifically enforceable,
the Company shall nevertheless be entitled to bring an action to seek
to recover monetary damages as a result of the breach of such provision
by Employee.
8. Non-Solicitation of Employees Covenant. Employee further agrees and
represents that during Employee's employment by the Company and for a
period of two (2) years following any termination of Employee's
employment for whatever reason, Employee will not, directly or
indirectly, on Employee's own behalf or in the service of, or on behalf
of any other individual or entity, divert, solicit or hire away, or
attempt to divert, solicit or hire away, to or for any individual or
entity which is engaged in providing Business services or products, any
person employed by the Company for whom Employee had supervisory
responsibility or with whom Employee had material contact while
employed by the Company, whether or not such employee is a full-time
employee or temporary employee of the Company, whether or not such
employee is employed pursuant to written agreement and whether or not
such employee is employed for a determined period or at-will.
9. Existing Restrictive Covenants. Employee represents and warrants that
Employee's employment with the Company does not and will not breach any
agreement which Employee has with any former employer to keep in
confidence confidential information or not to compete with any such
former employer. Employee will not disclose to the Company or use on
its behalf any confidential information of any other party required to
be kept confidential by Employee.
10. Return of Proprietary Information. Employee acknowledges that as a
result of Employee's employment with the Company, Employee may come
into the possession and control of Proprietary Information, such as
proprietary documents, drawings, specifications, manuals, notes,
computer programs, or other proprietary material. Employee
acknowledges, warrants and agrees that Employee will return to the
Company all such items and any copies or excerpts thereof, and any
other properties, files or documents obtained as a result of Employee's
employment with the Company, immediately upon the termination of
Employee's employment with the Company.
11. Proprietary Rights. During the course of Employee's employment with the
Company, Employee may make, develop or conceive of useful processes,
machines, compositions of matter, computer software, algorithms, works
of authorship expressing such algorithm, or any other discovery, idea,
concept, document or improvement which relates to or is useful to the
Company's Business (the "Inventions"), whether or not subject to
copyright or patent protection, and which may or may not be considered
Proprietary Information. Employee acknowledges that all such Inventions
will be "works made for hire" under United States copyright law and
will remain the sole and exclusive property of the Company. Employee
also hereby assigns and agrees to assign to the Company, in perpetuity,
all right, title and interest Employee may have in and to such
Inventions, including without limitation, all copyrights, and the right
to apply for any form of patent, utility
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<PAGE> 7
model, industrial design or similar proprietary right recognized by any
state, country or jurisdiction. Employee further agrees, at the
Company's request and expense, to do all things and sign all documents
or instruments necessary, in the opinion of the Company, to eliminate
any ambiguity as to the ownership of, and rights of the Company to,
such Inventions, including filing copyright and patent registrations
and defending and enforcing in litigation or otherwise all such rights.
Employee will not be obligated to assign to the Company any Invention
made by Employee while in the Company's employ which does not relate to
any business or activity in which the Company is or may reasonably be
expected to become engaged, except that Employee is so obligated if the
same relates to or is based on Proprietary Information to which
Employee will have had access during and by virtue of Employee's
employment or which arises out of work assigned to Employee by the
Company. Employee will not be obligated to assign any Invention which
may be wholly conceived by Employee after Employee leaves the employ of
the Company, except that Employee is so obligated if such Invention
involves the utilization of Proprietary Information obtained while in
the employ of the Company. Employee is not obligated to assign any
Invention which relates to or would be useful in any business or
activities in which the Company is engaged if such Invention was
conceived and reduced to practice by Employee prior to Employee's
employment with the Company.
12. Remedies. Employee agrees and acknowledges that the violation of any of
the covenants or agreements contained in Sections 6, 7, 8, 9, 10 and 11
of this Agreement would cause irreparable injury to the Company, that
the remedy at law for any such violation or threatened violation
thereof would be inadequate, and that the Company will be entitled, in
addition to any other remedy, to temporary and permanent injunctive or
other equitable relief without the necessity of proving actual damages
or posting a bond.
13. Notices. Any notice or communication under this Agreement will be in
writing and sent by registered or certified mail addressed to the
respective parties as follows:
If to the Company: If to Employee:
Medaphis Corporation
2700 Cumberland Parkway Kevin P. Castle
Suite 300 4629 Briar Hill Cove
Atlanta, GA 30339 Berkeley Lake, GA 30096
Attn: General Counsel
14. Severability. Subject to the application of Section 7(C) to the
interpretation of Sections 7 and 8, in case one or more of the
provisions contained in this Agreement is for any reason held to be
invalid, illegal or unenforceable in any respect, the parties agree
that it is their intent that the same will not affect any other
provision in this Agreement, and this Agreement will be construed as if
such invalid or illegal or unenforceable provision had never been
contained herein. It is the intent of the parties that this Agreement
be enforced to the maximum extent permitted by law.
15. Entire Agreement. This Agreement embodies the entire agreement of the
parties relating to the subject matter of this Agreement and supersedes
all prior agreements, oral or written, regarding the subject matter
hereof. No amendment or modification of this Agreement will be valid or
binding upon the parties unless made in writing and signed by the
parties.
-7-
<PAGE> 8
16. Binding Effect. This Agreement will be binding upon the parties and
their respective heirs, representatives, successors, transferees and
permitted assigns.
17. Assignment. This Agreement is one for personal services and will not be
assigned by Employee. The Company may assign this Agreement to its
parent company or to any of its subsidiaries or affiliated companies;
provided that the parent or any subsidiary or affiliate fulfills the
obligations of the Company under this Agreement.
18. Governing Law. This Agreement is entered into and will be interpreted
and enforced pursuant to the laws of the State of Georgia. The parties
hereto hereby agree that the appropriate forum and venue for any
disputes between any of the parties hereto arising out of this
Agreement shall be any court located in the geographical area comprised
by the United States District Court for the Northern District of
Georgia and each of the parties hereto hereby submits to the personal
jurisdiction of any such court. The foregoing shall not limit the
rights of any party to obtain execution of judgment in any other
jurisdiction. The parties further agree, to the extent permitted by
law, that a final and unappealable judgment against either of them in
any action or proceeding contemplated above shall be conclusive and may
be enforced in any other jurisdiction within or outside the United
States by suit on the judgment, a certified exemplified copy of which
shall be conclusive evidence of the fact and amount of such judgment.
19. Surviving Terms. Sections 6, 7, 8, 9, 10, 11 and 12 of this Agreement
shall survive termination of this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
COMPANY: EMPLOYEE:
MEDAPHIS CORPORATION
By:/s/ Randolph L. M. Hutto /s/ Kevin P. Castle
-------------------------------- ---------------------
Kevin P. Castle
Title: Executive Vice President
----------------------------
THIS AGREEMENT IS NOT VALID AND BINDING UPON THE COMPANY UNTIL SIGNED BY DAVID
E. MCDOWELL OR RANDOLPH L. M. HUTTO, ESQ.
-8-
<PAGE> 9
EXHIBIT A
INVENTIONS
Employee represents that there are no Inventions.
/s/ KPC
---------------------
Employee Initials
-9-
<PAGE> 1
EXHIBIT 11
MEDAPHIS CORPORATION
COMPUTATION OF BASIC & DILUTED EARNINGS PER SHARE
THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
DESCRIPTION 1998 1997
- ----------- -------- --------
<S> <C> <C>
Weighted average shares outstanding during the period ...................... 73,479 72,235
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 equivalents
outstanding during the period ............................................ 73,479 72,235
======== ========
Loss before extraordinary item ............................................. $ (5,150) $ (3,064)
Extraordinary item: early extinguishment of debt, net of tax ............... (5,557) --
-------- --------
Net loss .......................................................... $(10,707) $ (3,064)
======== ========
Basic net loss per common share:
Loss before extraordinary item ........................................... $ (0.07) $ (0.04)
Extraordinary item: early extinguishment of debt, net of tax ............. (0.08) --
-------- --------
Net loss .......................................................... $ (0.15) $ (0.04)
======== ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMAITON EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MEDAPHIS CORPORATION FOR THE THREE MONTH PERIOD ENDED
MARCH 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 7,125
<SECURITIES> 0
<RECEIVABLES> 178,483
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 207,409
<PP&E> 80,346
<DEPRECIATION> 0
<TOTAL-ASSETS> 880,309
<CURRENT-LIABILITIES> 108,723
<BONDS> 0
0
0
<COMMON> 740
<OTHER-SE> 494,018
<TOTAL-LIABILITY-AND-EQUITY> 880,309
<SALES> 0
<TOTAL-REVENUES> 140,340
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 142,520
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,375
<INCOME-PRETAX> (8,555)
<INCOME-TAX> (3,405)
<INCOME-CONTINUING> (5,150)
<DISCONTINUED> 0
<EXTRAORDINARY> (5,557)
<CHANGES> 0
<NET-INCOME> (10,707)
<EPS-PRIMARY> (0.15)
<EPS-DILUTED> (0.15)
</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 Quarterly Report on Form
10-Q 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, and prepayment of indebtedness
and those requiring maintenance of minimum net worth, minimum EBITDA and minimum
interest coverage and limiting leverage; (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
<PAGE> 2
conditions. As a result of the 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.
Investigations such as the California Investigation can be initiated
following the commencement of qui tam litigation which is commenced under
applicable state and federal statutes and is maintained under court seal without
disclosure to the defendant. Under the applicable statutes, the United States
and the State of California may elect to intervene fully or partially in qui tam
litigation, and proceed with the action. The United States typically will
provide a defendant with the opportunity to enter into settlement negotiations
prior to the intervention of the United States in the matter. An application by
the United States to partially lift the seal in qui tam litigation in order to
make disclosure of the complaint available to the defendant often precedes such
settlement discussions.
On February 6, 1998, on application of the United States, the United States
District Court for the Central District of California issued an order partially
lifting the seal on the qui tam suit entitled United States of America and State
of California, ex rel. Relator I and Relator II v. Compmed Corporation, Medaphis
Corporation, Does 1 to 200, Inclusive. Civil Action No. 94-8158 LGB (kx). On
February 11, 1998, the United States provided Medaphis with a copy of the
Complaint, Substitution of Attorney, and Order which prohibited the Company from
making any use of the Complaint, including any public disclosure, other than for
the purposes of settlement negotiations, without further order of the Court. On
February 12, 1998, upon the joint application of Medaphis and the United States,
the Court issued an order modifying its February 6, 1998 order to allow Medaphis
to make public disclosures concerning the Complaint and its contents to the
extent that Medaphis determined such disclosures were required by applicable
securities laws, provided that such disclosure did not reveal the Relators'
identities.
According to the Complaint, filed December 20, 1995 by the Relators and
which contains allegations raised by them, the action is to recover damages and
civil penalties on behalf of the United States and the State of California
arising out of alleged false claims presented by the defendants on behalf of
their clients for payment under various state and federal insurance programs. No
charges or claims by the government have been made. The Complaint includes
causes of action under the Federal False Claims Act, 31 U.S.C. sec 3729 et seq.,
and the California False Claims Act, Cal. Gov't Code sec. 12650 et seq. The
Complaint also includes causes of action relating to Medaphis's termination of
Relator II, including a count under the state and federal whistleblower
protection statutes. The Complaint alleges overpayments of approximately
$20,500,000 together with treble damages and additional penalties based on
statutory civil penalties. The Complaint alleges that at least 50,000 separate
false claims were filed under federal programs and at least 8,000 separate false
claims were filed under state programs. The Complaint also alleges unspecified
compensatory, general and punitive damages on behalf of Relator II on his or her
employment claims. The allegations in the Complaint are limited to the office of
CompMed (acquired by Medaphis) in Culver City, California. Medaphis believes
that
2
<PAGE> 3
this Complaint relates to and concerns the California Investigation. Medaphis is
engaged in discussions with the United States and the State of California, and
intends to pursue settlement discussions with the United States, the State of
California, and the Relators. The Company has agreed with the government to toll
applicable statutes of limitations through September 30, 1998 and anticipates
executing an agreement to that effect.
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 or the qui
tam suit will be resolved promptly, that additional subpoenas or search warrants
will not be received by Medaphis or MPSC or that the California Investigation or
the qui tam suit 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.
In September, 1996, MPSC became 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, which impacts only certain managed care plans,
cannot be determined by the Company, 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. The Company is
unable to estimate the possible range of loss, if any.
The Company learned in March 1997 that the United States Department of
Justice and the United States Attorney in Grand Rapids, Michigan are
investigating allegations concerning the Company's wholly owned subsidiary,
Gottlieb's Financial Services, Inc. ("GFS") (the "GFS Investigation"). Beginning
in February 1998, the Office of the Inspector General of Health and Human
Services has requested information from GFS following an audit of a GFS client.
GFS has complied with those requests. 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 each of the years ended
December 31, 1996 and 1997, GFS represented approximately 7% of Medaphis'
revenue. During those years, GFS processed approximately 5.6 million and 6.25
million claims, respectively, approximately 2 million and 2.3 million of which,
respectively, were made to government programs. The government has requested
that GFS voluntarily produce records, and GFS has complied 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 is in discussions with the United States and intends to
pursue settlement discussions with the United States.
3
<PAGE> 4
In addition, the Company decided in April 1998 to transition from the
computerized coding system to manual coding. There can be no assurances that the
Company will not be subject to customer complaints, claims and contract
terminations as a result of the coding system transition, or modifications
previously made to the system.
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.
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 unspecified 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, which motion is still pending. The Company is unable to
estimate a possible range of loss.
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 in excess of $100 million,
rescission, injunctive relief and costs. The Company is unable to estimate a
range of possible loss. 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.
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
unspecified compensatory and punitive damages, as well as fees, interest and
other costs. The Company is unable to estimate a possible range of loss. 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 May 12, 1998, the
court ruled in favor of defendants on the motions, dismissing all of plaintiff's
claims with prejudice and without leave to amend. The Company expects that the
judge will sign an order to that effect, after which statutory appeal periods
will begin to run.
4
<PAGE> 5
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 June 30, 1998. The
standstill and tolling agreements extends any applicable statute of limitations
for claims by the former BSG shareholders and provides that neither party will
file suit against the other prior to the expiration of the agreement.
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. The Company is unable to estimate a possible
range of loss. 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 subclass 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, unspecified rescissory and
compensatory damages, and interest, fees and other costs. Defendants have not
yet responded to the complaint. The Company is unable to estimate a possible
range of loss.
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.
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 and the November 19, 1997 and December 23, 1997 restatements of the
Company's financial statements. 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
5
<PAGE> 6
the lawsuits, the written demands and the pending governmental investigations
will not have a material adverse effect upon the Company, including, without
limitation, the Company's results of operations, financial position and cash
flow. Because the Company is unable to estimate a range of loss with respect to
any of the pending claims, the Company has not accrued any amount for any
contingent liability with respect to such claims.
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 prior 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) improving employee retention in light of stock price volatility
and continuing government investigations and civil litigation; (vi) reducing
costs and increasing efficiencies; and (vii) reevaluating the efficiency of its
operations.
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.
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 other amounts previously deemed immaterial, 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, the Board of Directors
determined that certain revenues and expenses may have been recorded incorrectly
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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 acquired in a merger transaction in June 1996 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 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
in its Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
Such financial statements were audited by Price Waterhouse, which issued an
unqualified audit opinion not subject to any modifying paragraphs.
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
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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.
In 1993, the Company acquired GFS, an emergency room physician billing
company, which had developed a computerized coding system. In 1994, the Company
acquired and merged into GFS another emergency room physician billing company,
Physician Billing, Inc., located in Grand Rapids, Michigan, which was then
migrated to the GFS coding system.
The Company decided in March 1998 to transition from the computerized
coding system to manual coding. The decision to terminate use of the coding
system was based on several factors. These included the high cost of continuing
management, compliance and quality assurance oversight and the failure to meet
the Company's current efficiency and productivity targets. In addition, the
system will not comply with anticipated revisions to government billing
regulations, and is not "Year 2000"compliant.
During the transition period, which should be completed by fall of 1998,
the Company will continue to utilize the coding system in conjunction with an
increasing volume of manual coding and will continue to support GFS with its
compliance and quality assurance programs in support of both the coding system
and manual coding. The Company does not expect to incur any material
extraordinary charges as a result of the transition from the computerized coding
system. However, there can be no assurance that third party claims or lost
business relating to transition from, or modifications previously made to, the
GFS coding system will not have a material adverse affect on the Company,
including, without limitation, on the Company's revenue, results of operations,
financial condition or cash flow.
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
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Company's reputation and standing in the client/server information technology
marketplace, affect its ability to attract new client/server information
technology business, result in the payment of damages to the 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. Through its review, the Company has identified a
number of older legacy systems that will be abandoned in favor of a limited
number of more efficient processing systems, rather than making all the systems
Year 2000 compliant. GFS's computerized coding system is one of the legacy
systems from which the Company has determined to transition. The Company
believes that it is on target to have completed these system migration efforts
with respect to its Physician Services and Hospital Services businesses in the
first quarter of 1999. Per-Se Technologies' products are scheduled to be Year
2000 compliant by the releases due out in the third quarter of 1998. The
estimated cost of the Company's Year 2000 compliance efforts is $10 million to
$15 million over 1998 and 1999, the majority of which represents redirection of
internal resources. 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
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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, 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 Balanced Budget Act of 1997
instituted substantial reductions in Medicare program expenditures. Medaphis
anticipates that future legislation may 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
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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 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. Under applicable law, 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 the Company's Financial Report on
Form 10-K for the year ended December 31, 1997 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
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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 Statement filed as
Exhibit 99.13 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
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